A Buyer's Guide to Reverse Mortgages
Reverse mortgages turn the original concept of a home equity loan on its head: The bank pays the homeowner, with the home as collateral. There's no credit check or income requirement -- the only major qualifications are that there be sufficient equity in the house and that the homeowner is over age 62. Reverse mortgages can be a great way to pay for living expenses, home improvement costs, travel, or medical expenses. They're not right for everybody, though, which is why anyone applying for a reverse mortgage must complete a counseling session with an objective third-party counselor who'll go over all financial options.
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Reverse mortgages can work even for high-net-worth individuals. If your parents aren't in need of extra cash or have a home worth more than the maximum payments allowed by the government ($417,000 for Federal Housing Authority, or FHA, loans), they can still use a reverse mortgage for more sophisticated estate planning. They should consult with their financial advisor about using the proceeds from a reverse mortgage to set up an irrevocable trust that can then be used to shelter some of their assets from estate taxes.
Although they've been available since 1990, reverse mortgages are still controversial as a financial tool for older adults because of lenders' unscrupulous marketing tactics in the early days of the loan's history. Although there are still some shady lenders and brokers, the reverse mortgage market is now tightly regulated by the federal government, and the loans are considered a much safer prospect than they once were.
Still, older homeowners need to know what they're getting into before signing up for a reverse mortgage. The loans are known for their high fees, relative to traditional home loans. They also require that the homeowner live in the house as the principal residence — and pay back the lender the full loan principal, interest, and amortized closing costs in the event that the house is sold — which means they're not perfect for everyone. So here are the basics of reverse mortgages, to help you understand whether your parent is a good candidate for one -- and how to choose which kind of reverse mortgage and what type of lender.
What is a reverse mortgage?
A reverse mortgage allows a homeowner over the age of 62 to convert the equity he has built up over time into cash, either in the form of a lump sum, monthly payment, or line of credit. Unlike a traditional home loan, a reverse mortgage has no monthly payments -- no repayment is required until the home is sold or no longer used as a principal residence. When the home is sold, the lender recovers its principal plus interest -- interest rates are tied to the U.S. Treasury bond rates, and over the life of the loan they can range from 2 percent to 10 percent, depending on which type of reverse mortgage your parents choose. The remaining equity in the house goes to the homeowner or his heirs (the heirs to the estate have the right to pay off the loan and assume ownership of the house).
What kind of reverse mortgages are available?
Basically, three kinds are available from most lenders. The two government-affiliated reverse mortgages are the Federal Housing Authority's HECM (Home Equity Conversion Mortgage), which accounts for about 90 percent of all reverse mortgages today, and the Fannie Mae Home Keeper, which is a government-backed loan with higher loan payouts than the FHA HECM. These loans are available with either monthly or annual adjustable interest rates tied to the one-year constant maturity treasury rate or the one-month LIBOR (the London Inter-Bank Offer Rate). Generally, monthly adjustable loans offer lower interest rates, but your parents should consult their financial planner about which interest rate and index is best for their situation.
In addition to these government-backed loans, private lenders may offer their own proprietary reverse mortgage products. These so-called jumbo loans typically offer larger payouts for homes with higher values than the government-backed loans, which max out at $417,000. Jumbo loans have higher interest rates and may have higher or additional fees than government-backed loans.
You can examine the three basic types by looking at our reverse mortgages comparison chart.
To qualify for a reverse mortgage, your parents must be over 62 years old and must have paid off all or most of their mortgage (whatever is left of their original mortgage will first be paid off by the reverse mortgage before your parents receive any money, so if the balance on the original mortgage is large, a reverse mortgage won't work for them). They must also meet with a HUD-approved counseling agency before signing up. Their home can be any single-family residence, including a condominium or mobile home, as long as it's their principal residence.
How does the money from a reverse mortgage get repaid?
The lender must be repaid when the borrower passes away, sells the home, fails to live in the house for twelve consecutive months (including time spent in a nursing home), fails to pay property taxes or insurance, or lets the property fall into disrepair beyond normal wear and tear.
When the loan is due -- generally when the last surviving borrower moves out of the house, sells the house, or dies -- the mortgage principal, interest charges, and closing costs are repaid from the proceeds of the sale of the house (or assets from the estate, if the house isn't sold).
What are the risks of a reverse mortgage?
It's important to watch out for unscrupulous reverse mortgage brokers who charge unnecessary counseling fees (reverse mortgage counseling is free through HUD) as well as exorbitant closing costs. Like any loan, reverse mortgage contracts can be confusing and may include hidden costs -- so read the fine print.
Another pitfall to keep in mind: Because Medicaid is based on income levels, Medicaid recipients need to make sure that the additional income they receive from the reverse mortgage doesn't disqualify them from those government benefits.
Can my parents lose their home?
Even if your parents sign up for a reverse mortgage, they -- not the lender -- retain the title to their home, so their home shouldn't be at risk unless they fail to meet the terms of the loan (see "How Does the Money From a Reverse Mortgage Get Repaid?" above). Your parents retain ownership of their home, and the government guarantees that they can't be forced to sell or move. HUD reverse mortgages are insured by the government, so even if real estate is down and your parents' house eventually sells for less than the amount of the reverse mortgage, the government will pay the difference.
How do you get a reverse mortgage?
The process has several stages. Before even filling out a loan application, the homeowners meet with a HUD-approved counselor to go over all their options to raise cash, including home equity lines and other types of loans besides reverse mortgages. The counselor will also make them aware of local grants that may help with specific expenses. For example, if your parents are considering a reverse mortgage to pay for a new roof on their home, the HUD counselor may point them in the direction of a home improvement grant or loan instead of a reverse mortgage.
After the counseling session, the homeowners fill out an application; the lender will disclose the total costs of the loan and verify the ownership and deed to the house. At this point, the home will probably be appraised and its general condition will be checked. If any structural defects are found, the homeowners would have to have them repaired before the loan could be processed. (In other words, there is no "as is" provision allowed.) After the appraisal is complete, the loan must be processed and underwritten before any payouts start, which can take from four to eight weeks.
How do you choose a lender?
Because reverse mortgages are so strictly regulated -- everything from the interest rate to the payout schedule is set by the government -- lenders must primarily rest on the strength of their reputations. Stick with one of the big national institutions or the bank your parents currently use.
When interviewing a lender or broker, make sure that it's FHA approved and a member of the National Reverse Mortgage Lenders Association. Find out how long it's been in the reverse mortgage business and double-check which index the interest rate is based on. Make sure your parent is given a written breakdown of all fees and expenses that will be rolled into the principal of the loan, as well as any up-front fees (these should usually include only the cost of running a credit check and an assortment of nominal fees).
The major nationwide lenders include 1st Mariner, American Reverse Mortgage Corp., BNY Mortgage, Financial Freedom Senior Funding, Live Well Financial, Seattle Mortgage, Vertical Lend, and Wells Fargo.
What kinds of fees should my parents expect?
The costs of obtaining a reverse mortgage can be high relative to other home loans, but they're rolled into the total amount of the loan and amortized over time, so the up-front costs of reverse mortgages are actually relatively low. With an HECM loan, the closing costs are tightly regulated. Expect to see an origination fee, which covers the lender's operating expenses and is capped at 2 percent of the maximum loan amount; a mortgage insurance premium, which guarantees that the government will step in and continue the loan if your lender goes out of business; and an appraisal fee, which typically ranges from $300 to $400. Other legitimate closing costs include the credit report fee, flood certification fee, closing fee, pest inspection, and title insurance, among other fees.
What's the fine print?
With a reverse mortgage, your parents will retain title to their home and continue to be responsible for paying the property taxes and insurance and for maintaining the property.
Check with your parent's bank to see whether it will transfer the loan to a loan servicing company, and whether your parents could eventually end up paying more in service fees if that happens.
The loan servicer, whether it's the original lender or a loan servicing company, can set aside money from the loan proceeds to cover the projected costs of servicing your parents' account. This amount is usually determined by the monthly service fee, which is typically about $30, and the borrowers' age and life expectancy.