Reverse Mortgage loans can seem very appealing, mainly if your home represents most of your net worth. However, there are some undeniable drawbacks as well.
If you are a homeowner who is nearing or has reached retirement age, you have probably seen a lot of reverse mortgage commercials on television or heard a lot of reverse mortgage advertisements on the radio.
In some cases, these loans can be very appealing, mainly if your home represents the majority of your net worth. However, there are some undeniable drawbacks as well. For some, the costs of reverse mortgages outweigh the benefits of using them to supplement their retirement incomes.
A reverse mortgage may provide much-needed assistance to older homeowners struggling to cover their basic living expenses. In practice, such a loan allows you to remain in your home while exchanging fees, interest, and home equity — which is the difference between the current market value of your home and the amount you owe — for cash or a line of credit.
Loans for home equity conversion, also known as HECMs, are the most commonly used type of loan. They are federally insured and available to applicants 62 and older who meet specific requirements.
On the other hand, these loans are not a panacea for retirement fund problems. Failure to comply with specific ongoing requirements could result in you defaulting and potentially losing your home. If your cash shortage is only temporary, there may be less expensive and less risky alternatives to consider.
Table of Contents
- 1 What is a reverse mortgage?
- 2 How do reverse mortgage works?
- 3 Is it worth it to get a reverse mortgage?
- 4 What are the eligibility criteria for a reverse mortgage?
- 5 What are the benefits of reverse mortgage?
- 6 What are the disadvantages of reverse mortgage?
- 7 What are the borrowing limits of a reverse mortgage?
- 8 What happens to a reverse mortgage when you die?
- 9 What are the costs applied to reverse mortgages?
- 10 What are the different types of reverse mortgages?
- 11 Is a reverse mortgage a non-recourse loan?
- 12 Conclusion
What is a reverse mortgage?
A traditional mortgage is when the borrower obtains a loan from a lender and repays it over some time. With each payment, you accumulate equity in the mortgaged property, and the loan balance decreases due to the costs.
A reverse mortgage is a type of loan in which you borrow money against the value of your home, much like a traditional mortgage. However, instead of receiving an upfront lump sum that must repay over time, you will receive payments from the lender, which will use to repay the loan.
Like a traditional mortgage, a reverse mortgage loan allows homeowners to borrow money against the value of their home as collateral for the loan. A reverse mortgage loan works in the same way as a traditional mortgage in that the title to your home remains in your name after the loan is paid off. In contrast to a conventional mortgage, borrowers who take out a reverse mortgage loan do not have to make monthly payments on their loan.
The loan is repaid when the borrower no longer resides in the house where he obtained the loan. Interest and fees are added to the loan balance each month, increasing the total amount owed.
Homeowners who take out a reverse mortgage loan must pay property taxes and homeowners insurance, live in the home as their primary residence, and maintain the property in good condition.
With a reverse mortgage loan, the amount owed to the lender by the homeowner increases over time rather than decreases. Interest and fees are added to the loan balance every month. As your loan balance rises, your home equity decreases in proportion to it.
A reverse mortgage loan is not the same as receiving free money. It is a loan in which the borrowed money plus interest and fees each month increases the loan balance. Homeowners or their heirs have to repay the loan at some point, usually through the sale of their homes.
How do reverse mortgage works?
The procedure for obtaining a reverse mortgage is pretty straightforward: It all starts with a borrower who already has a home of their own. The borrower either has a significant amount of equity in their home (typically at least 50% of the property’s value) or has completely paid off their mortgage.
They determine that they require the liquidity provided by the sale of their home’s equity and work with a reverse mortgage counselor to identify a lender and program that will meet their needs and goals.
After deciding on a specific loan program, the borrower must apply. The lender conducts a credit check on the borrower and examines the borrower’s property, including the title and appraised value.
According to the borrower’s preferences, a loan is funded once approved. Depending on the lender, the loan proceeds can be structured as a lump sum, a line of credit, or periodic annuity payments (such as monthly, quarterly, or annual payments).
After a lender funds a reverse mortgage, borrowers can use the funds following the terms of their loan agreement. Some loans have restrictions on how the funds can be used (for example, they can only use for improvements or renovations), whereas others are entirely unrestricted in their use.
These loans are valid until the borrower passes away or relocates, at which point they (or their heirs) can repay the loan or can sell the property to recoup the loan’s principal and interest. The borrower receives any money that is left over after the loan has been repaid in full.
Is it worth it to get a reverse mortgage?
A reverse mortgage may be beneficial, but it is inappropriate for everyone. Some factors can make a reverse mortgage a worthwhile investment, including the following:
Your house is increasing in value at an alarming rate. A reverse mortgage may be an option if you’ve built up a significant amount of equity in your home and want to leave money to your heirs after you pass away.
You intend to remain in your home for an extended period. The loan has significant upfront costs, just as with a traditional mortgage. You’ll want to make sure that you intend to remain in that home for an extended period to justify the costs.
You can cover the costs of your home. The fact that you must keep up with your property tax payments, insurance premiums, maintenance, and other expenses to keep your reverse mortgage current, it is critical that you have enough cash flow to cover these expenses.
In the end, the decision to take out a reverse mortgage should be carefully considered before proceeding. Even though it is a convenient way to obtain cash, it may put your financial situation at greater risk in the long run. Before committing to a reverse mortgage, make sure you understand all of the advantages and disadvantages of doing so.
What are the eligibility criteria for a reverse mortgage?
To be eligible for a government-sponsored reverse mortgage, the youngest owner of the property being mortgaged must be at least 62 years old at the time of application. There is a restriction on borrowing against one’s primary residence.
Borrowers must either own their home outright or have at least 50 percent equity in their home with no more than one primary lien—in other words, they cannot have a second lien resulting from something like a home equity line of credit or a second mortgage.
Because reverse mortgages are only available to people who already own their home outright, the funds received from a reverse mortgage are typically used to pay off their existing mortgage.
Most of the time, only specific types of properties are eligible for government-backed reverse mortgages. The following are examples of suitable properties:
- Single-family homes
- Properties with up to four units that are multi-family.
- Constructed Manufactured homes after June 1976.
- Condos or townhomes
In the case of government-sponsored reverse mortgages, borrowers are also required to attend an information session with a reverse mortgage counselor who the government has approved. They must also keep up with their property taxes and homeowner’s insurance payments and maintain the condition of their property.
Private reverse mortgages have their requirements, which differ depending on the lender and loan program.
What are the benefits of reverse mortgage?
If you’re having trouble keeping up with your financial obligations, a reverse mortgage may be able to help you get back on your feet. The following are some of the advantages of taking out a reverse mortgage.
1. Assists you in securing your retirement
Reverse mortgages are an excellent option for retirees who don’t have a lot of cash savings or investments but have a lot of equity in their homes and can use that to their advantage. A reverse mortgage lets you convert an otherwise illiquid asset into cash, which you can use to pay for retirement expenses or invest in other assets.
2. You have the option to remain in your home
Instead of selling your home to liquidate your asset, you can choose to keep the property and still receive cash from the sale. If you have to relocate, you won’t have to worry about potentially downsizing or being priced out of your neighborhood because of rising property values.
The third step is to pay off your existing home loan. A reverse mortgage does not require that your home be completely paid off to be approved. The proceeds of a reverse mortgage can even be used to pay off an existing home loan if you have one in place. This frees up funds that can be used to cover other expenses.
3. You will not be subject to taxation
According to the Internal Revenue Service, money received from a reverse mortgage is treated as a loan advance rather than as income. It means that the funds are not subject to taxation, in contrast to other forms of retirement income such as distributions from a 401(k) or an IRA.
4. You’re Safe and Secure If the balance is greater than the value of your home
Your home’s value may end up being less than the total amount owed on your reverse mortgage in some circumstances. It can occur if, for example, the value of real estate declines. If this happens, your heirs will not be responsible for paying the remaining balance.
What are the disadvantages of reverse mortgage?
So, what are the drawbacks of a reverse mortgage, exactly? Even though there appear to be numerous advantages, some significant risks are also to consider.
1. You may lose your home as a result of a foreclosure
Property taxes, homeowners insurance, homeowner’s association dues, and other costs associated with owning a home must be affordable to qualify for a reverse mortgage. Additionally, you must reside in the house as your primary residence for the majority of the year.
If you fall behind on these payments at any point during the loan period, or if you spend the majority of the year living elsewhere, you may be unable to repay the Reverse Mortgage, and you may lose your home to foreclosure.
2. Your heirs may receive a smaller inheritance
Homeownership is a critical component of accumulating generational wealth. On the other hand, a reverse mortgage usually necessitates the sale of the home to repay the debt. The entire loan balance, or 95 percent of the home’s appraised value, whichever is less, will be due and payable by your heirs upon your death. Typically, this entails selling the house or handing the property to the lender to satisfy the debt.
Not to mention the fact that a reverse mortgage depletes the equity in your home. You may not even have any equity left to leave to your heirs when the loan is paid off and you are no longer alive.
3. It is not a free service.
Even though you won’t have to make payments on a reverse mortgage, there is still a slew of expenses associated with taking out one of these loans. Apart from the fact that you must keep track of your taxes, insurance, and HOA fees regularly, you must also pay an upfront insurance premium.
Typically, this is equal to 2 percent of the appraised value of your home. You’ll also be required to pay origination fees at the time of closing. You do have the option of rolling these costs into your loan balance, but doing so reduces the amount of money you receive from the lender.
4. It has the potential to affect your other retirement benefits.
Even though a reverse mortgage is not considered income for tax purposes, it may have an impact on your eligibility for other need-based government programs such as Medicaid or Supplemental Security Income (SSI). You should consult with a benefits specialist to ensure that you will not jeopardize eligibility in any way as a result of this decision.
5. Reverse mortgages are difficult to understand.
Reverse mortgages are subject to a slew of regulations and restrictions. These loans come with several risks that may not be worth the extra money you pay. Except if you are entirely familiar with the terms of a reverse mortgage offer, you should proceed with caution.
What are the borrowing limits of a reverse mortgage?
With a proprietary reverse mortgage, there are no set limits on how much money you can borrow at any given time. Individual lenders are responsible for establishing all limitations and restrictions.
Owners of government-backed reverse mortgage programs, on the other hand, are prohibited from borrowing more than their home’s appraised value or the FHA’s maximum claim amount ($765,600) when using such programs. Instead, borrowers are only permitted to borrow a portion of the value of their property.
A part of the property’s value is used to secure loan expenses, and lenders typically require a buffer in case the value of the property declines. Borrowing limits are also adjusted based on the borrower’s age and credit history and the interest rate charged on the loan.
What happens to a reverse mortgage when you die?
In most cases, a reverse mortgage necessitates the sale of the home to pay off the debt. The entire loan balance, or 95 percent of the home’s appraised value, whichever is less, will be due and payable by your heirs upon your death. Typically, this entails selling the house or handing the property to the lender to satisfy the debt.
What are the costs applied to reverse mortgages?
The following are the two most significant costs associated with government-backed reverse mortgages:
Interest rates: If you take a lump sum, your interest rates may be fixed (with rates starting at less than 3.5 percent, comparable to conventional mortgages and significantly lower than other home equity loan products).
Otherwise, they’ll be variable, based on the London Interbank Offered Rate (LIBOR), with a margin added to account for the lender’s overhead costs.
The upfront mortgage insurance premium for a federally backed reverse mortgage is two percent, with annual premiums of one percent. Mortgage insurance premiums for conventional reverse mortgages are one percent.
Mortgage insurance is intended to protect lenders in the event of a default by the borrower. While reverse mortgages are not typically defaulted in the same way that conventional mortgages are—when borrowers fail to make payments—they can still default if owners fail to pay property taxes and insurance or if they fail to maintain their properties properly. Reverse mortgages are not as standard as conventional mortgages.
Along with these fees, lenders will charge their origination fees, which vary from lender to lender but are generally between 1 percent and 2 percent of the loan amount. Lenders typically charge additional fees for various services, including property appraisals, loan servicing and administration, and other closing costs, such as credit check fees.
Although all costs are typically included in the mortgage balance, lenders are not required to pay them out of their pocket in most cases.
What are the different types of reverse mortgages?
The majority of reverse mortgages are federally insured loans. Because they are government-insured, these products, like other government loans such as USDA or FHA loans, are subject to rules that do not apply to conventional mortgages.
These include eligibility requirements, underwriting processes, funding options, and, in some cases, restrictions on how funds can be used in certain situations. Private reverse mortgages are also available, with the same stringent eligibility requirements or lending standards as government-sponsored reverse mortgages.
Reverse Mortgage for a Specific Purpose
Single-purpose reverse mortgages are typically the least expensive type of reverse mortgage to obtain. This type of loan is made available by nonprofit organizations and state and local governments for specific purposes that the lender determines.
Loans may be provided for various purposes, including repairs and improvements. Loans, on the other hand, are only available in specific areas.
HECM stands for Home Equity Conversion Mortgage
HUD-insured home equity conversion mortgages (HECMs) are more expensive than conventional mortgages because they are backed by the Department of Housing and Urban Development (HUD). On the other hand, loan funds can be used for virtually anything.
Borrowers have the option of receiving their funds in a variety of ways, including a lump sum, fixed monthly payments, a line of credit, or a combination of regular payments and a line of credit, among other options.
Proprietary Reverse Mortgage (also known as a proprietary reverse mortgage)
Mortgages offered by private lenders and not backed by any government agency are known as proprietary reverse mortgages. Lenders are free to set their eligibility requirements, interest rates, fees, terms, and the underwriting process for their loans.
While these loans can be the most straightforward to obtain and the quickest to fund, they are also known to attract unscrupulous professionals who use reverse mortgages as a means of defrauding seniors out of the equity in their homes.
Is a reverse mortgage a non-recourse loan?
It is a non-recourse loan in the United States, thanks to the FHA-insured HECM (home equity conversion mortgage), also known as a reverse mortgage. For the most part, this means that the borrowers are not obligated to repay any loan balance that exceeds the net proceeds from the sale of their home.
To obtain a HUD-approved home equity loan, you must first consult with a housing counselor from an independent, government-approved housing counseling agency. You can learn more about HECMs by visiting the HUD website, calling 800-569-4287, or visiting the HUD office in your local area. Even if you’re only thinking about getting a reverse mortgage, you can speak with a counselor.
Consider consulting with an elder law or consumer protection attorney, as well as a financial advisor, because reverse mortgages are so complicated and can have severe consequences if not handled properly. Contact a foreclosure lawyer in your state if you’re concerned about the possibility of a reverse mortgage foreclosure happening.
Visit the AARP website to learn more about reverse mortgages in general, including their advantages and disadvantages.
In addition to providing a helpful reverse mortgage discussion guide, the consumer financial protection bureau advises consumers who are considering taking out a reverse mortgage to consider all other options before proceeding carefully.
Reverse mortgage information is also available on the Federal Trade Commission (FTC) website for homeowners considering taking out a reverse mortgage.