Intimidating. Confusing. Scary. These words are the usual reaction to the phrase “reverse mortgage.” And all are applicable. But, that doesn’t mean, under certain circumstances, that a reverse mortgage is not the right vehicle for you.
What exactly is a reverse mortgage? Well, think about your mortgage. In a mortgage, you borrow money from a lender and pay it back with interest over time. In a reverse mortgage, you borrow money from a lender but the lender pays it to you over time and charges you interest that is added to the amount you borrow.
Why use a reverse mortgage? If you are over the age of 62 and have paid off your mortgage so that you have equity in your home (meaning you can borrow against the value of your home) and you have a need or a desire to supplement your monthly income, you can borrow against the equity you have in your home and get monthly checks.
How much you can borrow is based on actuarial tables, and includes the age of the youngest borrower, the current interest rate and the value of the home. The younger the borrower, the less you can borrow. Why? Because in a reverse mortgage, the lender gets paid off when the youngest borrower dies or leaves the home permanently. In the meantime, interest you do not pay is added to the principal of what you borrow so the amount continually increases over time.
Most reverse mortgages today are “home equity conversion mortgages” or HECM mortgages. These are FHA-insured reverse mortgages that allow a borrower who is at least 62 to convert equity in their home into a monthly stream of income, line of credit or lump sum.
How do you qualify to take advantage of a HECM reverse mortgage? The borrower or youngest co-borrower must be 62 or older; the borrower must hold title to the home; any existing mortgage must be paid off before closing and the home must meet certain housing standards (be in good repair). Additionally, the borrower must continue to occupy the home as their principal residence. If the borrower leaves the home for more than 12 months, the reverse mortgage may become due and payable. The borrower must pay the taxes, insurance and maintenance on the home.
A HECM mortgage costs money. First, the borrower will be charged mortgage insurance premiums. Why? Because if the amount you borrow is greater than the amount the home is worth when you die, the insurance goes to pay off the lender for the difference. The borrower will also pay for standard closing costs, including costs of an appraisal, title search, surveys, inspections, recording fees, mortgage taxes and credit checks. The lender may charge an origination fee for processing the HECM loan and the lender may charge a servicing fee over the life of the loan.
What consumer protections do you have as borrower? You have the right to remain in the home indefinitely regardless of how large the loan balance becomes. With co-borrowers like a husband and wife, if one dies, the other has the right to live in the home. So, even if the amount you have borrowed on your HECM mortgage totals $200,000 and your home is worth $100,000, the lender cannot kick you out. You are still the owner of your home, not the lender.
What else? Only FHA-approved lenders may make HECM loans. The loans are also “NON-RECOURSE” and this is important to your heirs. This means that even if the loan is greater than the value of the home when you die, the lender cannot seek repayment of the difference from your heirs or your estate. So, because of the reverse mortgage, your heirs may not get the equity in your home when you die, because you have borrowed against it, but they are not going to be liable to pay the lender back the full value of what you borrowed if your home is worth less than what you borrowed. That is where the FHA insurance comes in to pay off the lender. And, if your home is worth more than what you have borrowed when you die, your heirs will get the difference when the home is sold.
There are no prepayment penalties in a HECM so if you want to pay the mortgage off, you can do so at any time without penalties. Most importantly, borrowers must attend mandatory credit counseling from an FHA-approved independent third-party counseling agency. I like this because these reverse mortgages are complicated and if you are considering one, you need to be armed with all the information about all the consequences before you commit. And, the borrower will receive mandatory extensive disclosures about the HECM.
Another important point: in Maryland, a lender cannot require a borrower to purchase an annuity, a long-term care policy or any other financial or insurance product as a condition to getting a reverse mortgage. Title, flood and hazard insurance would normally be required and are exempt from the prohibition because they are necessary to protect the home.
When does the lender have to be re-paid? When you die, no longer permanently reside in the home, when you have been absent from the home for 12 months, when you sell or make a gift of the home to a third party or if you fail to meet your obligations to pay taxes, insurance and maintenance on the home. If any of these things happen, the borrower has 6 months to satisfy the loan. This can be done by selling the home (remember, the borrower’s estate is not required to pay any difference if the amount borrowed is greater than the value of the home when you sell it).
HECM mortgages come with consumer protections. Proprietary reverse mortgages are non-FHA insured reverse mortgages that do not come with the same consumer protections – there are no limits on fees that can be charged to the borrower and these reverse mortgages are generally taken on high-value homes ($750,000 and more).
Finally, although reverse mortgages provide options for making your retirement years more comfortable by providing you with additional income, remember you are still borrowing money that has to be paid back. Some people will opt to get a home equity line of credit instead. In that case, the borrower gets the additional income but has to pay the lender back on a monthly basis. Whatever option you choose, get yourself educated before you commit to any course of action.
About the Author: Lyn Striegel is an attorney in private practice in Chesapeake Beach and Annapolis. Lyn has over thirty years experience in the fields of estate and financial planning and is the author of “Live Secure: Estate and Financial Planning for Women and the Men Who Love Them (2011 ed.).” Nothing in this article constitutes specific legal or financial advice and readers are advised to consult their own counsel.