A reverse mortgage loan is a financial tool capable of doing many things. Besides paying off your current mortgage, you can use it to pay bills, supplement retirement income, fix up your home, cover the cost of medical care, or simply reserve it as a powerful safety net for your retirement. Your options are virtually limitless. To access the funds, you don’t have to sell your home or even take on monthly mortgage payments. And, if you choose, you don’t have to repay the loan until you leave your home. However, you must continue maintaining the home and paying property taxes and homeowners insurance as part of your loan agreement.
How does a reverse mortgage work?
If you’ve had a traditional mortgage, you likely began making monthly payments to your lender soon after the loan closed. Each payment, which covered principal and interest, decreased your loan balance until the loan was paid off.
With a reverse mortgage, the process is reversed. Your lender pays you. Consider the lender’s payments to you like a loan advance. With each payment, your loan balance (which includes principal, interest, and associated fees) increases. But if you choose, you don’t have to pay back the money for as long as you live in your home. When you pass away, sell your home, or move out permanently, then you, your spouse, or your estate must repay the loan for which you have several repayment options. And of course, as with other mortgages, if you do not honor the loan terms, the loan would become due and payable and you could be subject to foreclosure.
How much money can you get?
The amount of money you receive is based on multiple factors, chief of which are your age, the appraised value of your home, your amount of home equity, and the interest rate you receive on your loan. In general, the older you are, the more equity you have in your home, and the more favorable your interest rate, the more money you can obtain.
That said, even if your home were valued at the limit for a government-insured reverse mortgage (also known as a home equity conversion mortgage or HECM), which is $822,375 in 2021, don’t expect to borrow the entire value of the home, even if your mortgage is paid off. You will receive a portion of its appraised value. One way to think of it is that some of your equity is converted to proceeds, and some of it serves as collateral for the loan.
Like a traditional mortgage, a reverse mortgage also comes with certain costs. Some of these expenses must be paid upfront while others, like your origination fee and initial mortgage insurance premium, can be rolled into your loan. If the latter, this will lower your payout.
Your payout will also be influenced by the type of payout plan you select. For example, if you want your payout all in one lump sum, your payout will be lower than if you select a reverse mortgage line of credit, which will likely offer the highest possible payout over time. More about your payout options in a moment.
As part of the approval process, your lender will evaluate whether you will be able to comfortably meet your loan obligations, which include maintaining your home and keeping up your property tax and homeowners insurance payments. Based on this evaluation, the lender may require that an account (Life Expectancy Set-Aside or LESA) be created to do this for you. A LESA will lower your proceeds but also give you one less thing to worry about. For this added peace of mind, some borrowers request a LESA even if the lender doesn’t require one.
Who is eligible for a reverse mortgage?
Reverse mortgages are designed to serve older Americans. Hence, you must be 62 or older to apply. Here are some other requirements for taking out a reverse mortgage:
What is the reverse mortgage process?
Early in the reverse mortgage process, you will connect with a reverse mortgage professional. Perhaps you responded to a radio, television, or internet ad or plugged some basic information (your age, home value, etc.) into an online reverse mortgage calculator, which has piqued your curiosity about reverse mortgages. Perhaps your financial advisor recommended that you speak with a reverse mortgage professional to protect your retirement portfolio.
During your session, the reverse mortgage professional will gather some basic information about you, such as your age and the value of your home, to determine if you meet the loan’s eligibility requirements. At the same time, be prepared to share your retirement objectives and goals to help your reverse mortgage professional assess whether you would be a good fit for a reverse mortgage.
– Financial Assessment
As part of the reverse mortgage professional’s due diligence, the lender must conduct what is known as a “financial assessment.” This process entails verification of your credit history and income from employment, rentals, Social Security, investments, and other financial sources. You will have to give your consent for the credit review. Ultimately, the financial assessment helps ensure you will have enough cash flow to maintain the home and pay property taxes and homeowners insurance as part of your reverse mortgage agreement.
– Reverse Mortgage Counseling
If the financial assessment pencils out, based on the preliminary financial information you’ve shared, the reverse mortgage professional will furnish you with a list to call to schedule a reverse mortgage counseling appointment. This is a critical consumer safeguard built into the reverse mortgage process. You can’t obtain a reverse mortgage without reverse mortgage counseling with an independent, HUD-certified, reverse mortgage counselor. The purpose of counseling is to ensure you understand the loan’s costs and financial implications as well as possible alternatives to a Home Equity Conversion Mortgage or HECM. Upon the completion of counseling, you must sign and submit your HECM Counseling Certificate to the lender. This is the lender’s cue to order an appraisal of your home.
– HUD-approved Appraisal
The appraisal establishes the value of your property, one of the key components for obtaining a reverse mortgage and determining your payout. This evaluation must be conducted by an independent, HUD-approved appraiser, as HUD is the agency ultimately insuring the loan.
– Processing and Underwriting
This step in the process ensures all the documents have been successfully submitted and reviewed and fit the lender’s acceptable level of risk for loaning the money. Once all conditions have been identified and satisfied, the final closing date can be set.
Overseen by a title agent or attorney, depending on the state, you will sign final closing documents. Closing costs are normally financed as part of the loan, but you can pay these costs upfront in lieu of financing them. At closing, the lender will also confirm the payout plan you have selected.
With most reverse mortgages, you have at least three business days after closing to cancel the reverse mortgage contract for any reason, without penalty. This is known as your “right of rescission.” This three-day right does not apply to the HECM for Purchase product.
What are the payout options?
You have three main options for receiving your money: a line of credit, monthly payouts, or a lump sum.
– Line of credit (adjustable interest rate)
◾ You can obtain it at a lower cost than a lump sum payment because you pay interest and fees only on the money you use.
◾ You can use a credit line growth feature that allows you to borrow some money now and leave some credit available for the future. The portion of the line you don’t use continues to grow, allowing you to borrow up to a maximum amount stated in your mortgage.
◾ You can combine it with a monthly payout.
– Monthly payout (adjustable interest rate)
◾ You receive monthly payouts to supplement your income.
◾ You can receive fixed monthly payouts for a set number of years (Term option) or you can choose to receive them for as long as you live in the home and comply with all loan terms (Tenure option), which include maintaining the home and paying property taxes and homeowners insurance, and your loan balance does not exceed the amount stated in the mortgage.
◾ You can receive a term or tenure option at a lower cost than a lump sum payment because you’ll be paying interest and fees only on the money you’ve drawn so far.
◾ You can combine with a line of credit.
– Lump sum (fixed interest rate)
◾ You can withdraw all available funds at once. The amount available may be lower compared to other payment options.
◾ You will pay higher costs than a line of credit or monthly payout because you’ll be paying interest and fees on the entire loan amount drawn at closing.
◾ Unlike the line of credit, if you choose a lump sum, the amount of available proceeds does not grow over time.
How is a reverse mortgage repaid?
The most common method of repayment is by selling the home, where proceeds from the sale are then used to repay the reverse mortgage loan in full. Either you or your heirs would typically take responsibility for the transaction and receive any remaining equity in the home after the reverse mortgage loan is repaid.
What happens if the sale of the home doesn’t cover the loan balance? Not to worry. If the loan is a federally insured Home Equity Conversion Mortgage (HECM), which most reverse mortgages are, borrowers or their heirs are only responsible for no more than the amount the home sells for (its current value). Insurance, backed by the Federal Housing Administration (FHA), covers the remaining loan balance.
In instances when heirs prefer to keep the home instead of selling it, they may choose another form of repayment. Common alternatives include refinancing the reverse mortgage loan into a traditional mortgage, or the use of personal savings or funds. Qualifying heirs may also refinance the home into another reverse mortgage.
A reverse mortgage payoff isn’t limited to these options, however. If you would like to make payments on the reverse mortgage during the life of the loan, you certainly may do so without penalty.
On the one hand, a reverse mortgage loan couldn’t be simpler. Instead of paying your lender year after year as you probably did if you had a traditional home mortgage, your lender starts paying you — tax-free money you can use to pay bills, make home renovations, or simply tuck away for a rainy day.
On the other hand, you should be clear about how you would use yours. As flexible as a reverse mortgage is, it is still a loan that must be repaid by you or your heirs. Therefore, include your family in your decision about taking out a reverse mortgage. Also seek the advice of your tax professional and financial advisor. While a reverse mortgage does not impact Social Security or Medicare, it may affect Medicaid or SSI eligibility.
Whatever you do, never rush into making a decision. Gather all the information you can from sources you trust. If this information-gathering takes a few extra weeks or even months, so be it. Remember, a reverse mortgage rewards age. The older you are, the more money you are likely to receive.