Most Reverse Mortgages are Sponsored by HUD, insured by FHA and referred to as Home Equity Conversation Mortgages (or HECM; pronounced “Heck-em”), so those are the programs I’ll reference in this explanation. There are several proprietary Reverse Mortgages too, and they’re often referred to as “Jumbo Reverse Mortgages”, and we’ll review those a little later.
A Reverse Mortgage is a fancy negative amortization mortgage loan and is very similar to a traditional negative amortization mortgage. However, it contains features that aren’t found in any other type of negative amortization program. A Reverse Mortgage is specifically designed to convert a portion of the homeowner’s equity into cash. The remaining equity that wasn’t converted into cash is typically used to make the interest payment. Each month a interest charge is incurred against the outstanding balance, but it’s deferred, so there aren’t any monthly mortgage payments with Reverse Mortgages. After the Reverse Mortgage Lender has been paid back, the remaining equity is retained by the homeowner. Homeowners must be at least 62 to qualify for a Reverse Mortgage. Traditional mortgage loans require income, assets, employment and credit as qualifiers, but none of those are considered for a Reverse Mortgage. One Reverse Mortgage program goes down to the age of 60, but that program is designed as a bridge Reverse Mortgage loan and intended to hold the homeowner over, until they turn 62 and can get a HECM.
How does it work?
A portion of the homeowner’s equity is converted into money and distributed to the homeowner in the form of cash, credit line, monthly annuity payment, or a combination of any of those methods. The amount of equity that’s converted into cash is determined by the homeowners age, interest rates, the value of the home and FHA’s lending limit.
Those figures are different for every homeowner because everybody was born on a different day, everybody’s home value is different, every Reverse Mortgage program has a different interest rate and FHA’s lending limit is different for every county across the Nation.
For example, right now I’m working on a Reverse Mortgage for Bob and Nancy. Bob is 66, Nancy is 63, their home is worth $206,000.00 and they live in Sulphur, Oklahoma. Since two homeowners are on Title to the home, the age of the youngest homeowner is used to calculate how much equity can be converted into cash. With this scenario, the homeowners are able to convert $128,302.56 of equity into cash. They also have an existing mortgage and owe $70,000.00 on it, so that lien needs to be paid off first and that amount will be deducted from the $128,302,56. Also, Bob and Nancy have decided to include the loan fees in the loan, because they don’t want to come up with any cash out of their pockets, so the fees will also be deducted from the $128,302.56. That leaves them with $41,463.18 or a monthly check for $228.37, and no monthly mortgage payment.
Reverse Mortgages assume the homeowner is going to live to be 100 years old, so younger homeowners don’t receive as much cash as older homeowners. Adding 20 years to both Bob and Nancy’s age leaves them with $77,231.89 or $585.95 per month. They receive more because they’re not going to live as long, so the lender can afford to risk leaving less equity in the house.
The homeowners retain 100% Title to their homes. The Reverse Mortgage Lender is simply a leinholder, which is the same exact way a Traditional Forward mortgage works. The Reverse Mortgage becomes due and payable when the last person on Title no longer occupies the home as their primary residence. So the mortgage will become due if the homeowners sold their home, rent their home, spend more then 12 months consecutively in a nursing facility, or die. Most homeowners want to die in their home, so that’s the most common method of a Reverse Mortgage becoming due. After the homeowner passes, an heir will inherit the home and it’s their responsibility to pay the Reverse Mortgage Lender, and there are 4 ways they can pay it off.
The first and most popular way is for the heir to sell the property. They’ll pay back the Reverse Mortgage Lender what’s due them and keep the remaining equity for themselves.
Refinancing the Reverse Mortgage with a Forward Mortgage is the second method, enabling them to keep the house.
The third method is to refinance the Reverse Mortgage with another Reverse Mortgage, if they’re old enough, enabling them to keep the house without a monthly mortgage payment.
The last method, and this one seems to be getting more popular, is for the homeowner to take out a last-to-die life insurance policy when they get the Reverse Mortgage, and make the heir(s) the beneficiary of the policy. This enables the heir to receive the insurance benefit tax free, pay back the Reverse Mortgage Lender, and keep the house without any mortgage payments.
With a traditional negative amortization mortgage, the Lender requires the homeowner to retain some equity in their property, for example, 15% equity. Once the loan amount increases to a Loan to Value ratio of 85, the homeowner isn’t allowed to lose anymore equity, so the loan will “recast” and convert to another type of loan, usually a fully amortized mortgage, with an increased monthly payment that’s normally much larger then the original payment. Reverse Mortgages never re-cast, so when the loan is due and payable, the house could potentially be worth less then the amount of money the homeowner borrowed. When this happens, neither the homeowner or their heirs are responsible for the negative amount. That’s because all HECM programs are non-recourse loans. That means the Reverse Mortgage Lender can never receive more then the value of home when the mortgage loan is paid off. But this feature isn’t free and comes at a hefty price - HUD requires the homeowner to purchase insurance when the loan is originated, and that fee is the primary reason the up front fees are so high, when compared with all the other Reverse Mortgage programs. The homeowner must also pay a small insurance fee every month, to maintain the insurance. There is a major benefit to paying the insurance though, it helps keep the interest rate lower then the non-HECM programs. All the other Reverse Mortgage programs don’t have an insurance program associated with them, but they’re also non-recourse loans, so they offset their risk with higher interest rates. Right now, as I write this, the HECM adjustable program with the lowest interest rate is 3.31%. The HECM fixed interest rate program is 5.43% and the non-insured Jumbo program is 6.80%.
For example, lets say Bob and Nancy’s house is worth $300,000.00 when the Reverse Mortgage becomes due, but they’ve borrowed $400,000.00. That means they’re negative by $100,000.00. But they don’t have to worry about the negative amount because it’s a non-recourse loan. Neither they nor their heirs are responsible for the negative amount because it’s covered by the insurance policy.
The proceeds aren’t taxed and don’t impact Social Security benefits. However, they can impact Medical and Medicaid. Homeowners are limited to a certain amount of money in their bank accounts when they’re involved in those programs, so they should take that into consideration when they decide how their cash will be distributed to them.
How do interest rates work with Reverse Mortgages? Are they the same as traditional “Forward” Mortgages?
Interest rates for Reverse Mortgages aren’t the same as interest rates for Forward Mortgages. Forward Mortgages have a feature called “Yield Spread Premium”, which enables the Loan Officer to modify interest rates for each loan program. That means every Loan Officer can offer a different interest rate, so it’s wise for homeowners to shop around and find a Loan Officer that’s offering the lowest interest rate. “Yield Spread Premiums” don’t exist with Reverse Mortgages, so every Lender offers identical interest rates. Also, interest rates change every Tuesday for all Reverse Mortgage programs with a variable interest rate, and daily for the fixed interest rate programs.
Additionally, when the interest rate is “locked” with an adjustable Reverse Mortgage program, it’s locked for 4 months and if it’s lower on the day the homeowner signs the final loan documents, the homeowner will receive the lower interest rate. For the fixed interest rate program, the interest rate can’t be locked until 3 days prior to the final loan documents being created.
How much are the fees? I’ve heard they’re high.
For the most part, the fees are similar amongst the different Reverse Mortgage Lenders. HUD doesn’t allow lenders to charge the homeowner for Processing or Underwriting, and there aren’t any junk fees. However, some lenders are able to charge lower Escrow and Title fees, so it’s worthwhile to ask all the lenders who are giving you quotes, for a Good Faith Estimate. The Good Faith Estimate will enable you to compare lenders side-by-side. What makes the fees high is the Insurance Premium, which is 2% of the value of the home, or FHA’s lending limit, whichever is lower. Right now, the highest lending limit in the continental United States is $362,790.00. If the home was worth $500,000.00, the insurance would be 2% of the lower of the two, at $7,255.80. That’s significant and none of the other Reverse Mortgage programs include that fee.
Coming Soon:
I’ve heard there’s some sort of counseling involved with Reverse Mortgages. How does that work?
Once I get the Reverse Mortgage, do I still have to pay property taxes and homeowners insurance?
What should I expect from the Lender when they provide me with a courtesy quote?
Can you recommend an easy to read book to me, that’ll help me understand how Reverse Mortgages work?
Is there a web site I can visit to receive a quick quote? (so I won’t have to talk with someone at a Reverse Mortgage company)
I’ve heard people say the bank gets your house with a Reverse Mortgage. Is that true? Why do people say that?
Can I use the money I receive to buy anything? Are there any restrictions?
Does it makes sense for me to purchase an Annuity from the cash I received? Or should I take the money payment option instead?
What questions should I ask Reverse Mortgage Lenders?
Are there any health requirements for Reverse Mortgages?
Will I save any money if I use a non-profit Reverse Mortgage Lender to do my Reverse Mortgage?