Is a Reverse Mortgage Right for You?
Have you seen one of the many ads for reverse mortgages on the television or received them in the mail? Many such ads paint reverse mortgages as ideal sources of income for any homeowner who’s 62 or older. In actuality, reverse mortgages are not for everyone.
Your age, circumstances, and estate plans can make a big difference in whether a reverse mortgage or another type loan may be best.
Plus, reverse mortgages are complicated and not easy to understand. This month's report looks at the basics of reverse mortgages and outlines some steps that may help you determine if one is right for you.
What is a reverse mortgage?
A reverse mortgage is a type of home loan in which the homeowners convert part of the equity in their home to cash. Generally, payback of the loan isn't required as long as the home remains the principal residence of the borrowers. The loan is paid back when the last surviving borrower sells the home, moves out permanently, or dies. In the last two instances, the home is usually sold to pay the lender.
The homeowner keeps title to the home and is still responsible for property taxes, insurance, maintenance, and any other expenses. Failure to keep up with these obligations could cause the lender to call the reverse mortgage due, in which case, the borrower would have to repay the loan at that time.
The amount of the reverse mortgage grows over time because interest is charged monthly on the outstanding balance and is added to the amount owed. Usually, as your loan grows, the amount of your home equity decreases. Most interest rates are variable and can adjust monthly or annually.
What are the qualifications for a reverse mortgage?
The borrowers—and everyone else on the title—must be at least age 62 and the home must be their principal residence. The homeowner must own the home free and clear or the existing mortgage must be paid off as part of the reverse mortgage transaction.
To qualify for a reverse mortgage the home must be a single family residence or a two to four unit property that the borrower owns and occupies one unit. Townhouses, detached homes, units in HUD-approved condominiums, and some manufactured homes are eligible. Most co-ops and mobile homes are not eligible.
There are no income or credit qualifications. The amount that can be borrowed is determined by the age of borrower, the appraised value of the home, current interest rates, where the home is located, and the type of reverse mortgage. Generally, the percentage of equity that can be borrowed increases with the age of the borrower.
Who would benefit from a reverse mortgage?
A reverse mortgage might be appropriate for someone who has most of their assets tied up in their home and who is planning to stay in their home for many more years. Because a reverse mortgage reduces the amount of equity in the home, it may not be a good choice for someone who wants to leave something to their heirs. Some people choose to include their heirs in the process when they are considering a reverse mortgage, others don't.
There are three types of reverse mortgages:
Federally-insured reverse mortgages, also known as Home Equity Conversion Mortgages (HECMs), are backed by the U.S. Department of Housing and Urban Development (HUD). Most reverse mortgages are HECMs.
Proprietary reverse mortgages are private loans that are backed by the companies that develop them.
Single-purpose reverse mortgages are offered by some state and local government agencies and non-profit organizations. These are not available everywhere. They can only be used for the one specific purpose specified by the lender. Examples of such specific purposes include to pay property taxes or to finance home repairs or improvements. This type of reverse mortgage is primarily for low or moderate income homeowners.
The HECM program requires that homeowners receive consumer education and counseling by a HUD-approved HECM counselor. The counseling is free. Some states require counseling for any reverse mortgage.
The counselor should help you understand the costs and benefits of reverse mortgages, the impact it could have on state and federal benefit eligibility, how a reverse mortgage may affect your estate, and alternatives to a reverse mortgage.
Talking with a HECM counselor is smart even if counseling is not required.
To find a counselor in your area start with this page on the HECM Resources site provided by the AARP Foundation's Reverse Mortgage Education Project which is funded by AARP and the U.S. Department of Housing and Urban Development (HUD).
You may have a choice in how you receive the money from a reverse mortgage. Generally speaking, you will have one or more of the following options:
- Receive it all at once in a single lump sum of cash.
- Receive it as a fixed monthly cash advance for a specific amount of time (called a term payout) or for as long as you live in your home (called a tenure payout).
- Receive it as a line of credit which allows you to decide how much you need and withdraw it when you need it.
- Receive it as a combination of these.
- Fixed rate reverse mortgages have only one payout option – the single lump of cash.
Just like regular mortgages, reverse mortgages have various associated costs. Most of these costs can be paid with the proceeds from the reverse mortgage but doing so reduces the amount of money received.
Origination fee. This fee is charged by the lender to cover the preparation of the loan paperwork and the processing of the loan. This fee can be as high as 2% of the home's value. For example, for a home appraised at $150,000 the origination fee with an HECM could be as high as $3000. HECM origination fees are capped at $6000.
Third-party closing costs. These costs include the appraisal, title search and insurance, surveys, inspections, recording fees, mortgage taxes, credit reports, couriers, and any other services required for closing the loan. These costs can vary by home value and by state or area within a state. These costs generally range from $2000 to $3000, though there are areas in some states where these costs will be higher than $3000 or lower than $2000.
Mortgage insurance premium. Mortgage insurance is required for HECMs and is a big cost. It insures that the borrower will receive all of the loan even if the lender defaults. It also insures that the lender will be repaid even if the value of the home declines. There are two parts: an upfront premium due at closing (either 2% of the home's value or 2% of the FHA HECM mortgage limit for the area – whichever is less), and 0.5% added to the interest rate of the outstanding loan balance.
This insurance also guarantees that the borrowers debt cannot be larger than the value of the home when the loan is repaid. This means that when the home is sold to pay off the debt, the amount paid to lender cannot exceed the proceeds of the sale and that the lender cannot legally seek repayment from the borrower's income, their other assets, or from their heirs.
Servicing fee. This is a monthly fee charged by the lenders to service the loan. Servicing includes making payments to the borrower, paying insurance premiums, and acting on requests from borrower. On HECMs, this fee is limited to $30 per month if the interest rate is adjusted annually or $35 per month if the interest rate is adjusted monthly.
Interest. Most reverse mortgages have variable interest rates and are tied to the current one-year U.S. Treasury Security rate. Some lenders are now offering reverse mortgages that are tied to the London Interbank Offered Rate (LIBOR). The interest rate may adjust monthly or annually.
- Margin of 1% to 1.5% is added to the current one-year U.S. Treasury Security rate to determine the interest rate.
- Monthly changes in the interest rate must be the same change as the U.S. Treasury Security rate.
- Interest rate caps are not required for HECMs but some lenders provide them.
- Margin of around 3% is added to the current one-year U.S. Treasury Security rate to determine the interest rate.
- Annual changes in the interest rate must be the same change as the U.S. Treasury Security rate.
- Changes in the interest rate is limited to 2 percentage points per year and 5 percentage points over the life of the loan.
- Can allow a person with limited income and few assets beyond the equity in their home to remain in their home and supplement their income with loan proceeds.
- The loan advances are not taxable.
- Unless it is a single-purpose reverse mortgage, it can be used for any purpose.
- No monthly loan payments. No payment is due until the loan is closed because of the death of the borrower, the home is sold, or the borrower decides to pay off the loan.
- Not a good choice if you plan to sell your house and move in the foreseeable future.
- The interest is not deductible on income tax returns until the loan is paid off.
- Even though most reverse mortgages don't affect your Social Security or Medicare benefits, it may affect your eligibility for certain "need based" benefits such as Medicaid and Supplemental Social Security income, and food stamps.
- There may be little or no equity left to leave to heirs. Depending on how you feel about your heirs, this might be an advantage.
- Reverse mortgages are expensive compared to other home equity loans. Interest rates, fees and costs are generally higher than other loans.
- Financing the closing costs, service fees, and any other costs can significantly reduce the amount of the loan available.
- The reverse mortgage must be the only mortgage on the home, so paying off an existing mortgage reduces the amount of loan available for other expenses.
Reverse mortgages are complicated. Before agreeing to terms, make sure that you do your homework – check out the lender, the terms of the mortgage and other options.
- Beware of sales pitches for annuities, insurance, investments, and other financial products that push reverse mortgages as the way to get the money for these types of purchases. Experts recommend that reverse mortgages shouldn't be used for investments because the investments will probably not earn more than the loan will cost.
- Don't pay for information about reverse mortgages. A typical scam is to help a senior find lenders in return for a "small" percentage of the loan.
- Reverse mortgages are best used for big expenses such as medical bills or to help with your budget and other necessities. Once the proceeds are used for luxuries or dream vacations, it is no longer available for necessities or emergencies.
For more information
To help you make an informed decision about reverse mortgages and other alternatives, the AARP Foundation has produced the booklet, Reverse Mortgages Loans: Borrowing Against Your Home (pdf).
The AARP website also has a series of articles that cover the basics and many other issues related to reverse mortgages.
The fact sheet Reverse Mortgages: Get the Facts Before Cashing in on Your Home's Equity from the FTC has more information.
Some Tips for Consumers Considering a Reverse Mortgage is a Consumer Facts for Older Americans newsletter from the National Consumer Law Center. It describes reverse mortgage basics, other issues to consider, special warnings, and how to find impartial help.
FHA's Reverse Mortgage for Seniors — Home Equity Conversion Mortgage from the U.S. Department of Housing and Urban Development (HUD). This section on the HUD site provides information and resources for HECMs.
Reverse mortgages and their alternatives — Living off your home equity from Consumer Reports provides a good overview of reverse mortgages.