Reverse mortgages have gotten a lot of much more favorable press lately as much of the hysteria has started to disappear and people are actually looking at the program and what it really does, not what they heard it does from some unnamed source. We’ve spent hours responding to negative articles in years past that were written by reporters who completely misrepresented the facts and tried to sensationalize their opinion by reporting something that just wasn’t true but they either didn’t take the time to investigate the real story or they didn’t understand it well enough themselves to be able to give a fair accounting of the facts. Because of these misrepresentations and half-truths floating around, many borrowers and their families feared reverse mortgages without ever know what they really were or how they really worked.
We’re going to pull back the curtain and let you see what a reverse mortgage is and how it works right now. We are a little unique for a reverse mortgage lender in that we don’t believe that the reverse mortgage is right for every borrower. That’s right, we actually believe that there are many folks who should not get a reverse mortgage and we will cover that in this article as well. People used to believe that the reverse mortgage was the loan of last resort. That simply isn’t the case and we will dispel that myth as well.
Let’s start by clearly defining what a reverse mortgage is. A reverse mortgage is a loan. It’s not a government grant program. You are not selling your house to anyone. Just like any other loan, you have certain obligations to maintain your home, to pay your taxes and insurance. The reverse mortgage allows you to stay in your home until the last borrower on the loan (or under the current guidelines, a qualified spouse who is under the age of 62 at the time the loan is obtained and is recognized as a Non-borrowing spouse) permanently leaves the residence. That would mean death or moved out of the house and HUD considers an absence of 12 months or more permanently leaving so vacations, trips to the summer home and short (up to 12 months) stays in the hospital are not considered permanently leaving.
A reverse mortgage is different than a traditional or forward loan in that it operates exactly in reverse. The traditional loan is a falling debt, rising equity loan while the reverse mortgage is a falling equity, rising debt loan. In other words, as you make payments on a traditional loan, the debt or the amount you owe is reduced and therefore the equity you have in the property increases over time. With the reverse mortgage, you make no payments so as you draw out funds and as interest accrues on the loan, the balance grows and your equity position in the property becomes smaller. There is a secret here though that I’m going to let you in on. There is never a payment due on a reverse mortgage but there is also no prepayment penalty of any kind with a reverse mortgage. In other words, you can make a payment if you wish at any time up to an including payment in full without penalty. Many borrowers choose to repay some or all of the accruing interest or whatever amount they desire, the choice is the borrowers but there is no payment required.
A reverse mortgage loan amount is determined differently than a standard or forward mortgage and you don’t hear people talking about the “Loan to Value Ratios” like you would on a traditional loan. On a traditional loan, the lender agrees to lend a set amount that is determined as a percentage of the value of the home and can change based on a number of factors including borrower’s credit, the required loan amount, the property type, etc. With a reverse mortgage, there are a number of factors input into a calculator and the borrowers’ benefit amount or Principal Limit are determined based on the borrowers’ age(s), the value of the home or the HUD lending limit (whichever is less), and the interest rates in effect at the time. From the Principal Limit any costs to obtain the loan are subtracted, any existing mortgages and liens must be paid in full and any remaining money is the borrowers’ to do with as they please. The current HUD lending limit is $625,500.
Because borrowers are not required to make any payments, the interest accrues on the balance and the entire loan is paid back when the last borrower permanently leaves the home, the younger a borrower is, the less they will receive under the program based on the HUD calculator. All borrowers have to be a minimum of 62 years of age. The Principal Limit is determined based on the age of the youngest borrower on the loan because the program uses actuarial tables to determine how long borrowers are likely to continue to accrue interest. (Link to HUD.Gov HECM Actuarial Review)
If there are multiple borrowers, then the age of the younger borrower will lower the amount available even when an older borrower is also on the loan because the terms allow all borrowers to live in the home for the rest of their lives without having to make a payment. Of course there will always be exceptions, but the premise is that a 62 year old borrower will be able to accrue a lot more interest over his/her life than an 82 year old borrower with the same terms and so the HUD calculator allows the 82 year old borrower to start with a higher Principal Limit.
There are a number of different ways borrowers can opt to take the funds available to them on a reverse mortgage. They can take a lump sum draw of the funds available to them (and I will get into this further in a minute), they can get a line of credit that they can access as they choose, they can get a payment for a set amount and period of time known as a Term payment or can opt for a Tenure payment which is a guaranteed payment for life as long as they live in the home. In addition to these options, they can use a modified version of each and “blend” the programs if you will.
For example, a borrower in Southern California born in 1951 owning a $385,000 home that has no mortgages may decide it’s time to get a reverse mortgage. Our borrower would like $50,000 at closing to make some changes to the property and to fund a college plan for her grandchild. She has additional income that she will begin receiving in 4 years but until then, would like to augment her income by $1,000 per month. She can take a Modified Term loan with a $50,000 draw at closing and set up the monthly payment for 4 years of $1,000 per month. That would leave her an additional $107,000 in a line of credit that she would have available that she could use or not, completely her choice. If she does not use the line, she does not accrue interest on any funds she does not use and the line of credit grows on the unused portion.
This credit line growth is what all the folks, including financial planners, are really starting to sit up and take notice of. Let’s go back to the $200,000 credit line shown above. As we discussed earlier, many people considered the reverse mortgage the loan of last resorts in the past. But let’s consider another borrower who is a savvy planner and is planning for her future needs. She has the income for her current needs but is concerned that she may need more money later. So she obtains her reverse mortgage and has that same $200,000 line of credit available to her after her costs to obtain the mortgage. Her line of credit is growing at the same rate on the unused portion of the line as she would have been accruing all interest and mortgage insurance premium had she borrowed the money. If rates don’t change, in 10 years that line of credit available to her would be over $350,000. In 15 years that line would grow to almost $500,000 and in 20 years when she may need the funds the most, her line would have more than $660,000 available to her. If interest rates go up 1% in the third year and one more percent in the 7th year, after 20 years the borrowers available line of credit would be over $820,000.
Now this is not income, it’s not interest that anyone is paying to you and if you do borrow the money, you owe it and it will accrue interest once you do borrow the funds. You or your heirs would have to pay it back when the property sells. But where else can you ensure that you will have between $660,000 and $800,000 available to you in 20 years? The calculator is shown below and you can see the very modest rate increases used. If the accrual rates rise more, the growth rate will be higher.
The fixed rate option requires borrowers to take a lump sum draw, meaning borrowers must take the full draw of all the money available to them at the close of the loan. They cannot leave any funds in the loan for future draws (there are no future draws allowed with the fixed rate). The reason for this is also because of growth of the line. As you can see, the growth rate can be quite substantial and if there were many borrowers with yet unused funds who borrowed at low fixed rates but wanted to finally access their funds years later after rates had risen, borrowers would have substantially higher funds available to them at rates that were not available and lenders might not be able to cover the demand of below market requests for funds. Therefore, HUD stopped the fixed rate line of credit when some lenders attempted to offer the product over a year ago.
Due to the fact that borrowers experienced a much higher default rate on taxes and insurance when 100% of the funds were taken at the initial draw, HUD changed the method by which the funds would be available to borrowers which no longer allows all borrowers access to 100% of the Principal Limit at the close of the loan. The new parameters coincide with how much of the money is needed to pay off existing loans and liens on the property. HUD calls these necessary payoffs “mandatory obligations”. Borrowers have access to up to 100% of their principal limit if they are using the funds to purchase a home or to pay mandatory obligations in conjunction with the transaction. Borrowers can also include up to 10% of the principal limit in cash (up to the maximum Principal Limit) to be paid to the borrower above and beyond the mandatory obligations if needed so that the borrower can still get some money at closing. Let’s use some round numbers for examples to illustrate this. If a borrower has a $100,000 principal limit and they have no loans/liens on their home, they can take up to 60% or $60,000 of their proceeds at closing or any time in the first 12 months of the loan. The remaining $40,000 is available to the borrower any time after 12 months.
This is where the fixed rate loan starts to impact borrowers the most now. If you do not have existing liens to pay off, you would lose the availability of the remaining funds after the initial draw. In other words, in our example, the fixed rate borrower would receive the $60,000 but since the fixed rate is a single draw, there would be no further access to funds and so they would not be able to receive the additional $40,000 and would forfeit those funds. If the entire $100,000 was being used to pay off an existing loan, either program would work equally well because all the money would be required to pay off the mandatory obligation (the existing loan) and HUD allows that.
Now comes the tricky part. There is mortgage insurance on all government insured reverse mortgages consisting of the Up Front Initial Mortgage Insurance Premium (IMIP) and the annual renewal. Borrowers who are limited by HUD or who qualify for more but agree to limit themselves to 60% of their Principal Limit in the first 12 months pay a premium of 0.5% for the IMIP whereas borrowers who require more than 60% of their principal limit in the first 12 months must pay an IMIP of 2.5% of the property value or the HUD maximum lending limit of $625,500, whichever is less. Going back to our example, the property value to get the $100,000 Principal Limit might be $190,000 and so the IMIP at the lower level equates to $950.00 while the premium for a borrower who requires more than 60% would be $4,750 – 5 times that amount. If that same borrower has loans and fees in the amount of $55,000 to pay off, the program will allow the borrower to take 60% in the first year or the mandatory property charges plus 10% of the Principal Limit (in this case, $10,000). HUD allows the borrower to take $10,000 at closing, but if the borrower agrees to limit the availability of cash to the 60% level in the first 12 months, there would be less money available in the first 12 months, but the borrower would pay almost $4,000 less in fees and would have all that money available after 12 months’ time – literally on day 366.
With regard to pricing, lenders are now more willing than ever to help pay costs whenever they can on reverse mortgages. Especially if you have a loan that you are paying off, there is often some room in the value of the loan for the lender to be able to make back money they spend on your behalf when they sell the loan and lender credits are allowed by HUD. Shop around and see what is available. Education is the key and knowing your goals will help you procure a loan that is best for your circumstances. A very low margin will accrue the least amount of interest once you start using the line, but if you are looking for the greatest amount of line of credit growth, a higher margin grows at a higher rate. And getting the least amount of fees on your loan won’t help you if you plan to be there for 20 years and in that 20 years the interest will cost you tens of thousands of dollars more and your goal was to preserve equity. Knowing what you want out of your reverse mortgage will help you choose the option that actually gets you there.
And finally, I told you that we do not recommend reverse mortgages for everyone. If a reverse mortgage does not meet your needs and you are still going to be scraping to get by, you need to face that fact before you begin to use your equity. If the costs of the mortgage will be almost as much as you will receive from the loan due to the fact that you live in an area where closing costs are very high and your property value is less than $40,000, you need to think hard about whether or not you want to use your equity on such an endeavor. If the mortgage doesn’t make your life easier and you’re thinking that you are just going to have to sell in a few years anyway, again, consider making that move now before you begin to erode your equity and the next move becomes harder. The reverse mortgage is supposed to be the last loan you will ever need and if you know this is not your forever home, consider using your reverse mortgage to buy the right house instead of as a temporary solution that is not a true solution at all.
By and large, most borrowers can benefit when they do their research and plan carefully but you need to know how they work, what your plans are and which options will best achieve your goals. Education is the key and don’t be afraid to compare. If you didn’t before, hopefully you now know how they work and are on your way to determining if a reverse mortgage is right for you.
“How does a Reverse Mortgage Work” by www.reverse.mortgage
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- What is a Reverse Mortgage
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