What is a reverse mortgage?
How does a reverse mortgage work (and do I need one)?
The most prevalent Reverse Mortgage is a HUD insured home equity loan or HECM ( Home Equity Conversion Mortgage) that a homeowner 62 or older does not have to pay back until they die, move from their home or not honor loan requirements such as not paying taxes or maintaining the home. It was designed in a way to provide the borrower with a limited percentage (45-80% depending on age) of their home's value and protect the borrower's ownership interest in the home. The amount of money they have access to is based on age, home value and the rates for the version they choose, whether monthly adjusting, annual adjusting or fixed. The homeowner retains title to the home for as long as they live in the home and can use the proceeds for anything they wish and will never owe more than the home's value if they were to sell before they pass away. In addition, the heirs or the estate of the borrower will never owe more than the home's market value once the last remaining borrower passes away. A reverse mortgage is a cash flow tool and a way to turn an illiquid asset (the home) into liquidity (cash).
Why would you need a reverse mortgage?
If a homeowner has a need for cash flow that helps them maintain their health, their home or their long term financial situation and they do not have another source for that cash flow, a reverse mortgage may be a useful tool for them. If they cannot afford to remain in their home due to higher taxes, higher mortgage amount, or higher maintenance costs, they could first consider selling and moving from the property. Most folks do not wish to leave their home, as it is where they raised a family and has the emotional attachment that not just any place can provide. If assisted living is being considered, but unwanted by the homeowner for various reasons, the reverse mortgage can help pay for more than sufficient in-home companion and personal care instead; often at lower monthly costs. Quality of life concerns and living with dignity come into play where in-home companion care is concerned and the comfort and knowledge of their surroundings is often the deciding factor. More than 60% of all reverse mortgages are used to pay off an existing mortgage. This allows the homeowner to increase their monthly cash flow by pocketing the amount they would have sent to the lender each month. In most cases there's such a drastic increase in cash flow by not having to pay, that it more than outweighs their concerns over other issues and has been used to save homes from foreclosure.
Is a reverse mortgage worth the fees involved?
A reverse mortgage has upfront fees that are almost always financed into the loan. Those fees have been considered to be high as they include a 2% mortgage insurance premium (MIP) of the home's value, up to $6000 in origination fees for the lender (2% of first $200,000 and 1% of remaining home value) and they typical real estate closing costs consisting of appraisal, title, settlement and other fees. Someone considering a reverse mortgage should note that this is not a short term loan and that these fees spread over a longer time period makes better sense and that the older you are the more of a chance that there will be equity remaining upon the maturation of the loan. The younger the borrower, the longer the interest can compound and use up more of any remaining equity.
Is the borrower at the age where they can begin to use up their home equity to soon?
The more equity used up earlier lessens the amount of equity you may have access to later, there's no doubt about that but there's no telling when emergencies may require access to funds. The older we get increases the chances of these emergencies but since we can't foretell when these events will take place we have the option to access that cash when a reverse mortgage is already in place. Can a reverse mortgage meet the immediate cash flow need and also provide for those future, unforeseen extra expenses? That needs to be considered in the decision. The interest is compounded on any money used and even though the rates are historically lower than regular mortgages, compounded interest can add up significantly over time, drastically lowering future cash access or remaining home equity. Someone in their early 60's may find it challenging to be able to know enough equity will remain into their 80's and 90's without strict budgeting and financial constraints on their spending. The average reverse mortgage borrower was in the mid 70's but that average has dropped slightly into the lower 70's as the economy has tightened. Since it was designed to provide more to the oldest of borrowers, its never too late to engage in a reverse mortgage where cash flow is a concern.
Are there other options instead of using a reverse mortgage?
You can sell and move into assisted living, you can move in with your children, you can rent, you can downsize (more on that later) or you can look into community programs for the aged to find assistance programs that provide some type of financial aid to provide for housing (any housing). If it's a short term need, a home equity line of credit may be an option if you can make the monthly payments as the fees are much less. This type of loan has credit, income and asset requirements where the reverse mortgage requires only an age and some equity to qualify but no requirement to repay. Some states offer tax deferment programs or tax abatement programs for those that need it but then you may not be able to qualify for other loan types since they place a lien on your property for that abatement. Some states also offer low-cost home repair services or programs to pay for prescription drugs or utilities, meals or other needs. If your need is small they may be of great help to you if you qualify as most are based on monthly or annual income minimums.
Is a reverse mortgage something that you can explain to your family or friends as something you can benefit from?
Do you fully understand how these loans work? Be prepared to be able to ask yourself the same questions posed in this article and if you can't answer all of them, you should make sure you are working with the right company that can answer them and openly show you the merits and shortfalls of your need for this product.
How do I get my money?
Once a reverse mortgage is in place, the borrower has the option of taking the money in many ways but most popular is the credit line. The credit line is essentially a cash account that grows over time and as you need access to the fund in that account, you simply make a request and its transferred directly into your bank's checking or savings, which ever you selected. If you don't need access to that money, it will continue to grow over time at a predetermined rate but always with positive growth, it can never decrease in value unless you take from that account. Another way to access the money is through a lump sum, usually dispersed at the time of closing and that money is also transferred directly into a checking or savings account but it is accruing interest in your account. Other ways to access the money are lifetime predetermined monthly payments for as long as the borrower lives in the home. Even if the home's value is less than the unpaid balance of the loan, those payments will continue and this is called tenure. A term payment is a predetermined monthly amount dispersed over a predetermined time frame, so if someone needs $500 a month for 5 years to pay off a car loan, they can use the term to make those payments and the remaining amount can be placed in the credit line or paid as a lump sum, or any variable. Once the borrower determines how they want their money and something changes they can make those changes for a nominal fee and are never locked into any one plan.
Do I always own my home?
Yes you do, its always the biggest misnomer as older folks remember a program from years ago where the bank opened what was essentially an annuity and when the money ran out, the bank took your home. The FHA/HUD version was designed in a way, as mentioned in the beginning of this article, that allowed the homeowner to protect the borrower's ownership interest and not have to worry about owing more than the market value of the home. This relinquished the heirs of the estate from owing more than the home could be sold for (market value). The HUD MIP or Mortgage Insurance Premium is in place for a couple of reasons, first is to prevent the homeowner or their heirs from having to pay back any loan proceeds that exceed the current market value of the home upon the sale or death of the homeowner. A second use of the MIP is if the lender failed to provide capital resources for the loan, HUD takes over and sits in second position on the deed should the first (lender) fail to honor their first position. A 2% MIP is collected on all originated reverse mortgages and .50% is added to the monthly interest rate on all unpaid balances and that money goes to HUD to pay off all shortfalls where the homeowner sells the home and a balance exceeds the price a home is sold for. HUD keeps a monitor of an approximate home value as an annual exercise and will step in and take over the handling and servicing of the loan once a 98% loan to value limit has been reached. At that point or after, if the borrower would pass away HUD would be brought in to sell the home and pay off the loan with proceeds from the sale and make up the shortfall with MIP funds. Something important that should also be considered is that if the heirs or estate was interested in owning the home in an instance like this, they would have to repay the full outstanding balance of the loan, regardless of the home's market value. It was once thought that the heirs or estate could forego the excess amount over the market value, but that's not the case if someone was interested in buying the family home as they would have to pay off any balance before being allowed to take ownership.
What kind of loan do I need?
If the borrower is worried about future issues with Medicare insurance for example, they want to leave the money in a credit line and take the money in a monthly adjustable versus a fixed version (that forces the borrower to take the amount as a lump sum) as any lump sum could possibly disqualify them from receiving funds or they would have to surrender that amount before qualifying. Medicaid and programs like it require minimum monthly amounts to be left in the account at the end of the month, so if the borrower has more than the minimum in their account at the end of the month, it could disqualify them. A line of credit is not considered income and can't affect the minimum remaining cash in any account that is monitored by Medicaid. Fixed rate reverse mortgages are good for those not worried about qualifying plans but concerned about the variances in indexes and how it affects the interest accruing on their unpaid balances. Currently (02/09) the fixed rate is 5.65% and the monthly adjusting rate is around 3.15% so the chance that the rate could go above the fixe rate is pretty good at this time as a 15 year look back of the average rate has been around 6.50%.
If the borrower needed to maximize future cash flow capabilities and was using the reverse mortgage to pay off certain mortgages or other high interest loan instruments, again, the credit line would be a better option as it gives them growth opportunities that no other option affords them and the monthly adjustable provides the best option for that. Lump sums are good for paying off debts and for known expenses, tenures are best for maximizing monthly cash flow for the entire time you intend to live in your home and terms are best used for specific costs spread over specific times such as loans (loan payoffs) or incurred costs like in-home companion care for specific periods of time.
When would I have to pay back my reverse mortgage or when would I no longer qualify?
The reverse mortgage must be repaid:
- Upon the passing of the last remaining homeowner
- Upon the sale of the home
- If taxes and insurance are not kept current
- If the home is not properly maintained
- If the homeowner declared bankruptcy
- Abandonment of the home
- If the loan was found to have been secured based on fraudulent terms
It's also possible when:
- You rent out a portion of the home for income
- If you add a new owner to the home's title without qualifying it with your lender
- If your zoning changes
- If there is additional debt taken out against the home
Can I cancel my loan at any time?
As the origination process is taking place, the homeowner can cancel the loan at any time and even up to 3 days after the closing of the loan during a rescission period only by letter or fax. Once the 3 days are up, the loan cannot be canceled; however the loan can be paid back at any time with no penalties or fees.
What are the loan types and which ones are best for specific needs?
There are currently 3 versions of HUD based reverse mortgages; monthly adjusting, annual adjusting and fixed. The reverse mortgage is a cash flow tool and it provides cash for various reasons. Typically the monthly adjustable reverse mortgages have carried the lowest interest rates and therefore the largest amount of cash. 1.) If its purpose is to pay off a large existing mortgage, then the borrower would want a version providing the maximum amount and the monthly adjustable usually provides more than the others. 2.) If the borrower was concerned about leaving the most future remaining equity for heirs, they would want to choose the version that accrued the least amount of interest while also providing future growth capabilities. In this case the monthly adjustable carries those strengths. 3.) The fixed rate program may be interesting to some worried that the adjustable rates will increase past the current fixed rates but the caveat is that the fixed rate program requires that the borrower take the entire lump sum, so that could be used to pay off a large mortgage where the borrower is locked into 1 rate for the life of the loan. That would invalidate the reason to protect future remaining equity because the entire lump sum would be accruing interest from day one, quickly eating up remaining equity, even at modest rates. 4.) For those folks interested in a lifetime, or tenure payment, the adjustable is easily the best program for that as it allows for maximized monthly payments. The fixed has a tenure program but a greatly increase rate than its lump sum version (almost like a penalty for taking this version). 5.) If someone is interested in an increased future access to cash, the adjustable is again the best version as it has the potential to deliver the highest credit line growth.
What is a TALC?
The TALC is the total annual loan cost and is required to be included into the loan package of a reverse mortgage. It combines all the loan's costs into an annual rate average like the APR does on home, car and credit card loans. The TALC is great for realizing that this is not a short term loan as this shows a borrower the fees are front loaded. If a borrower is intending to move within 2 years of originating a reverse mortgage, it would be prudent to look at alternatives unless all alternatives were exhausted. The longer the borrower is in the loan, the initial fees become a smaller part of the unpaid balance.
What is that service fee and service fee set aside?
After a loan closes the servicing company "services" your loan. They provide you statements, make sure you are compliant each year by reaching out to you to make sure you still live there and are keeping taxes and insurance current. They also provide you with the loan advances you make from your credit line or send you your monthly tenure payments. The typical monthly fee on monthly adjustable is $35 but can be as low as $25. The fee on the annual adjustable is $30. The borrower does not make the monthly fee payment and that fee does not incur interest. The fee comes from a service fee set aside that is calculated at the time of your loan's closing. The service fee set aside amount pays the monthly fee and that set aside is calculated by taking the age of the borrower and adding her remaining life expectancy. A 75 year old woman would have a remaining 12 years, so that fee would be 12 times $35 or $5040.00. The set aside is just that, a reserve that is taken out of the home's equity before fees are calculated. The bank nor the borrower has access to that money while the loan is in place. On regular forward mortgages there are service fees but they are typically added to the interest rate and don't show up on statements. You've paid them before but didn't know it.
Why does a reverse mortgage borrower have to go to counseling and does it cost anything?
Borrowers must have a discussion with a certified HECM counselor before being eligible for the reverse mortgage. The counselor or agency must be approved by HUD. They are there for the client's benefit as they go over the types, fees, needs and wants of the client. They discuss alternatives and are a checks and balance put in place to protect the borrower from unscrupulous lending practices and they make sure the borrower is of sound mind since some folks can fall prey to offers promising larger returns than make sense and the counselor should be able to help provide that firewall from potential issues. The counseling can be done in person; face to face, or over the phone and can be charged a fee of up to $125.00. Some counseling agencies require up front payments but some also allow for the fee to be paid upon the closing of the loan. Some counseling agencies provide this service for free but that is not as prevalent as in the past as most credit counseling agencies are maxed out with other credit and housing related issues. A counselor will provide the client with a comparison page of what they qualify for based on their particular scenario and will present them with a counseling certificate that is then given to the lender that the client chooses so they can assign an FHA case number to that borrower. Once that case number is assigned, the client is ready for processing and an appraisal is ordered to determine the market value of the home and if repairs are needed.
If there are repairs needed on the home, will they have to be completed before the loan can close?
In a regular mortgage situation, if the shutters are hanging off the home or the front porch rails are broken, the seller must fix them before the buyer's mortgage company will finance the transaction. In a reverse mortgage those repairs can be made up to 6 months after the loan closes and can be paid out of pocket or through the proceeds from the reverse mortgage with a repair rider. The costs of repairs cannot exceed 15% of the home's value. The repair rider sets aside 1.5 times the repair value (determined by an appraiser or inspector). After the work is performed by the homeowner or a licensed handyman, the work done is re-inspected and if agreed upon by all parties, a 2 party check is given to the homeowner with their name and the handyman's for the cost of the work completed. If there is money left over from the 1.5 times calculation, the money can go back into the homeowner's credit line.
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