Until you were eligible for Social Security and Medicare, or approaching the age when you would be, you may not have known exactly how these two pillars of retirement worked. You may not have understood, for example, that Medicare isn’t free or that for every year that you delay taking Social Security past full retirement age, up to age 70, you get an 8% bump in your benefit. Knowing that kind of information could certainly make for a smoother, less bumpy retirement.
There’s another important piece of information you should know about, and it’s a reverse mortgage. You may not need a reverse mortgage now, but you should at least know about it so you’ll be in full command of all your retirement options.
One fact to nail down from the start is a reverse mortgage is not a government program or a government benefit, but rather a loan backed by the U.S. government, which has made it possible for more than one million older Americans to convert some of their home equity into cash so they can live more comfortably and securely in retirement. They can use the cash virtually any way they wish, such as using it to make a Medicare payment or delay taking Social Security to maximize their lifetime benefit.
Like Social Security (1935) and Medicare (1965), reverse mortgages have been around for a while. The first one was made in 1961. Over that time, these loans have been strengthened with more consumer protections and safeguards, but even after 60 years, people in their retirement planning tend to overlook several facts about reverse mortgages that, if more fully understood and appreciated, could influence their decision about using one at some point to improve their retirement.
Let’s look at 10 of these underappreciated reverse mortgage realities, with the heads-up that it can often take hearing these items several times before they sink in, the same kind of educational and learning curve that you may have experienced when you heard all those Social Security and Medicare terms for the first time.
If you’re unclear about any of the following facts or explanations, don’t hesitate to reach out to your reverse mortgage professional.
1. There is more than one kind of reverse mortgage.
Most reverse mortgages are Home Equity Conversion Mortgages or HECMs. This is a reverse mortgage insured by the U.S. federal government, only available through an FHA-approved lender. In addition to HECM loans, some lenders may offer proprietary reverse mortgage loans, which are not insured by the federal government and are typically designed for borrowers with higher home values.
Some state and local governments and non-profit organizations also offer single-purpose reverse mortgage loans. These reverse mortgage loans may be used only for the purpose specified by the lender (for example home repairs or property taxes). They may only be available in some areas and may be only for homeowners with low-to-moderate income. These non-HECM reverse mortgage loans are not federally insured.
2. A reverse mortgage is a non-recourse loan.
One of the hallmark advantages of a reverse mortgage is you do not have to repay it until you sell your home, permanently move out of it, pass away or do not comply with loan terms. If your heirs are left to settle your estate, and there is an outstanding loan balance after they sell the home, they are not responsible for making up the difference. FHA insurance steps in and makes up the deficit.
3. An essential factor in determining your payout from a reverse mortgage is something called the expected interest rate.
Today, people talk about interest rates as often as they do the weather, but one type of interest rate, the expected interest rate or EIR, may be new to you. The expected interest rate is the interest rate your lender expects to prevail over the life of your reverse mortgage. It’s called “expected” because no crystal ball has yet been invented that can pinpoint what the interest rate will be on any given day.
Your reverse mortgage lender takes the expected rate of interest along with your age and aligns them with a corresponding principal limit factor (PLF), found in tables published by the FHA. The PLF is critical because your lender multiplies this factor with your home’s appraised value (a maximum claim amount or MCA not to exceed the FHA’s lending limit of $822,375 in 2021) to determine your payout or principal limit.
Let’s look at a quick example: PLF of 0.5 x MCA of $500,000 = principal limit of $250,000.
So, depending on the expected interest rate, your age, and the value of your home, you could be looking at a payout of about $250,000 (but the payout could be less). Also, the payout may be less if you have an existing mortgage or other lien to pay off, which is one of the conditions of a reverse mortgage. How you choose to receive your proceeds may also affect your payout. A line of credit option typically gives you the highest possible proceeds and a lump sum the lowest.
4. You won’t get all your money at once.
Hearing you won’t get all your money upfront may surprise you, but this consumer protection was put in place as sort of a brake to prevent borrowers from zipping through all their loan proceeds the first year. Therefore, you are limited to a first-year draw of 60% of your principal limit. If mandatory obligations (like money to pay off an existing mortgage) exceed 60%, you can access an additional 10% of the principal limit (not to exceed the principal limit) the first year. The remainder of your proceeds is accessible the following year and thereafter.
5. Your payments aren’t reduced even if your home loses value.
With either a term payout plan (monthly payouts over a finite period) or a tenure payment plan (monthly payments for life¹ as long as you continue to honor your loan terms, such as home maintenance and the payment of property taxes and homeowners insurance), your payment will be the same each month — even if your home loses value. The same is true for a reverse mortgage line of credit. It cannot be reduced, frozen, or canceled if your home loses value.
6. You can receive payments for life¹.
It’s true, as long as you continue to honor the terms of your reverse mortgage loan, which include keeping your property in good condition and paying your property taxes and homeowners insurance, just as you would with any other kind of mortgage. Receiving reverse mortgage payments for life is known as “tenure,” one of six payment plans available to you with a reverse mortgage. Expect a tenure payout to be less, however, than a term payout (a finite period of payouts) because of the possibility of a tenure plan’s extended payout period.
¹Available with Tenure-Based or Modified Tenure plans, so long as Borrower does not default on the loan. Borrower must maintain home as principal residence, pay all taxes, insurance, maintain the home, and comply with all other loan terms. With Modified Tenure plans, lender will set aside a specific amount of money for a line of credit.
7. You don’t need to boast a certain credit score to be eligible for a reverse mortgage.
Unlike most traditional mortgages, you don’t have to boast a certain credit score or have a job to obtain a reverse mortgage. What you do need, however, is the ability to show you can comfortably meet the terms of your loan, which include maintaining your home and paying your property taxes and homeowners insurance.
To determine whether you can meet that standard, your lender will review your income, cash flow, credit history, and other financial factors as part of a financial assessment. Even if the financial assessment shows that meeting the loan’s monthly obligations would be a financial strain, you may still be loan eligible with the implementation of a Life Expectancy Set-Aside or LESA. This is a reserve account set up specifically to pay your property taxes and homeowners insurance over the expected life of your loan. This money (considered a “mandatory obligation”) is subtracted from your principal limit. As long as there is money in the LESA, your property taxes and homeowners insurance are automatically paid, which can lighten your financial burden in retirement.
8. If you select a reverse mortgage line of credit, you’ll also receive a bonus “growth” feature.
Unlike a home equity line of credit (HELOC), if you select a reverse mortgage line of credit, the line cannot be frozen, reduced, or canceled as long as you continue to honor your loan terms. Also, unlike a home equity line of credit (HELOC), which typically requires interest payments soon after your loan closes, a reverse mortgage line of credit requires no such repayment of interest or principal unless you permanently leave your home or fail to comply with your loan terms.
Many borrowers use their reverse mortgage line of credit as an expanding financial safety net. There is no charge to keep the line open and whatever portion of the line remains untouched continues to grow at the same rate as the interest accrued on the loan, plus the 0.5% annual mortgage insurance premium. So, if the interest rate on your reverse mortgage is 3.5%, then your line of credit will grow at 4% (3.5% + 0.5%).
9. You can use a reverse mortgage to help you buy a new home just as easily as using one to keep you in your current one.
You could use the funds from a HECM (a government-insured reverse mortgage) loan so that you can continue living in your current home, or you could put them toward the purchase of a new home that better fits your retirement needs. Of course, borrowers remain responsible for paying property taxes and homeowner insurance, must occupy home as their primary residence, pay for ongoing maintenance, and otherwise comply with loan terms. This latter option is known as a HECM for Purchase loan. As a down payment on the new home, you could use the proceeds from the sale of your previous home, along with other savings and investments. Your reverse mortgage loan would provide the additional funds to satisfy the purchase price. Not only will your initial cash outlay be less than it would be for an all-cash home purchase, but your monthly cash flow is likely to increase as a HECM for Purchase requires no monthly mortgage payments. You are still responsible, however, for maintaining your home and paying your property taxes and homeowners insurance. Your loan repayment only comes due when you leave the home.
10. A reverse mortgage loan isn’t a backdoor way for your lender to own your home.
A reverse mortgage is simply a loan and financial tool designed to help you retire better. When taking out a reverse mortgage loan, you, not the lender, retain title to the property. The lender puts a lien onto the title to ensure repayment of the loan. These same requirements apply to a traditional mortgage.
Even if you were to exhaust all your loan proceeds, you cannot lose your home as long as you comply with your loan terms, such as maintaining your home and paying your property taxes and homeowners insurance.
Reverse mortgages are now 60 years old. Given all that time, some of the facts about reverse mortgages tend to get overlooked or overshadowed, and, at times, even confused, misunderstood, or misrepresented.
Yet despite a few growing pains over the years, which have been corrected with new safeguards and protections, reverse mortgages have emerged stronger, safer, and wiser, helping them serve as a viable and powerful financial option for many older Americans seeking a more secure retirement. To find out if a reverse mortgage loan is right for you, click here.
We hope this article has given you some help with things to think about. Of course, every situation is different. This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.