Reverse Mortgages 2021

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What is a Reverse Mortgage & How does it work?

As you retire, and your income becomes less steady, most of your wealth might be stored in your home equity. However, there is no way for you to actually access that equity or accumulated wealth unless you sell your home or get a loan using your home as collateral. Reverse mortgages provide a feasible option for you to have a steady income by accessing your home’s equity while continuing to live in your house without the obligation of monthly home loan payments.

What is a reverse mortgage?

A reverse mortgage is a type of loan offered to homeowners who are at least 62 years old and want to supplement their income during retirement. In a reverse mortgage, a homeowner is able to borrow money against their home’s equity and does not have to make any home loan payments as long as they still live in the house as a primary residence. The borrower gets to keep the house’s title, however, he is also still responsible for paying all the other common homeownership costs, such as property taxes.

In order to qualify for a reverse mortgage, the borrower must own the house outright or have at least 50% equity in his home. The balance of the accumulated money borrowed, interest, and other fees charged become due when all the borrowers on the reverse mortgage either die, move away or sell the house. In which case, all or some of the sale’s proceeds will go to the lender to repay the reverse mortgage.

The amount one can borrow through a reverse mortgage depends primarily on the age of the youngest borrower, the interest rate charged, and the home’s appraised value. These factors determine the initial principal limit, also knowing as your borrowing limit. For example, for an average interest rate of 5%, this principal limit can be anywhere from 41% of the home’s equity for a 62-year-old borrower to 74% for a 99-year-old borrower. Out of this principal limit, the amount you can actually access also depends on the payment plan you choose. For example, if you choose to receive the funds in one lump sum payment, 40% of that principal limit is deemed as ‘unusable funds’, while the remaining 60% would be available to you after other deductions such as origination fees, upfront mortgage insurance premium, closing costs and after paying off any existing mortgage.

What you should know

  • Reverse mortgages are for homeowners who are at least 62 years old
  • There are no income or credit score requirements
  • The homeowners must own at least 50% equity in their home
  • The lender makes the payments to you as long as you continue living in the house
  • The loan is to be repaid when the borrower either dies, moves away, or sells the house
  • The amount one can borrow can vary greatly as it depends on the borrowers’ ages, interest rate, home’s appraised value, amount of any existing mortgage, and chosen payment plan

How does a reverse mortgage work?

Regular Mortgage

Reverse mrotgage options

Reverse Mortgage

Reverse mrotgage options

While in a forward mortgage, such as a conventional loan, you use monthly payments to pay off what you borrowed to buy the house, thus slowly building up equity with each payment made, the opposite happens with a reverse mortgage. In a reverse mortgage, the lender makes the payments to you through either a lump sum, monthly payments, a line of credit, or a combination throughout the years, in return for your home’s equity. In other words, the more you borrow, the less home equity you will have but the good news is that you should not worry about paying back the loan.

While you don’t have to make any mortgage payments during the time you live there, the accumulated loan together with its interest and other fees charged is to be paid when the borrower no longer lives in the house. This usually means that the house has to be sold in order to repay the loan unless the borrower’s heirs want to keep the house and repay the loan separately. Lastly, there is a limit to how much you can borrow as the loan amount should not exceed your home’s value.

Reverse Mortgage Requirements

  • All borrowers on the home’s title must be at least 62 years old
  • The home must be the borrower’s primary residence
  • You must own at least 50% of your house’s equity. In the case that your mortgage is not paid off yet, usually, the reverse mortgage will be used to pay the outstanding mortgage first
  • The other homeownership costs are still your responsibility. This sometimes means that you must agree to use some of the funds from the reverse mortgage to pay for things such as property taxes, insurance, maintenance, and repairs
  • You must meet with an approved counselor from the Department of Housing and Urban Development before applying for some types of reverse mortgages (HECMs)

Tax Implications

The money you borrow from a reverse mortgage is tax-free, that is it won’t be counted as income, but rather as an advanced loan. However, the interest charged on the reverse mortgage is not tax-deductible. Since the interest is not being paid, but rather added to your outstanding loan balance, you won’t be able to claim any deductions throughout the years. Only when you repay the loan and all of its interest, you will be permitted to write off the reverse mortgage’s interest as an expense when filing your income taxes.

Types of Reverse Mortgages

There are 3 types of reverse mortgages:

  • Home Equity Conversion Mortgage (HECM) - This is by far the most popular version of reverse mortgages in which the funds can be used for any purpose. HECMs are federally insured mortgages and are only offered by Federal Housing Administration-approved lenders. Although HECMs are considered a safer option because of this, they also come with a lot of upfront costs and mortgage insurance, which makes them quite expensive. How much you can borrow through a HECM is determined by your age, the value of your home, and the interest rates, all discussed in the required HUD counseling session. The limit on your house’s value set by FHA for 2021 was $822 375. This means that for homeowners of houses that are worth more, HECMs might not be the best alternative. Lastly, HECM has additional criteria relating to your property.
  • Proprietary Reverse Mortgage - This is a type of reverse mortgage offered by private lenders who are not federally insured. Contrary to the HECM, there is no house value limit for Proprietary Reverse mortgages, which makes them a more appealing option to homeowners with higher-valued homes. Another reason why you can borrow more with proprietary reverse mortgages is that since they are not federally insured, they do not have upfront or monthly insurance premiums, leaving more room for borrowing.
HECMProprietary
PurposeAnyAny
Backed by governmentYes, FHANo, private
Lending limitYes, $822 375No limit
Insurance requiredYesNo
Counseling requiredYesNo
  • Single-Purpose Reverse Mortgage - This reverse mortgage can be offered by non-for-profit, state, or local government agencies. Contrary to HECM, where the money borrowed can be used for any purpose, with the single-purpose reverse mortgage, you must use the funds for one specific need, such as repairing a part of the house. This is usually the least expensive option out of the three, as far as interest and fees go.

How much can I borrow with a reverse mortgage?

The amount you can borrow with a reverse mortgage depends on several factors, such as:

  1. Age of the youngest borrower
  2. Home’s appraised value
  3. Current Interest rates
  4. Type of Reverse mortgage
  5. Amount of any existing mortgage or large debt
  6. Payment plan chosen

Taking HECM as an example since it is the most popular type of reverse mortgage. To estimate how much a borrower can receive from a reverse mortgage, we’d have to compare the home’s value with the maximum limit of $822375, taking the lower of the two. Then, the age of the youngest borrower and interest rate will determine the principal limit factor, which is the maximum % of the home’s value that a borrower can receive through a reverse mortgage. From this amount, the loan origination fees, closing costs, upfront insurance premium, and any outstanding balance of existing mortgage would be deducted to decide the total amount available to the borrower. Lastly, the amount the borrower can receive as upfront cash is determined on whether he chooses to receive the funds as a lump sum, monthly payments, or line of credit. In the case of the lump sum payment, 40% of the principal limit would not be available for use and would be categorized as ‘unusable funds’. While this is not the case with monthly payments and a line of credit, there are still limitations on how much you can borrow upfront in the first year. The maximum amount one can borrow in their first year is 60% of the borrowing limit.

Forms of Payment

HECM, the most popular type of reverse mortgages, offers a number of different ways in which you can receive your funds.

The Fixed-Rate Payment Plan

  • Lump-sum - You receive all the available funds together as a lump sum and pay a fixed interest rate (usually higher than the adjustable-rate) on it. This option is mostly used by individuals who are looking to pay off an existing mortgage or a different large debt.

Adjustable-Rate Payment Plans

The adjustable-rate payment plans offer interest rates that consist of an index plus a margin decided by the lender. The adjustable interest rate can adjust yearly or monthly based on a benchmark interest rate. There are 5 different options available to you if you want to have an adjustable interest rate.

  • Equal monthly payments as long as the borrower lives in the house - This can be the right choice for you if you plan to live in the house for your whole life or a long period of time. The monthly payments are calculated assuming that you will live until the age of 100, however, the payments will continue even if you live longer.
  • Equal monthly payments for a fixed period of time (Reverse Annuity Mortgage) - If you don’t plan to live in the house for a long period of time and have an idea of when you will move out, getting monthly payments for a set number of months can be more suitable for you.
  • Line of credit - With a line of credit, you get to pay interest on the amount borrowed only and the rest continues to grow at the same interest rate. While this option provides a whole lot more flexibility to someone in accessing their equity as they wish to, it also presents the risk of using up too much too fast.
  • Equal monthly payments for as long as the borrower lives in the house + a line of credit - This option gives the flexibility of not being restricted to only your monthly payment if you experience larger expenses during certain months. How much to allocate to the payments and line of credit is up to you.
  • Equal monthly payments for a fixed period of time + a line of credit - You will be able to get higher monthly payments than with the life-long plans and you can combine these payments with access to a line of credit.

Reverse Mortgages Pros and Cons

To assess if a reverse mortgage is the right decision for you, it is important to be aware of the benefits and drawbacks that reverse mortgages present.

Pros

  • A good way to have access to cash and meet basic living needs
  • You keep the house’s title and can continue living there
  • You do not need to pay for what you borrow as long as you continue to live in the house
  • Even though your credit history will be reviewed in a financial assessment, there are no credit score or income requirements
  • Non-borrowing spouses can continue to live in the property upon the borrower’s death
  • Neither you nor your heirs are liable for any loan amount that exceeds the value of the house
  • There are options available to heirs who want to keep the house, such as purchasing the house at the lower of 95% of the house’s appraised value or the loan balance. They can also choose to refinance the loan.

Cons

  • A large portion of the equity goes to expenses such as interest fees, upfront, monthly insurance premiums, closing costs, which take up from what you can borrow
  • You will still have to continue paying for homeownership costs such as property taxes, maintenance, homeowner’s insurance, etc.
  • You will probably not be able to pass down the house to your heirs
  • You might outlive your loan’s proceeds
  • The loan balance might come due for different reasons, such as if you don’t live in the house for more than 6 months or if you unable to pay the homeownership liabilities
  • If you pass away and you live with a roommate, friend, or relative, they won’t be able to continue living in the house

What alternatives are there to a reverse mortgage?

There are a few options for you to choose from other than a reverse mortgage:

Reverse mrotgage options
  1. HELOC: A home equity line of credit (HELOC) allows you to borrow funds based on home equity. It works like a credit card where funds can be borrowed, repaid, and borrowed again. Most lenders allow you to borrow up to 80% of the home value. You can determine your monthly payment using our HELOC payment calculator.
  2. Home Equity Loan: A home equity loan works similarly to a HELOC where funds are borrowed based on the equity owned in the home. However, instead of it being a credit facility, you receive the funds as a lump-sum amount at the start of the loan. Closing costs are lower for home equity loans than reverse mortgages.
  3. Mortgage Refinancing: Refinancing is the process of getting a new mortgage with better terms and paying off your existing mortgage balance. You can also borrow additional funds by taking out a cash-out refinance. Be sure to check out if refinance closing costs are not beyond the budget as it can be 3% - 5% of the loan balance.
  4. Downsizing: Instead of borrowing funds, you can choose to sell your existing home and buy a new smaller home that will have fewer maintenance costs. The difference in funds can be used for other expenses. Bridge loans can be used if you want to buy and sell a house simultaneously.
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