What is a Reverse Mortgage?
Reverse Mortgages - the Facts
If you are aged 62 or older, and live in the USA, and are looking for some extra cash, for whatever reason, then you may like to consider taking out a reverse morgage. A reverse mortgage is a financial product, that is different in many ways to normal remortgage deals , due to the fact that it lets you convert some of the equity in your home into cash but with the advantage that you don't have to sell your home and there are no additional monthly payments to make.
No monthly payments? What sort of a morgage is that ? Reverse mortgage loans are a form of home loan in which you receive money from the mortgage provider, that you don't have to pay back until you leave your home (feet first if necessary).
The mortgage is paid back when you die or if you sell your home, or if your home ceases to be your primary residence. Reverse mortgages are generally tax-free, and many have no restrictions regarding income.
This may all sound too good to be true, but bear in mind that reverse mortgages also have a significant disadvantage - namely, because you are not paying any money back, the reverse mortgage increases over time as the interest on the loan adds up. You can end up handing your home over to the mortgage provider/bank and some people call it Generational Theft. Remember banks are not your friend, they are there to make money and they will make their money from you, so you really do have to think 36 times before entering into such a deal. Avoid reverse mortgages if you possibly can.
There are 3 types of reverse mortgage
- single-purpose reverse morgages - these are offered by a number of state and local government agencies and non-profit organizations
- federally-insured reverse mortgages, aka HECMs (Home Equity Conversion Mortgages) which are backed by HUD (the US Department of Housing and Urban Development)
- proprietary reverse mortgages, i.e. private loans backed by the loan providers
Single-purpose reverse mortgages cost the least, but are not available everywhere and are restricted to one purpose. This purpose is specified by the government or non-profit lender e.g. it may be stipulated that the loan can only be used to finance home repairs, or property taxes. The majority of homeowners on low to moderate incomes qualify for such loans.
Proprietary reverse mortgages and HECMs cost more than traditional home loans, and can involve high up-front costs. This is important to bear in mind, particularly if you intend moving out quite soon or want to borrow only a small amount. HECM mortgages are widely available, can be used for any purpose and have no requirements regarding income or health.
If you want to apply for a HECM, you must first meet a counsellor from an independent housing counselling agency that has been government-approved. There are a number of lenders that offer proprietary reverse mortgages that also require counselling. The counsellor must explain the costs invovled and the financial implications, and also indicate any alternatives there may be to a HECM, such as government and non-profit programs, single-purpose and proprietary reverse mortgage.
Counselors must also be able to provide advice on the costs of the various types of reverse mortgages and explain how payment options and fees will affect the overall cost of the loan. Counselling agencies generally charge in the region of $125. You can choose to pay the fees from the loan, and you cannot be refused a loan simply for not having the money to pay the fees. .
The amount you will be able to borrow with a proprietary reverse mortgage or HECM is governed by a number of factors - age, the type of reverse mortgage, the appraised value of the property, and interest rates. Generally speaking, older people with more equity in their home, and less still owing on their mortgage will be able to borrow more.
With an HECM you can choose between several payment options.
- a “term” option – you receive fixed monthly payments in cash over a specific period of time.
- a “tenure” option – you receive fixed monthly payments in cash for the length of time you continue to live in your home.
- a line of credit - you can draw from the loan whenever you choose and in whatever amount you choose, until the line of credit has been used up.
- a combination of a line of credit and monthly payments.
If you wish to change your payment option at any time you may do so but there is a fee of around $20.
HECMs normally advance larger loans for a lower overall cost, when compared with proprietary loans. But if your home is a higher-value home, then you may find you will be able to get a large loan advance from a proprietary reverse mortgage.
Features of Reverse Mortgages
- Reverse mortgage loans are not taxed, and usually do not affect any Medicare or Social Security benefits.
- You keep the title to your home.
- You don’t make any monthly repayments.
- The loan must be paid back when the last surviving borrower either dies, sells the home, or the home ceases to be their principal residence.
With a HECM loan, you can live in a nursing home or medical facility for a maximum of twelve consecutive months before you need to repay the mortgage.
However, be aware that:
- Lenders will usually charge an origination fee, a mortgage insurance premium (for federally-insured HECMs), and additional closing costs. Lenders also sometimes apply servicing fees during the period of the mortgage. The lender can set these fees and costs, but origination fees are laid down by law.
- The amount owed on a reverse mortgage increases over time. Interest is applied to the outstanding balance each month and added to the amount owed. This means of course that the total amount owed increases over time as you draw down the funds interest accrues on the loan.
- Some reverse mortgages have fixed rates, but most of them have variable rates tied to a financial index: it is probably that these interest rates will change along with market conditions.
- Reverse mortgages can eat up all or a part of the equity in your home, thus leaving less equity for you and any heirs you may have. Reverse mortgages generally have what is known a a “non-recourse” clause. This clause means that you or your heirs cannot owe more than the value of your home at the moment the loan is repaid.
- You keep title to your home. This means that you are liable for property taxes, utilities, insurance, maintenance, fuel and other expenses. If you fail to pay your property taxes, take out homeowner's insurance, or maintain your home, your lender may require you to repay the mortgage.
- Interest cannot be deducted fromincome tax returns until the loan is partly or fully paid off.
One final point, shop around and make sure you understand what you are signing. Most reverse mortgages give you at least 3 business days after agreeing the mortgage to cancel it for any reason, without penalty. To cancel the mortgage, you have to inform the lender in writing by certified mail, with a return receipt.