What is a Reverse Mortgage?
A Reverse Mortgage is a unique type of loan available to homeowners over the age of 62 that have either paid off their home entirely or amassed a considerable amount of equity. Reverse Mortgages are available through the FHA’s Home Equity Conversion Mortgage (HECM) program. HECM enables homeowners to either withdraw payments from the equity of their home with limitations or receive a single disbursement lump-sum payment at the time of mortgage closing. Eligible homeowners are able to defer payments on the loan until they die, sell or move out of the home. In other words, eligible homeowners who receive a HECM Reverse Mortgage effectively will not have to make a payment on their home for the rest of their life.
How Does a Reverse Mortgage Work?
A “normal” mortgage requires a homeowner to make monthly payments over a set number of years (amortization period). In a Reverse Mortgage a homeowner receives money from a lender that does not have to be paid back for as long as the borrower lives in the home. The monthly payments are paid from the equity of the home as are the payments that the homeowner would normally make to repay the loan. This negative amortization results in the unpaid principal balance on the loan to increase every month. Despite the increase in the unpaid principal balance the borrower is guaranteed to be able to live their home payment free until they die, sell or move out of the home.
What are the Types of Reverse Mortgage?
There are four types of reverse mortgages:
- Single-Purpose Reverse Mortgages, offered by some state and local government agencies and nonprofit organizations. Single-Purpose Reverse Mortgages are strict as to their use and can typically only be used for one purpose such as home improvements/repairs and/or to pay off property taxes. For example, On September 28, 2014, California Governor Jerry Brown signed AB 2231 (Statutes of 2014, Chapter 703), which reinstated the previously suspended Property Tax Postponement Program with some revisions. This program allows elderly, blind and disabled citizens with an annual household income of $35,500 or less and at least 40% equity in their homes to apply to defer payment of property taxes on their principal residence. Under this bill, applications may be filed with the State Controller’s Office beginning September 1, 2016. Single-Purpose Reverse Mortgages are low cost but are limited in scope and application.
- Federally-Insured Reverse Mortgages, known as Home Equity Conversion Mortgages (HECMs) and backed by the U. S. Department of Housing and Urban Development (HUD) is a type of Federal Housing Administration (FHA) insured reverse mortgage. HECMs allow senior homeowners the option of converting the equity in their home to cash. The amount of money that may be borrowed is dependent on a mathematical formula taking into consideration the appraised value of the home and the age of the borrower. The homeowner receives cash payments advanced against the equity of the home. While Interest accrues on the outstanding loan balance, no payments must be made until the home is sold or the borrower dies. HECMs typically have lower interest rates that Proprietary Reverse Mortgages. Since the FHA insures HECM loans, homeowners will not owe more than value of the loan in the event that the loan exceeds the value of the home’s equity.
- Proprietary Reverse Mortgages, at one time private companies competed against the FHA’s HECM program. However, due to the housing crisis, Proprietary / Private Company Reverse Mortgages are now, mostly obsolete. Proprietary Reverse Mortgages were an alternative to HECM and even had some advantages to HECM. However, senior homeowners seeking a Reverse mortgage will have to comply with the rules established by the FHA’s HECM program or search for the few remaining Proprietary Reverse Mortgage programs still available.
- Jumbo Reverse Mortgages are a subset of Proprietary Reverse Mortgages and like traditional Proprietary Reverse Mortgages virtually disappeared during the housing crisis. However, as demand for reverse mortgages have grown among senior homeowners having loan balances that exceed HECM guidelines private companies have started to offer Jumbo Reverse Mortgages again. Jumbo Reverse Mortgages typically have higher interest rates and costs than HECMs but are available to senior homeowners that have significant amounts of equity in their home but, for one reason or another, do not meet HECM guidelines. Homeowners considering Jumbo Reverse Mortgages should thoroughly investigate the pros and cons of a Jumbo Reverse Mortgage before signing up.
What Payment Options are Available with a Reverse mortgage?
The Payment Options that are available to a homeowner borrowing through a HECM or Proprietary Reverse Mortgage depends on several factors including age, current interest rates and the appraised value of the house. As a rule of thumb, the older the borrower, the lower the borrower’s loan balance and the more equity the borrower has results in more money available to the borrower through a Reverse mortgage. It is extremely important that borrowers fully understand the payment options before selecting a program. Homeowners can choose between adjustable or fixed interest rate programs.
For ADJUSTABLE interest rate mortgages, borrowers can select one of the following payment plans:
Tenure – the borrower will receive equal monthly payments for as long as at least one borrower lives and continues to occupy the property as a principal residence.
Term – the borrower will receive equal monthly payments for a fixed period of months selected.
Line of Credit – the borrower has the option to receive unscheduled payments or installments determined by the borrower until the line of credit is exhausted.
Modified Tenure – the borrower receives a combination of a line of credit and scheduled monthly payments for as long as the borrower remains in the home.
Modified Term – the borrower receives a combination of a line of credit plus monthly payments for a fixed period of months selected by the borrower.
For FIXED interest rate mortgages, the borrower will receive the Single Disbursement Lump Sum payment plan.
What are the qualifications for a Reverse Mortgage?
In order to qualify for a HECM Reverse Mortgage the borrower must:
- Be 62 years of age or older;
- Own the property outright or have a very low Loan-to-Value (“LTV”);
- Occupy the property as their primary residence;
- Not be delinquent on any federal debt;
- Be able to continue making payments on ancillary property charges such as property taxes, insurance, HOA fees, mello roos, etc.;
- Complete consumer education counseling by a HUD-approved HECM counselor.
What are the Property Requirements for a Reverse Mortgage?
The following eligible property types must meet all FHA property standards and flood requirements:
- Single family home or 2-4 unit home with one unit occupied by the borrower;
- HUD-approved condominium project;
- Manufactured home that meets FHA requirements;
What are the Financial Requirements for a Reverse Mortgage?
In order to obtain a HECM Reverse Mortgage the borrower’s income, assets, monthly living expenses and credit history will be verified. It is also necessary to verify the payment of real estate taxes and hazard and flood insurance premiums.
How is the Amount that can be Borrowed Determined in a Reverse Mortgage?
The maximum amount that can be borrowed depends on:
- Age of the youngest borrower or non-borrowing spouse;
- Current interest rate;
- Lesser of appraised value or the HECM FHA mortgage limit of $625,500 or the sales price; and
- Initial Mortgage Insurance Premium
How Long Can a Borrower Live in their House With a Reverse Mortgage?
A borrower cannot outlive a reverse mortgage. As long as at least one of the borrowers continues to live in the property as their primary residence and continues to make payments on all property related ancillary charges such as property taxes and hazard insurance the loan will not become due.
When Does a Reverse Mortgage Have to Be Paid Back?
A HECM Reverse Mortgage loan has to be paid off when the last surviving borrower dies, sells the home or permanently moves out. A borrower is considered to have “permanently moved” out when the borrower has lived at place other than the property for one continuous year. An example of permanently moving out is when a borrower stays in a nursing home or assisted living for more than 12 continuous months. This is an important consideration that both the borrower and the borrower’s family needs to be aware of when choosing a HECM Reverse Mortgage. A HECM Reverse Mortgage also becomes due if the borrower stops paying the property taxes or homeowner’s insurance, or fails to maintain the property.
More specifically, if the borrower is the ONLY borrower on the HECM Reverse Mortgage and:
- The Borrower Lives ALONE: The Loan will have to be paid off when you die, sell the home, or move out.
- The Borrower Lives with a Non-Borrower Spouse or Partner: If the Reverse Mortgage was originated before August 4, 2014, the loan will have to be paid off when the borrower dies, sells the home, or moves out. If the borrower’s spouse or partner cannot afford to pay off the loan balance the spouse or partner will have to sell the property or move out.
- The Borrower Lives with the Borrower’s children, relatives or other roommates: The loan will have to be paid off when the borrower dies, sells the home, or moves out. It is IMPORTANT to understand that the borrower’s heirs will have to either repay the loan or sell the home if any of the aforementioned occurs.
If there is More Than One Borrower on the Reverse Mortgage:
- The Borrowers Live Together: The loan will have to be paid off when both borrowers have died or moved out. One co-borrower can continue to live in the home without paying off the loan after the death of the other co-borrower or if the other co-borrower moves out.
- The Borrowers Live with Children or Other Relatives or Roommates: The loan will have to be paid off when both borrowers have died or moved out. As long as one borrower is still alive and living in the property then their children or other relatives can continue to live there too. If the heirs cannot afford to repay the loan the heirs will have to sell the property and or move out.
What Happens to the Property When a Borrower Dies With a Reverse Mortgage?
A Reverse Mortgage must be completely paid off when all borrowers on a Reverse Mortgage die or permanently move out of the house. When the borrowers die or permanently move out of the home, the borrowers’ heirs will have an opportunity to pay off the loan or sell the property. If the home is worth more than the loan balance the heirs will get to keep whatever amount exceeds the Reverse Mortgage loan payoff. If the home is worth less than the Reverse Mortgage loan payoff then the heirs will not owe any money beyond what the home is worth.
If the heirs desire to keep the property then the heirs will need to pay off the outstanding Reverse Mortgage loan balance. If the heirs cannot afford to pay off the loan in cash, then the heirs might be able to pay off the loan by acquiring a loan just as if the heirs were purchasing the property.
What is the Purpose of the Required HUD Counseling for HECM?
When applying for a HECM Reverse Mortgage a borrower must meet with a counselor from an independent government-approved housing counseling agency. The counselor is required to explain all issues related to a Reverse Mortgage including the costs associated with a Reverse Mortgage, the financial implication of the getting a Reverse mortgage as well as possible alternatives to the HECM. The counselor also should be able to help the borrower compare the different types of HECM Reverse Mortgage programs as well as the long term implications of these programs. The purpose of the counseling is to provide would-be borrowers with information and the pros and cons of HECM Reverse Mortgage from an uninterested 3rd party. The counselor does not have a financial interest in whether or not the borrower ultimately decides to obtain a HECM Reverse Mortgage thus allowing the borrower to obtain bias free information. Borrowers can visit HUD for a list of approved counselors or call 1-800-569-4287. There is a modest charge associated with the counseling services. The fee can be paid through the proceeds of the HECM Reverse Mortgage.
What Happens to a Borrower’s Loan Balance with a HECM Reverse Mortgage?
Since the borrower does not make payments directly to the lender in a HECM Reverse Mortgage, the payments are made from the equity of the property. Each month the borrower’s loan balance increases as loan funds are advanced to the borrower and interest accrues on the outstanding loan balance.
What kind of Interest Rates do Reverse Mortgages Have?
Interest rates on Reverse Mortgages can either be fixed or adjustable depending on the HECM program selected by the borrower. Adjustable rates are typically tied to financial indexes and will change with market conditions.
What Kind of Fees Should are Associated with Reverse Mortgages?
Fortunately most of the fees associated with a Reverse Mortgage can be financed with the Reverse Mortgage so the borrower would have little or no out-of-pocket expenses. The costs are merely added to the principal and paid along with the interest accrued on the total principal balance when the loan becomes due. Just to be clear, like all mortgage loans HECM Reverse Mortgages will have associated costs. Costs can include origination fees, mortgage insurance premiums, title and escrow fees as well as other standard closing costs. Lenders may also charge a service fee during the term of the mortgage.
Can a reverse mortgage be refinanced?
Yes, it is possible to refinance out of a Reverse Mortgage depending on the borrower’s ability to satisfy the income requirements of a new loan. Additionally, a borrower’s ability to refinance out of a reverse mortgage is heavily dependent on how much equity the borrower has at the time of considering a refinance.
What Changes Did HUD Make for the “Due and Payable Status” for Married Mortgagors?
On April 25, 2014, HUD issued Mortgagee Letter 2014-07 which revised the provisions regarding Non-Borrower Spouses. The changes, applying to any HECM with a case number issued after August 4, 2014, require that the HECM must contain a provision deferring the “Due and Payable” status that occurs because of the death of the last surviving mortgagor. The provision applies if a mortgagor was married at the time of closing and the Non-Borrowing Spouse was identified at the time of closing. The HECM documents must contain a provision deferring the “Due and Payable” status until the death of the last surviving Non-Borrowing Spouse or until a listed event occurs.
What needs to occur in order for the Deferral Period to apply to a Non-Borrowing Spouse?
In order for the Deferral Period to apply to a Non-Borrowing Spouse the Non-Borrowing Spouse must:
- Have been married to a HECM borrower at the time the loan closed and have remained the spouse of the HECM borrower for the duration of the HECM borrower’s lifetime;
- Have been identified to the mortgagee at the time of origination and specifically named as a Non-Borrowing Spouse in the HECM documents; and
- Have occupied, and continued to occupy, the property securing the HECM as his or her principal Residence.
What must a Non-Borrowing Spouse continue to satisfy during the Deferral Period?
- The Non-Borrowing Spouse must, within 90 days from the death of the last surviving HECM mortgagor, establish legal ownership or other ongoing legal right to remain (e.g., executed lease, court order, etc.) in the property securing the HECM;
- The Non-Borrowing Spouse must ensure that all other obligations of the HECM mortgagor(s) contained in the loan documents continue to be satisfied; and
- The Non- Borrowing Spouse must ensure that the HECM does not become eligible to be called due and payable for any other reason.
Will the Non-Borrowing Spouse Have Access to any of the HECM Proceeds During the Deferral Period?
The HECM is not assumable. The “Due and Payable” status will be deferred but due to the non-assumability of the HECM the Non-Borrowing Spouse will not be entitled to receive disbursements from the HECM during the deferral period. The proceeds of the HECM will be made available during a Deferral Period only for the specific reasons identified in Mortgagee Letter 2014-07 and the original loan documents.
Who Holds Title to the Property in a HECM Reverse Mortgage?
In a HECM Reverse Mortgage the borrower retains ownership to the home just as the borrower would in a “regular” mortgage. This is, perhaps, one of the biggest misconceptions about Reverse Mortgages.
Are there any restrictions on how a borrower can use disbursements from a HECM Reverse Mortgages?
There are no restrictions on how a borrower can use the proceeds from disbursements of a HECM Reverse Mortgage.
Does the Borrower Have to Make Payments to the Bank During the Term of the HECM Reverse Mortgage?
No. The borrower does not have to make payments on the HECM Reverse Mortgage during the term of the loan. However, the borrower is required to continue making property tax and homeowner’s insurance. Failure to timely pay property tax and homeowner’s insurance will result in the HECM Reverse Mortgage becoming “Due and Payable”.
Will the Borrower’s Heirs be Entitled to the Remaining Equity when the House is Sold?
Yes. When the loan must be repaid, the borrower’s heirs can either pay off the outstanding principal balance or sell the property and use the proceeds to pay off the reverse mortgage. After the heirs pay off the reverse mortgage the remaining equity is becomes part of the borrower’s estate.
Can the Borrower Bequeath to the Borrower’s Children?
Yes. The borrower can bequeath the property (pass it down via a will or trust) to whomever the borrower desires. However, the heirs will need to either pay off the Reverse Mortgage or acquire a new loan to pay off the Reverse Mortgage.
How Will a Reverse Mortgage Affect a Borrower’s Public Benefits?
Anyone considering a Reverse Mortgage should seek professional advice about how obtaining disbursements from a Reverse Mortgage will affect public benefits. Generally, disbursements from a Reverse Mortgage will not affect Social Security or Medicare but may affect Medicaid.
Are Taxes Owed on Disbursements from a HECM Reverse Mortgage?
Disbursements from a HECM Reverse Mortgage are considered loan disbursements. Proceeds from loans are typically not considered income and are not taxable. Consult a tax advisor for more information.