What is a reverse mortgage?
A reverse mortgage can be a powerful way to secure extra money to use as you see fit. You won’t have to sell your home or pay additional monthly bills.
Most reverse mortgages are federally insured Home Equity Conversion Mortgages (HECMs) that come with no limits on what you may do with your money.
You may use the money to cover living expenses, pay medical bills, complete home projects or go on vacation.
In fact, if you have an existing mortgage, you can use the reverse mortgage money to pay it off.
However, reverse mortgages aren’t free to get, and they’ll burn up the equity in your home, meaning less money for you or your heirs when it comes time to sell.
How does a reverse mortgage work?
In a regular mortgage, you borrow money to buy a house and pay the lender monthly to pay off your property. In a reverse mortgage, the lender pays you for equity in your property.
Basically, you keep the title to your property and get an advance on your equity in exchange for the lender owning a stake in your house.
The payments you receive from a reverse mortgage aren’t taxable and won’t affect your Social Security or Medicare benefits.
In most cases, you don’t have to pay the lender back until you either move out of the property, sell your property — or pass away.
This often results in a decision to sell your home to pay off the debt you’ve accumulated, though your spouse or kids could choose to get a new mortgage to pay off the debt and keep the home.
Most reverse mortgages have a non-recourse clause that states you cannot owe more than the appraised value of the home when the loan is due. That means that when you die, you won’t have to worry about your heirs owing any money.
Who is eligible for a reverse mortgage?
To qualify for a reverse mortgage, you need to be 62 years of age and have either paid off a significant amount of your home loan (typically 50%) or own the property outright.
You must use that address as your primary residence, not be delinquent on any federal debt and have enough cash coming in to pay the costs associated with maintaining your property — such as property taxes, Homeowners Association fees, home insurance and repairs.
The property must be a single-family home or have no more than four units. As long as it’s approved by the Department of Housing and Urban Development, the HECM program can allow you to take a reverse mortgage out on your condominium.
Like a traditional mortgage, you also have to meet some financial standards to qualify for a reverse mortgage. You have to verify your income, assets, monthly living expenses and credit history and prove that you will pay your property taxes and home insurance premiums in a timely manner.
Are there different types of reverse mortgages?
You have a few options for reverse mortgages — some of which are backed by the federal government, some of which are not.
Home Equity Conversion Mortgage
The most common type of reverse mortgage, the Home Equity Conversion Mortgage (HECM) is a government-issued loan that can only be received from a Federal Housing Administration (FHA) approved lender.
To qualify for this type of reverse mortgage, you’re required to take part in a consumer information session given by an HECM counselor approved by the Department of Housing and Urban Development. They will walk you through everything that a HECM entails and help you figure out if this financing option is right for you.
Because these types of loans are heavily regulated, there are a lot of hoops you have to jump through. But an HECM also allows for more flexibility in how your loan gets paid to you.
Your HECM can take the form of a tenure payment plan, offering small monthly payments for as long as you stay in the home; a term payment plan, with larger monthly payments over a fixed period; a line of credit, allowing you to take what you need when you need it; or a modified plan that combines a tenure or term payment plan with a line of credit.
Single-Purpose Reverse Mortgage
Single-Purpose Reverse Mortgages are government-regulated mortgages that are for — you guessed it — a single purpose. The purpose of the loan must be approved by the lender and used for that explicit purpose only.
Because Single-Purpose Reverse Mortgages are so inflexible, they tend to be the least expensive type to take out. They’re also easier to qualify for, which means low- to moderate-income households have easier access to their equity.
Unlike HECMs, Single-Purpose Reverse Mortgages are only paid out in a lump sum. These types of loans are not available in every state, so check to make sure you live in an area that offers them.
Proprietary Reverse Mortgage
Unlike HECM or Single-Purpose Reverse Mortgages, Proprietary Reverse Mortgages are not backed by the federal government. They’re offered by private lending companies and often have more relaxed eligibility requirements.
Because they’re not federally insured, you have a lot of flexibility with how you use the loan amount. This freedom can come at a cost, as these types of reverse mortgages have fewer protections in place for people who take one on.
There’s more power in the lender’s hands. They determine eligibility, loan terms and amounts. While you might be able to get a bigger loan using a Proprietary Reverse Mortgage, it can come at the cost of higher interest rates.
As these types of reverse mortgages can be riskier, you should do extensive research to see if this is right for you before committing to one.
How much money can I receive with a reverse mortgage?
A number of factors determine the amount you receive with a reverse mortgage.
The general rule is, the older you are and the higher the value of your property, the more you can qualify for. The age is based on the youngest borrower or non-borrowing spouse in the home.
The type of loan also affects the amount of money you receive. HECM amounts are limited by the appraised value of the property and capped by the FHA mortgage limit of $970,800.
Single-Purpose Reverse Mortgage amounts are usually smaller, as you are only tapping into your home equity for a specific purpose.
Proprietary Reverse Mortgages can give you the most money, as it’s up to the lender. This type of mortgage can even allow homeowners to borrow more of their equity or include homes that exceed the FHA limit. But these types of reverse mortgages tend to come with higher interest rates.
What can you use a reverse mortgage for?
Depending on the type of reverse mortgage you qualify for, it’s really up to you how you want to use the money.
HECMs and Proprietary Reverse Mortgages are very flexible in the ways you can use the money.
Single-Purpose Reverse Mortgages, much as the name suggests, require you to use the money for a specific purpose approved by your lender.
Many people use their reverse mortgages to pay for living expenses, home renovations or leisure activities, such as travel. They can also be used to pay off your existing mortgage, so you don’t have to worry about monthly payments.
Are there any fees/costs for a reverse mortgage?
Similar to a regular FHA loan, a HECM will see you pay mortgage insurance premiums (both upfront and annually) to guarantee you receive the money you’re expecting.
The upfront fee is 2% of your home’s value, though it’s typically rolled into your loan amount. The annual fee is 0.5% of your loan’s total balance.
Then expect your lender to hit you with its own charges, like origination fees, service fees and closing costs. With a HECM, lender fees are capped at $6,000.
Origination fees compensate the lender for processing your mortgage. The fee will either be $2,500 or 2% of the first $200,000 of your home value with 1% on anything over, whichever is greater.
Monthly service fees compensate the lender for sending account statements, disbursing loan proceeds and making sure your loan requirements are met — like paying taxes and insurance premiums. The fee can be no more than $35 if your interest rate is adjusted monthly or $30 if it’s adjusted annually or fixed.
Closing costs can vary depending on the lender and type of reverse mortgage you choose. They pay for things like an appraisal, title search and insurance, surveys, inspections, recording fees, mortgage taxes and credit checks.
You’ll most likely be paying for all of this if you go with an HECM, but Single-Purpose Reverse Mortgages are able to omit some of these costs.
Proprietary Mortgages have fewer fees associated with them. Most don’t require mortgage insurance fees — but there’s a tradeoff.
Because they’re so heavily regulated by the federal government, HECMs and Single-Purpose Reverse Mortgages will usually have lower interest rates than Proprietary Mortgages, which are run by private lenders at whatever rates they choose.
You are able to finance some of these costs, but that will effectively decrease the size of the loan available to you. Make sure to review your financing options.
Alternatives to a reverse mortgage
A reverse mortgage isn’t the only way to tap into the equity of your home for extra cash. If you’re under age 62, or you think you might leave the home someday, you’ll want to consider other options.
A cash-out refinance allows you to replace your current mortgage with a bigger one and pocket the difference. You’ll typically be forced to keep at least some equity in your home — perhaps 20%. Like any normal mortgage, you’ll make monthly payments on the new loan, with interest.
A home equity loan is a second mortgage on your home that allows you to access some of your current equity (often 75% to 90% of it) in a lump sum. You’ll now have two sets of monthly payments, and a home equity loan typically carries a higher interest rate than a first mortgage.
A home equity line of credit (HELOC) is similar but acts more like a credit card. Instead of a lump sum, you get a pool of cash you can access at will, and you’ll only accumulate interest on the amount you pull out and don’t replace. The “draw period” is determined by your lender and typically ranges from five to 25 years — once it’s over, you’ll have to repay any outstanding cash.
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