A reverse mortgage, or home equity conversion mortgage (HECM), is a special kind of loan that gives homeowners access to the equity in their home.
These loans are usually given to older homeowners, allowing them to stop paying their monthly mortgage payments (if they haven’t already).
Reverse mortgage loans are insured by the Federal Housing Administration (FHA).
In a reverse mortgage, your house secures the money you get, and the value of your home determines the amount of money you will receive per month.
In determining your monthly payout, lenders typically factor in 4% annual appreciation, with the actual appreciation (or depreciation) of your home determining your options in the future.
If your house appreciates more than the forecasted 4%, you may be able to pay off the balance of your reverse mortgage and get a second mortgage for a higher monthly payout.
If your house depreciates or stays level, you will most likely continue to receive the same monthly payments.
Either way, it’s a potential win-win for eligible borrowers as long as they are willing and able to pay property taxes, homeowner's insurance, and maintenance fees.
ELIGIBILITY
Potential borrowers must be at least 62 years old and live in the home as their primary residence.
This means second homes and investment properties do not qualify for a reverse mortgage.
If the borrower has a younger spouse (under 62 years of age) when they take out a reverse mortgage, their spouse will be protected by the HECM program if the borrower were to die.
The surviving spouse can keep living in the home without having to repay the reverse mortgage balance as long as they keep up with property taxes, homeowner's insurance, and maintenance.
To qualify for an FHA/HUD-approved reverse mortgage, potential borrowers have to take an informational course with an approved counselor.
These counseling courses are meant to protect potential borrowers from severe financial risks like home foreclosure, and to help borrowers understand precisely what they’re getting into regarding the costs of a reverse mortgage, payment options, tax implication, interest rates, and more.
Financial Assessment
Potential borrowers have to go through a financial assessment before they can qualify for a reverse mortgage.
Even though reverse mortgage borrowers don’t have to make monthly payments, the FHA needs to make sure potential borrowers have the financial ability to pay property taxes, homeowner's insurance, and other property charges.
During the financial assessment, borrowers will be evaluated for residual income (or the income left over after borrowers pay their monthly expenses), credit score, and history.
Borrowers must have made all housing payments on time in the last 12 months and cannot have any major faults in their credit history over the previous 12 months.
Every lender and every borrower is different, so we encourage all potential borrowers to do their research, contact multiple lenders, and receive counseling from certified professionals.
Loan Disbursement
Borrowers have different options when it comes to how their loan is distributed or disbursed.
Depending on the borrowers’ needs or preferences, it’s possible to receive the loan as a lump sum in cash, as monthly payments for a set number of years, as a line of credit, or as a combination of some of these, which only applies to adjustable-rate reverse mortgages.
The fixed-rate reverse mortgage only offers the lump sum disbursement.
REPAYING A REVERSE MORTGAGE
So, how does a reverse mortgage actually work?
These days, a 62-year-old is possibly looking at many more years of life.
What happens if the house doesn’t appreciate and the monthly payments pile up so that the borrower owes more than the house is worth?
For example: Let’s say Bill is 62 and his house is worth $250,000.
The reverse mortgage lender he deals with calculates a $602 monthly payout.
His house doesn’t appreciate at all.
Factoring the interest rate the loan will surpass the value of the house when he is about 80.
If Bill dies at 85, his loan exceeds the value of his house.
In other words, the house is underwater.
Will his heirs have to pay?
The answer is no.
Since reverse mortgages are insured by the Federal Housing Administration (FHA), the house goes into foreclosure and the FHA absorbs the debt.
The homeowner’s heirs are not responsible.
THE FATE OF THE HOME IN OTHER SCENARIOS
What If The Heirs Want To Keep The Home?
Let’s say the heirs of the above example DO want to keep the home.
HUD offers an option for these situations where the heirs can get around the debt.
For houses underwater, HUD will allow heirs to cancel the debt by paying 95% of HUD’s appraisal of the house regardless of what is remaining on the debt.
What if You’re a Non-Borrowing Spouse?
If the borrower leaves behind a non-borrowing spouse, several stipulations allow the bereaved to remain in the house indefinitely while still collecting the reverse mortgage payments.
This can happen provided that, at the time of the reverse mortgage the non-borrowing spouse was under 62 and married to the borrower and remained married until the death of the borrower.
If the house value far exceeds the reverse mortgage loan balance, and the heirs do not want the house, they can sell the house to pay off the balance and keep the remaining money.
If they DO want the house, they have up to one year to pay off the loan balance and thereby retain the house.
If the homeowner has a change of heart and wants to leave the house, they can sell the house to pay off the reverse mortgage balance and keep the remaining money.
Additionally, if a homeowner comes into money somehow and wants to be free of the debt, they can pay off the balance and close the reverse mortgage.
WHEN DOES A REVERSE MORTGAGE LOAN BECOME DUE?
The loan becomes due when the homeowner dies, sells the home, or no longer uses it as a primary residence.
It may also come due should the owner not keep up with property taxes, homeowner’s insurance, and other maintenance expenses, but these defaults are generally rare.
Most defaults on reverse mortgages in the United States are due to borrowers not paying property taxes or homeowners insurance, or for not performing regular maintenance on the property.
The big problem with this is that in the US, these defaults can result in foreclosure.
CLOSING COSTS
It’s important to point out that reverse mortgages come with closing costs, but these usually get rolled into the reverse mortgage loan.
Some of these closing costs include: counseling fees (for the required counseling session with the certified professional), origination fees, third-party fees (third-party services used for title insurance process, appraisal process, escrow, credit reports, etc.), and initial mortgage insurance premium (a one-time payment to FHA to insure the reverse mortgage).
Each of these closing costs can vary from lender to lender, and some may even waive them, but it’s important to take the time to verify which of these costs will apply to you.
Are you 62 years or older? Do you own your house?
Our advertising partner American Advisors Group (AAG) can give you a free information kit on reverse mortgages.
If you want more information on Reverse Mortgages, you can read our review of the top 10 best reverse mortgage companies of 2019.