At first blush, a reverse mortgage sounds sweet to those of us who are 62 years or older and who may be afraid of running out of retirement savings. It may also look like a good option for those of us rounding the bend of middle age and seeing our retirement years on the road ahead.
Many of us are struggling to save for retirement, with less than two-fifths of us believing we are on track for saving a sufficient amount of funds. However, at least 75% of Americans ages 45 years or older do own their home, making a reverse mortgage especially attractive to those who have a lot of equity in their house.
A reverse mortgage gives you access to a portion of that equity while you remain in your home with no monthly premium payment. The loan doesn't become due until you move, sell the house, pass away, or fail to comply with the loan’s requirements (maintain the property, for instance). You can choose to get your payment in a lump sum, as a line of credit, a monthly payment, or in combination (with a partial lump sum).
Sounds too good to be true, right?
Obtaining a reverse mortgage has its pros and cons. One of the major negatives is having to deal with the possibility of foreclosure. From April to December 2016, there was an average of 3,663 foreclosures per month on reverse mortgages, a significant increase from an average of 491 per month during the previous seven years. Foreclosure is one of the big risks with traditional mortgages as well as reverse mortgages.
Foreclosures do work differently between the two types of mortgages. Let’s first review what a reverse mortgage is before we go over what foreclosure entails in a traditional mortgage versus a reverse mortgage.
What is a Reverse Mortgage?
There are three types of reverse mortgages currently available.
Home Equity Conversion Mortgages
Home Equity Conversion Mortgages (HECM) are federally-insured loans backed by the Federal Housing Administration (FHA) that are only available through FHA-approved lenders.
HECMs are the most common type of reverse mortgage loans but can carry a high-interest rate along with other charges and fees including initial and annual mortgage insurance premiums, third-party lender fees, an origination fee, and other processing fees. There is also a maximum loan limit of $679,650 as of January 2018.
Proprietary Reverse Mortgages
Proprietary Reverse Mortgages are private non-insured loans backed by mortgage companies. These loans may work for you if you own a higher-value home with a low mortgage balance. Interest rates tend to be high as are closing costs and fees.
In 2017, the Department of Housing and Urban Development (HUD) updated the HECM guidelines, causing a downswing in new HECM loans. With this shift, more private lenders moved into this market.
Single-Purpose Reverse Mortgages
Single-Purpose Reverse Mortgages are offered by some state or local government agencies and nonprofits.
This type of loan is not available in every state. Valid single purposes include home repairs, property taxes, and home renovations. This is the least expensive reverse mortgage loan.
How do Reverse Mortgages Work?
One of the first steps to take before choosing to go with a reverse mortgage is to talk to a HECM counselor to discuss your personal situation, the program’s eligibility requirements, and any financial implications.
You will have to work with an FHA-approved lender to obtain a HECM loan.
Borrower Requirements
- Attend the HUD-approved HECM counselor meeting
- Be 62 years of age or older
- Occupy the home as your primary residence
- Have no delinquency on federal debt (student loans, for instance)
- Paid down a significant portion of the mortgage or own your home outright
- Have a savings reserve to cover taxes, insurance, and other expenses
Financial Requirements
- Your assets, debts, monthly expenses, credit history, and real estate tax payment history
Property Requirements
- Single-family or multi-unit home with one unit occupied by the borrower
- HUD-approved condo complex
- FHA approved manufactured home
- Current appraisal
Mortgage Amount
- Your age, your non-borrowing spouse, or the youngest borrower’s age on the loan
- Current interest rate
- The appraised value of your home or the HECM maximum limit, whichever is less
Payment
- As stated above, you can choose to receive the payment in one lump sum, as a line of credit, a monthly payment, or in combination. If you are not financially disciplined, experts recommend you do not take a lump sum or line of credit payment and instead go with a monthly payment where you have some protection from overspending the loan.
What is a Reverse Mortgage Foreclosure?
There might be a misconception out there that a foreclosure is not possible with a reverse mortgage. That is not true. Let’s look at the different types of mortgage loan foreclosures.
Traditional Mortgage Foreclosure
With a traditional mortgage, a loan goes into foreclosure after the borrower misses four monthly premium payments (typically). Many borrowers get behind on their mortgage payments but can catch up. It’s always wise to talk to your lender as soon as possible if you get behind in payments.
Most lenders will work with you on a payment plan. After the missed payments, the lender will notify the borrower that they have 90 days before it officially forecloses. If the borrower cannot return the payments, the lender will take possession of the home.
Reverse Mortgage Foreclosure
With both types of loan, foreclosure ultimately results in the transference of a home’s title from the borrower to the bank.
With a reverse mortgage loan, payment does not become due until the borrower:
- moves out
- sells the home
- passes away
- does not maintain the property
- doesn't pay taxes or insurance
- fails to follow the loan’s guidelines
When one of these events occurs, the full amount of the loan becomes due.
The reverse mortgage lender sends a Due and Payable letter to the borrower, which lists the amount due and options for paying it back to avoid foreclosure. The borrower or heir can pay the loan balance or 95% of the appraised value of the home, whichever is less and can request two 90-day extensions if needed. If the borrower or heir cannot pay back the loan, then the lender takes possession of the home.
Note: with a reverse mortgage the amount due can be substantial because the entire loan plus accrued interest and any finance fees and charges become due.
What to Watch Out For
- Don’t go for the sales pitch: only work with a trusted lender and pay attention to all the loan details, especially the fine print.
- You may owe more over time: if you roll in closing costs and other finance charges and fees, and your loan has a higher interest rate or variable interest rate (which can increase quickly), you may end up owing a lot more than your current mortgage.
- The interest on a reverse mortgage is not tax deductible until the loan is paid in full.
- You may lose federal benefits such as Medicaid or Supplemental Security Income by taking out a reverse mortgage.
- If you are leaving your home to a family member, then they will be responsible for paying the loan in full when it becomes due. The loan amount may be greater than the value of the home. If you have a HECM loan, then your heirs don't need to worry because the government will pay the difference.
- Work with the HECM counselor: this could save you and your family a lot of heartache in the long run.
As tempting as a reverse mortgage may sound, especially to those of us who haven't saved enough for retirement, it may not be the best approach for everyone.
Work with your financial advisor and the HECM counselor before making a final decision.
Remember that if you have a lot of equity in your home, you can receive a higher loan amount. And if you have other assets that could help cover the loan once it becomes due, then a reverse mortgage may make sense for you.
As an alternative, you can look into a home equity line of credit (HELOC) from a reputable company.
Just take your time and do your homework. This is a big decision to make as you travel your road to retirement.