How a Reverse Mortgage Really Works
What is a reverse mortgage and how does it really work? We get this question all the time, from borrowers, family members and even others in the lending industry and other professional industries who just don’t understand the product. It seems that almost everyone has an opinion on reverse mortgages and often they are based on almost no factual knowledge.
Often people base their opinions on something they heard, some report they read from a reporter who may not have had all the information themselves or were looking to make a sensational article or were just flat out wrong. We have debunked many such articles throughout the years and wanted to take an opportunity to let folks know just what a reverse mortgage really is and give some factual examples as to how they work.
Firstly, reverse mortgages are not for everyone. They have a very important role in many borrowers’ retirement plans, but they don’t work for all borrowers. We recognize that and with the examples we will give, we will also explain when this is not advantageous to borrowers and their families. A reverse mortgage is a loan. It’s not a government grant.
If you take a reverse mortgage, it must be repaid either by you or your heirs with the eventual sale or refinancing of the home if you don’t have the cash assets to pay the loan off and most borrowers do not have that money sitting in a bank account.
How Much Can You Get?
A reverse mortgage is a loan that allows borrowers to use a portion of the equity in their homes to obtain cash that requires no monthly repayment for as long as the borrower continues to live in the home and meet the loan requirements. Borrowers still must pay their taxes, insurance and any other property assessments (i.e. HOA dues) as well as maintain the homes in a reasonable manner just as with any other loan.
Let’s break that down. Borrowers are eligible to receive a portion of the equity in their home. You do not get 100% of the value of your home and because borrowers can live in the home, often for many years without making a payment, that amount will be less than 50% of the value of the home.
The amount for which you will be eligible will depend on several factors that are built into a calculator that HUD uses (or a jumbo-proprietary program that uses their own parameters but works in the same manner). The borrower(s) age, the property value or the HUD maximum lending limit, current interest rates, and if the transaction is a purchase, the purchase price will all affect the amount for which the borrower is eligible. The formula HUD uses takes into consideration actuarial tables since a 62-year-old borrower has a much greater propensity to accrue interest over their remaining life expectancy than an 80-year-old borrower.
If you look at the examples below, you can see what the difference would be in the proceeds between two borrowers living in the same valued homes with the same interest rate on their loans, but one borrower is 62 years of age and one is 80.
Make no mistake, current property values have helped many borrowers get more on their reverse mortgages, but rising rates will wipe that out if borrowers sit on the fence and wait for values to increase.
Look at the second set of examples below and notice what happens to the funds available to borrowers when rates rise just one half to one percent. It takes far more appreciation than most properties will experience to make up for drop in the amounts borrowers receive, even with just a half of a percent increase in the rates.
The next part of the statement about what a reverse mortgage is said that borrowers could “…obtain cash that requires no monthly repayment…”. All borrowers receive the same benefits on the reverse mortgage program based on the calculator results (which take into consideration their age, interest rates and property values). However, one of the biggest caveats that will affect the amount of funds available to most borrowers is that the reverse mortgage must be the only loan on title at the time the borrower closes the loan.
Any current mortgages/liens must be paid in full. If you have two borrowers who both have a benefit of $200,000 under the program and one has a current mortgage of $100,000 and the other borrower’s home is free and clear, the first borrower must first pay off their existing loan and will be left with $100,000 to spend as desired while the second borrower will have the entire $200,000 available. The first borrower will not have as much cash available, but that borrower will also no longer be paying the monthly payment on the old $100,000 loan.
Borrowers receive full disclosure of the amounts available to them for the life of the loan long before they close and have many options as to how they can receive their funds. After any existing loans are paid in full, borrowers can choose to receive their remaining funds as a lump sum (fixed or adjustable but there may be limits on fixed rate draws in the first year if the funds are not being used to pay off existing liens or purchase a new home), as a line of credit they can access when they wish, borrowers can choose a monthly payment for a set amount or period of time that will be paid as long as they choose and as long as they have funds remaining in their loan (known as a term payment), or they can choose a payment as determined by the calculator that will continue for the life of the borrower as long as they live in the home (Tenure option).
There are some examples below of the different options for a 75-year-old borrower with no existing mortgage to pay off.
Each Payment Option has its Pros and Cons
Each option has its positives and potential drawbacks. For example, the fixed rate loan is a one-time draw only and borrowers must take all the funds available at the inception. If you need all the money from the start to purchase the home or to pay off your existing loan, this might be a good choice and it would keep your interest rate from rising in the future.
On the other hand, if you want a line of credit or a monthly payment option, then the only options available are the adjustable rate options. The loans do have annual and life time caps, but the rates can increase over time. Another positive factor on the adjustable rate options though is that the amount of the loan that you do not use will grow over time at the same rate your loan accrues interest and mortgage insurance.
In other words, if you have money available to you on your line, that amount will grow by the interest rate plus the mortgage insurance accrual rate annually. For a $200,000 line of credit with a 5% interest plus the MIP accrual rate, that equates to $10,000 in the first year of growth. The next year, the line of credit would grow at the rate in effect at that time but on the new balance of $210,000.
This is not interest that anyone paid to you and if it is ever explained to you this way, that is an absolute mischaracterization of the treatment of the growth of the line. This is a credit line increase that is available to you because you didn’t use all your funds and accrue as much interest as someone who did.
If you do use the line later, they are borrowed funds and they would be repaid when the loan is repaid unlike interest earned as in money in a bank account that belongs to you and you don’t have to pay the bank back when you take it out of your account.
Line of Credit Growth Rate Example
(after 12 full months)
|Available Line of Credit
(Starting at $200,000)
Since a reverse mortgage is a loan, you accrue interest on the money you borrow. There is no payment required so the balance grows and as the balance grows, so does the amount of interest you accrue. There is never a payment due with a reverse mortgage, but there is never a prepayment penalty either. Borrowers who do not wish to see their balance grow solely due to the accumulation of interest can make payments of any amount at any time.
The beauty of this is that since there is no payment due, there are no due dates, no minimums due and if it is not convenient to make a payment in any given month even if you want to, there are no negative ramifications to your credit, etc. if you choose not to pay sometimes.
Borrowers have complete control. They can allow their balance to grow, they can keep it level by paying any interest due or they can reduce it by paying more than the accruing interest – but they don’t have do anything but live in the home as their primary residence, pay the taxes and insurance along with any other assessments and maintain the home. The last thing borrowers need to consider is the effect the loan will have on heirs.
Effects on Family Members
The biggest complaint I hear is mostly from heirs who may be current spouses who were not married to the borrower at the time the loan was received, family members who were shocked when they learn of the existence of the reverse mortgage or of others who moved in with the borrowers but now learn they cannot remain in the home under the terms of the loan after the original borrowers have all permanently left the home.
As I started out by saying, the loan uses certain known factors to determine benefits. Therefore, the reverse mortgage does not allow assumption of the loan by new borrowers or the addition of new spouses, etc. after the loan has closed that would skew all the loan assumptions. If borrowers want new spouses to be included in the security of a reverse mortgage, they must be willing to refinance into a new reverse mortgage in both borrowers’ names.
Family members need to realize that discussing the ramifications of the reverse mortgage and effects on the amounts left to heirs should take place long before the passing of the individual(s) who felt it necessary to get the loan in the first place. If the senior homeowner feels that some assistance is necessary, but family members do not want to see their inheritance lowered, perhaps family members can all pool together and create a family reverse mortgage of their own whereby the family members provide for the seniors’ needs and then are repaid with the selling of the home.
Ultimately, the heirs would save the amount of the interest and costs, but they would have to be certain they had the wherewithal to be able to meet the homeowners’ needs in addition to their own cash expenditures until that time came. Otherwise, the reverse mortgage allows senior homeowners the freedom to age in place or to buy a home that better suits their needs without having to rely on family members when their income and/or savings would not otherwise permit or without requiring them to utilize all their savings to do so.
It gives them the option of making a payment without the requirement to do so and since they always own the home, they can sell or pay the loan off for any reason at any time without penalty. What makes a reverse mortgage right or wrong is whether it is right or wrong for your circumstances, not what happened to your friend’s mother’s uncle when he died, and the family didn’t get the inheritance they expected.
The experts at All Reverse Mortgage® are here to answer all of your questions! If you would like to see some examples of how a reverse mortgage can work for you, request a quote here or call our experts at Toll Free (800) 565-1722