Introduction
Reverse mortgages are an excellent financial solution for some older homeowners, providing financial security and independence. Many older homeowners are now taking advantage of these programs, which are insured by the United States Department of Housing and Urban Development.
Some of the features of reverse mortgages include:
- Converts your home equity into cash without requiring you to sell your home or incur monthly mortgage payments
- Home ownership remains with you and transfers to your heirs
- No income or credit requirements
- You pay no income tax as your loan proceeds are received.
- Repayment of loan is usually not necessary while you occupy your home, and the amount owed to the lender cannot exceed the value of your home
- The US Government insures the availability of your cash and income
Reverse mortgages are commonly used to:
- Enjoying retirement
- Eliminating mortgage and other debt obligations
- Increasing monthly income
- Creating cash reserves
- Covering health care costs
- Making home improvements and repairs
- Completing estate planning and gifting to family members
How Reverse Mortgages Work
Reverse mortgages help older homeowners to convert their home equity into cash without having to sell their home or incur monthly mortgage payments. They are home loans, similar to regular loans in most respects. Title to the home remains with the homeowners, and the reverse mortgage is attached to the home like a regular home loan.
The main difference between reverse mortgages and regular home loans is that they don’t need to be repaid as long as one homeowner remains living there. This is because monthly charges are added to the loan balance and collected at the end of the loan rather than every month. Interest is only charged on the amount used (like a credit card or home equity line of credit).
Outstanding Loan Balance
As the cash from a reverse mortgage is used by the homeowners, and as the interest accumulates, the outstanding loan balance gradually grows. Below is an example of how this might occur (assumes interest rate of 6% annually):
| Loan balance – start of month |
$30,000 |
| Monthly cash taken by homeowners |
$1,200 |
| Monthly interest and servicing charges |
$190 |
| Loan balance – end of month |
$31,390 |
Affect on Home Equity
If the value of the home goes up faster than the outstanding loan balance, home equity increases while the homeowners use their reverse mortgage, and vice versa. Below is an example of how this might occur (assumes home appreciation of 4% annually):
| |
Home Value |
Loan Balance |
Equity |
| Start of Month |
$500,000 |
$30,000 |
$470,000 |
| End of Month |
$501,667 |
$31,390* |
$470,277 |
* From example above
End of the Loan
If the homeowners remain in their home for the rest of their lives, when the last homeowner passes away the home goes to their heirs. The outstanding loan balance must be repaid at that time.
The heirs may sell the home, repay the outstanding loan balance and keep the remaining cash. Or the heirs may refinance the outstanding loan balance (or use other means to repay it) and keep the home. If the outstanding loan balance is greater than the value of the home, the heirs are not required to make up the difference unless they elect to keep the home.
If the homeowners decide to sell their home and move to another location after obtaining a reverse mortgage, they simply repay the outstanding loan balance and keep the remaining sale proceeds. If the outstanding loan balance is greater than the value of the home, the homeowners are not required to make up the difference.
Ways To Receive Cash From A Reverse Mortgage
The cash from a reverse mortgage must first be used in the following ways:
- Repaying existing mortgages balances and liens (eliminates mortgage payments)
- Making required home repairs (if any)
The remaining cash may be received in the following ways:
- Payments for life (Tenure)
- Payments for a stated period of time (Term)
- Line of Credit
- Lump Sum at Loan Closing
- Combination Plan
Not all programs allow for all of the above options, so contact Castle Financial to learn more.
Tenure
Receiving payments for life (Tenure) is usually best for homeowners that need additional cash every month. Homeowners can count on receiving Tenure payments for as long as they live in their home. This may be the safest choice for some because the cash will never run out.
Term
Receiving payments for a stated period of time (Term) may be best for homeowners that need more monthly cash than Tenure will allow. For example, homeowners may elect to receive $4,000 a month, but at the end of 5 years their cash may be used up (contact an expert for an estimate of what you might receive). The reverse mortgage need not be repaid at that time, but the homeowners will have no more cash available from their reverse mortgage. If this happens the homeowners may have the option of obtaining a new, larger reverse mortgage, or they may consider other options.
Line of Credit
The Line of Credit option allows homeowners to receive cash whenever they want. This option is usually best for homeowners that need additional cash occasionally rather than every month. Remember that interest is only charged on the cash used from a reverse mortgage, so this option may be the best way to avoid unnecessary interest charges.
One interesting feature of the Line of Credit option is that it grows. For example, homeowners with an available Line of Credit of $100,000 will have more than that available in a year. This growth feature applies to the unused portion of the Line of Credit.
Lump Sum at Loan Closing
Homeowners that need cash right away to payoff debts, cover immediate expenses, or fulfill financial and estate planning goals may receive a Lump Sum at Loan Closing. This option is usually available under all programs.
Combination Plan
Homeowners may choose a combination of the above options. For example, they may decide to receive a Lump Sum at Loan Closing to fulfill financial planning goals, set up a Line of Credit for emergencies, and receive Tenure payments. The larger the Lump Sum at Loan Closing and Line of Credit, the smaller the Tenure payments will be.
Common Uses of Reverse Mortgages
The cash available from reverse mortgages may be used by the homeowners for many things. Common uses include simply enjoying retirement, eliminating mortgage and other debt obligations, increasing monthly income, creating cash reserves, covering health care costs, making home improvements and repairs, and estate planning / gifting to family members.
Enjoying Retirement
Many homeowners use reverse mortgages to simply enjoy retirement in the manner they had planned: go on vacations, participate in their favorite activities, eat at restaurants, enjoy the company of friends and family.
Eliminating Mortgages and Other Debt
The cash available from a reverse mortgage must first be used to eliminate existing mortgages and liens on the home. This will also eliminate any monthly mortgage payments the homeowners are required to make. For example, if the homeowners are now making monthly mortgage payments of $1,000, the homeowners can now use that $1,000 every month to spend on other things (which is similar to receiving Tenure payments for that amount).
Homeowners may also elect to receive a Lump Sum at Closing that may be used for any purpose. For example, the homeowners may elect to payoff any credit card debt and eliminate those monthly payments.
Making Home Improvements and Repairs
Reverse mortgages are often used to make home improvements and repairs. Homeowners may be required to make specific repairs to their home, which must first be covered by the cash available from a reverse mortgage. Required repairs are typically related to the structural soundness and safety of the home (for example a leaking roof). Homeowners may also elect to make any other improvements and repairs they choose.
Increasing Monthly Income
Receiving Tenure or Term payments will effectively increase the monthly income of the homeowners by the amount of those payments. Accessing a Line of Credit can also have that effect. Eliminating mortgage and other debt obligations will also effectively increase monthly income as outlined above.
Creating Cash Reserves
Homeowners may create cash reserves by establishing a Line of Credit with their reverse mortgage, by depositing reverse mortgage proceeds into their bank account, or by investing. Some homeowners also create cash reserves by saving excess Tenure or Term payments, or because their existing mortgage and other debt obligations have been eliminated.
Covering Health Care Costs
Many homeowners use cash from their reverse mortgages to help cover health care costs, including in-home health care or prescription drug expenses. Reverse mortgages are a useful tool to help cover in-home health care costs so that homeowners may remain in their homes rather than move to an assisted living or nursing home facility.
Financial and Estate Planning
Some homeowners use reverse mortgages for financial and estate planning. For example, reverse mortgages are also often used to make gifts to family members to fund a college education or buy a home.
Qualifying For A Reverse Mortgage
To qualify for a reverse mortgage, all homeowners must be at least 62 years old (although some programs with limited benefits allow for younger ages). There are no income or credit requirements.
The value of the home, the county in which it is located, and interest rates may affect the amount of cash available. The ages of the homeowners also affect the amount of cash available, with older homeowners qualifying for more.
Closing costs are usually covered by the loan itself, so very little cash is usually needed to obtain a reverse mortgage.
The amount of outstanding mortgages and liens on the property may not exceed the cash available to the homeowners. This is because the cash from a reverse mortgage must first be used to repay them. This is illustrated below:
| Example 1 |
|
| Cash available from reverse mortgage |
$200,000 |
| Balance on existing mortgages and liens |
$195,000 |
| Excess |
$5,000 |
The above homeowners should qualify for a reverse mortgage. By obtaining a reverse mortgage they would eliminate their mortgage payments and have an additional $5,000 available.
| Example 2 |
|
| Cash available from reverse mortgage |
$200,000 |
| Balance on existing mortgages |
$220,000 |
| Shortfall |
$20,000 |
The above homeowners do not qualify for a reverse mortgage unless they bring in $20,000 of their own cash. By doing so the homeowners would eliminate their monthly mortgage payments.
| These are examples only. Cash available also needs to be adequate to cover any required repairs unless the homeowners can cover them. Contact an expert to determine whether or not you might qualify for a reverse mortgage. |
The Process of Obtaining a Reverse Mortgage
Obtaining a reverse mortgage includes the following steps:
Responsibilities of the Homeowners
- Researching options through an experienced and reputable lender, and understanding the transaction prior to application
- Speaking to a reverse mortgage counselor
- Completing loan application papers, and supplying any required documentation and good faith deposit
- Providing the appraiser access to the home
- Signing loan documents
The homeowners may need to assist in other areas if needed.
Responsibilities of the Lender
In addition to assisting the homeowners with the steps above, there are many additional responsibilities of the lender. Reputable lenders assist the homeowners in finding the program that best suits their needs, and identify and resolve any potential issues quickly to ensure the process is a smooth as possible.
Counseling
Most reverse mortgages require that all homeowners receive reverse mortgage counseling from an approved third-party counselor. The purpose of the counseling is to ensure that the homeowners understand how reverse mortgages work and what their options are. It protects the homeowners and lender, helping to ensure that everyone is fully informed. Most homeowners receive counseling via the telephone, or it may be done in person.
Required Repairs
If the appraiser identifies significant deferred maintenance (like a leaking roof), its repair may be required as a condition of the loan. Any home repairs required by the appraiser may usually be done after the reverse mortgage has been completed and paid for from reverse mortgage proceeds, so upfront cash is usually not needed.
Living Trusts
If the homeowners have placed their home in a living trust, it will need to be reviewed to ensure that the reverse mortgage doesn’t violate its terms (most living trusts allow for reverse mortgages).
Other Property Types
If the home is a condo or manufactured home, the property will need to be reviewed to ensure it is in compliance with program requirements.
Manufactured homes usually need to be on land owned by the homeowners (monthly rented space is not allowed), although land leased on a very long term basis is sometimes allowed. Manufactured homes usually need to be built after 1976 and be permanently attached to a HUD-approved foundation.
Reverse Mortgage Costs
Reverse mortgage costs consist of Closing Costs, Interest and Monthly Mortgage Insurance Premium (HUD program only), and Monthly Servicing Charges. All of these costs are usually absorbed by the loan itself, so very little cash is needed to obtain a reverse mortgage. All reverse mortgages have safeguards that impose strict limits on the costs that lenders may charge.
Closing Costs
Closing Costs are one-time charges incurred when putting a reverse mortgage in place. They are comprised of 3 main items: Origination Fee, MIP, and Other Financed Closing Costs.
- Origination Fee. The Origination Fee is the lender’s revenue, and it covers the lender’s costs in helping homeowners explore and obtain reverse mortgages. Without revenue to the lender reverse mortgages would not be available to homeowners.
- Mortgage Insurance Premium (MIP). This cost is paid to HUD, where it is used to insure HUD and homeowners against the risk of the outstanding loan balance exceeding the value of the home (HUD absorbs these shortfalls rather than the homeowners or their heirs).
- Other Financed Closing Costs. These are the costs charged by the various third-parties involved in putting reverse mortgages in place. Examples include costs relating to appraisal, title insurance, escrow, county recording fees, etc.
Interest and Monthly MIP
The main difference between reverse mortgages and regular home loans is that they don’t need to be repaid as long as one homeowner remains living there. This is because interest and other monthly charges are added to the loan balance and collected at the end of the loan, rather than every month. Interest and MIP are only charged on the amount used.
Monthly Servicing Charges
All home loans have servicing charges, but they are typically invisible to the homeowners because they are included in the interest rate. Reverse mortgages break them out of the interest rate in order to better disclose costs to older homeowners.
Monthly Servicing Charges are the Loan Servicer’s revenue. They cover the Loan Servicer’s costs in helping homeowners have access to their reverse mortgage, as well as other costs the Loan Servicer incurs. Without revenue to the Loan Servicer reverse mortgages would not be available to homeowners.
Are Reverse Mortgages For Everyone?
Just like anything in life, reverse mortgages are not for everyone. They are best suited for retired homeowners on a fixed income that prefer to remain in their home, that need or would enjoy having more cash. These homeowners usually enjoy tremendous benefits from reverse mortgages.
Homeowners that already have adequate income and assets to fund their retirement years may also find them an excellent tool for enhancing their quality of life or executing their financial and estates plans.
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