Reverse Mortgages 2021

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What is a reverse mortgage?

Reverse mortgage is the process of taking a loan by accessing the equity you own in the home. As the name suggests, the homeowner receives money from the lender and in return, they give up part of the equity ownership in the home. Just as when an individual takes a mortgage and makes monthly mortgage payment to own more of the home, in this case, the lender pays the individual to own part of the home. Reverse mortgages are for homeowners who are 62 years and older and are looking to supplement their income to cover their expenses. All proceeds from a reverse mortgage are tax-free.

The homeowners who use a reverse mortgage are not liable to pay back the loan unless the home is sold or vacated. No monthly loan payments have to be made by the borrower as long as they stay in the home during that period. The loan is payable when the individual who owns the home dies, moves away, or sells the house. The borrower still has to pay property taxes, homeowner’s insurance, and any HOA fees.

How does a reverse mortgage work?

In a traditional mortgage process such as when you get a conventional loan or a government-backed mortgage, you as the borrower get funds from the lender. The funds you receive for the mortgage are used to purchase a portion of the house and your ownership stake in the home increases. During the term of the mortgage, you make monthly mortgage payments to the lender to pay off your debt.

Traditional Mortgage Process

A reverse mortgage is different from a traditional mortgage. In this case, you are again borrowing funds from the lender, but based on the equity you own in the home. Instead of you making the payments to the lender, the lender makes payments to you and in return the lender starts owning a portion of the home. Over time your level of debt rises as you borrow more from the lender, and simultaneously your home equity decreases. The home is the collateral, once the owner moves or dies, the lender is paid back the entire amount and any accrued interest.

Reverse Mortgage Process

What are the eligibility requirements to get a reverse mortgage?

You have to meet certain eligibility criteria in order to get a reverse mortgage loan:

  1. 62 years and older
  2. Primary residence
  3. Must own a majority of the home with minimal existing mortgage balance
  4. All property taxes, homeowner’s insurance, and HOA fees must be current and paid
  5. No other forms of federal debt
  6. Eligible property – single unit, multi-family, condominium, and townhouse
  7. Educational session with a HUD-approved counselor

How much can I borrow with a reverse mortgage?

The average amount you can borrow is 60% of the total equity you own in the home, for example, if you have $300,000 in home equity, you can borrow $180,000. However, the actual amount you can borrow depends on several factors such as:

It will vary from lender to lender based on these factors, hence, it is important to do your research and shop around several lenders. In most cases, if you have more equity in the home or own the home outright, you will receive the maximum amount allowed by the lender.

There is flexibility in how you want to receive the funds:

  1. Single Lump-Sum Amount: You receive the entire borrowed amount in one go at the beginning of the reverse mortgage. This can only be accepted for a fixed-rate loan and will result in a lower borrowing amount as the risk for the lender rises.
  2. Fixed Annuity: You will receive a fixed monthly amount for a certain period of time such as 10 years.
  3. Tenured Annuity: You will receive funds monthly for the rest of your life
  4. Credit Line: You can draw funds from the reverse mortgage and pay it back, giving you the option to draw the funds again, like a credit card or HELOC. You only have to pay interest on the outstanding balance and not on your total loan amount.
  5. Combination: You get monthly payments and access to a line of credit

What are the different types of reverse mortgages?

There are 3 different types of reverse mortgages for different financial needs.

Home Equity Conversion Mortgage (HECM)

Home equity conversion mortgage (HECM) is the most common and popular type of reverse mortgage as it is insured by the federal government. The insurance results in higher upfront expenses, however, there are no income limitations and the funds can be used for any purpose. HECM’s are provided by FHA-approved lenders and in the event the amount you borrow is more than the value of the home, the FHA will cover all or most of the loss. As a result of this, you will need to pay for mortgage insurance which can be financed into the loan. The HECM mortgage limit for 2021 is $822,375 increasing from $765,600 in 2020.

Proprietary reverse mortgage

If you have a home that is valued at an amount greater than the limits set for the HECM then a proprietary reverse mortgage is used. These mortgages are not insured by the government through the FHA as they are too large. For example, in 2021 if your home’s value is greater than $822,375 then a proprietary reverse mortgage should be used to borrow a larger amount.

A proprietary reverse mortgage is used for jumbo loans as these loans are larger than the conforming loan limits and FHA loan limits. The fees for this mortgage are higher than HECM, however, the eligibility requirements can be easier as the private lender has more flexibility in who they accept.

Single-purpose reverse mortgage 

This type of reverse mortgage is offered by non-profits, state and local government agencies. It has the lowest fee compared to the options as this is targeted towards low to moderate-income earners. Lenders can restrict how the funds are used as it is meant for specific purposes such as mortgage payments, handicap remodeling, paying taxes, etc. The amount that can be borrowed is less than the other two types of reverse mortgages, however, the interest and fees are smaller.

What are the costs of getting a reverse mortgage?

Just like a mortgage, reverse mortgages also have closing costs which can be a significant amount for most homeowners. Costs can vary based on the type of reverse mortgage being used, proprietary reverse mortgage costs are based on the private lender and single-purpose reverse mortgage is cheaper and dependent on the agency.

HECM which is the most popular type of reverse mortgage has the following costs:

  1. Mortgage Insurance: as the loan is insured by the FHA, the insurance premium has to be paid by the borrower. At closing the borrower has to pay 2% of the loan amount as initial upfront MIP and an annual MIP of 0.5% of the outstanding balance. You can choose to finance these costs into your loan, however, it reduces how much you can borrow.
  2. Loan Origination Fee: Processing your reverse mortgage is the largest expense to get a reverse mortgage. Lenders charge the greater of $2,500 or 2% of the first $200,000 of the home value, following which 1% is added if the home value is greater than $200,000. The maximum fee that borrowers can pay is capped at $6,000.
  3. Service Charge – There is some additional fee to maintain the HECM, lenders will charge up to $35 per month based on the size and type of the loan.
  4. Third-Party Fees – Appraisal, home inspections, flood checking, title search and insurance, and other fees will add to the closing costs. A full list can be found on our closing costs page.

Pros and Cons of a reverse mortgage

What is the upside to a reverse mortgage?

  1. No monthly repayments are required for the reverse mortgage
  2. No restrictions on how the proceeds are used unless it’s a single-purpose reverse mortgage
  3. Funds can be used to supplement retired individuals’ income
  4. Spouses can remain in the home after the borrowing spouse dies

What is the downside to a reverse mortgage?

  1. House maintenance, property tax, homeowner’s insurance, and HOA fees still need to be paid by the homeowner
  2. A reverse mortgage involves selling home equity which can reduce your overall estate and inheritance.
  3. Fees and closing costs are high which can reduce the overall amount that can be borrowed

Should I get a reverse mortgage?

There are several factors to consider getting a reverse mortgage:

  1. Supplement Income: It can be a great source of income during retirement to supplement your savings. HECM can be used for any expenses from medical, food, or taxes.
  2. Flexibility: The proceeds from a reverse mortgage can be obtained in numerous ways from lump-sum amounts to periodic annuities. You can tailor the proceeds to your expenses such that when you receive a reverse mortgage payment it will be used to cover the expense due at that point in time.
  3. Home Appreciation: If the home appreciates and becomes worth more than the reverse mortgage balance, you can receive the difference.

However, there are also several reasons to be vary of reverse mortgages:

  1. Home Depreciation: By chance, if the value of the home falls and it’s less than the value of the reverse mortgage loan then you might need to foreclose on the home or give the ownership to the lender.
  2. Deceased Borrower: There can be several complications when the borrower passes away such as for the individuals living in the home, heirs, and repayment of the reverse mortgage loan balance. The family can keep the home if they repay the mortgage balance.
  3. Scams: As the target market for reverse mortgages are elderly retired people, lenders often use high-pressure sales techniques which can often confuse the potential borrower. Therefore, it is essential to go to a trusted advisor or lender.

What alternatives are there to a reverse mortgage?

There are a few options other than a reverse mortgage:

  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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