A reverse mortgage is a loan that allows seniors to borrow against the equity in their home without making monthly mortgage payments. The most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM), a program insured by the Federal Housing Administration since 1988.
The amount of funds available from a reverse mortgage is based on the age of the youngest borrower or spouse, home value, and current interest rates. Funds received are tax-free and may be used for virtually anything. You may take funds in a lump sum, a line of credit, monthly payments, or a combination thereof.
The loan must be repaid when the last surviving borrower dies or leaves the home permanently or if they stop paying property taxes or homeowner’s insurance. The borrower always owns the home and can repay the loan at any time, such as with a refinance or upon sale or in the case of a sale upon the passing of the borrower(s), any remaining equity will go to the borrower’s heirs or beneficiaries, as specified in their will or trust or court order if the borrower left no instructions.
Suppose the loan balance exceeds the home value at the time of maturity. In that case, no debt will pass to the borrowers’ heirs, as reverse mortgages are non-recourse loans. The heirs can still pay the loan in full at 95% of the home’s current value if they want to keep the property, even if the balance owing is higher.
How reverse mortgages are different from traditional loans
A reverse mortgage differs from a traditional or “forward” loan because it operates precisely in reverse. The traditional loan is a falling debt, rising equity loan. A reverse mortgage is a falling equity, rising debt loan. In other words, as you make payments on a traditional loan, the amount you owe is reduced. Therefore, the equity you have in the property increases over time.
With the reverse mortgage, you make no regular payments. So, as you draw out funds and interest accrues on the loan, the balance grows, and your equity position in the property becomes smaller. There is never a payment due on a reverse mortgage or a prepayment penalty. You can make a payment at any time, up to and including payment in full, without penalty, even though no payment is due.
Some borrowers may choose to repay some or all the accruing interest or whatever amount they desire. The choice is up to the borrower, depending on their goals.
How much are you eligible to receive
The money you can receive from a reverse mortgage generally ranges from 40-60% of your home’s appraised value. The older you are, the more you can receive, as loan amounts are based primarily on your life expectancy and current interest rates.
With a reverse mortgage, several factors dictate the loan amount, including:
- The age of the youngest borrower
- Value of the home or the 2023 lending limit (whichever is less)
- The interest rates in effect at the time
Also factoring into the loan amount are the following:
- Costs to obtain the loan (which are subtracted from the Principal Limit or available loan amount)
- Existing mortgages and liens (which must be paid in full)
- Any remaining money belongs to you.
Tip: Calculate how much you can get by using ARLO’s Reverse Mortgage Calculator
How does your age affect the amount available?
You must be at least 62 years of age for a reverse mortgage. The Principal Limit of the loan is determined based on the age of the youngest borrower because the program uses actuarial tables to determine how long borrowers are likely to continue to accrue interest.
If there are multiple borrowers, the age of the youngest borrower will lower the amount available 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. Still, the premise is that a 62-year-old borrower can accrue more interest over their life than an 82-year-old borrower with the same terms. Therefore, HUD allows the 82-year-old borrower to start with a higher Principal Limit.
Reverse mortgage payment options
There are several ways borrowers can receive funds from a reverse mortgage:
- Cash lump sum at closing
- Line of credit that you can draw from as needed
- Payment for a set amount and period, known as a “term payment.”
- Guaranteed payment for life (known as a “tenure payment”) lasts for as long as you live in your home.
In addition to these options, you can use a modified version of each and “blend” the programs. For example, a married couple in California, born in 1951 and owning a $500,000 home, may decide to get a reverse mortgage.
The couple would like $100,000 at closing to improve their property and fund a college plan for their grandchild. They have a more significant social security benefit that will begin in four years. Until then, they would like to increase their monthly income by $1,000.
They can take a modified term loan with a $100,000 draw at closing and set up a monthly payment of four years of $1,000 per month. That would leave an additional $125,000 in a line of credit available.
In addition, they would receive a guaranteed growth rate on their unused line of credit funds.
How the line of credit growth rate works
In the past, many considered the reverse mortgage loan a last resort. Let us consider a borrower who is savvy and is planning for her future needs. She has the income for her current needs but is concerned that she may need more later.
So, she obtains her reverse mortgage and has the same $200,000 line of credit available to her after the costs to get the loan.
Her line of credit grows at the same rate on the unused portion of the line as what would have accrued in interest and mortgage insurance premiums had she borrowed the money.
As the years go by, her credit line increases, meaning if she one day needs more funds than she does now, they will be there for her.
If rates do not change, here is what her access to credit looks like over time:
- 10 years: $350,000
- 15 years: $500,000
- 20 years: $660,000
Remember that is if rates do not change. If interest rates go up 1% in the third year and one more percent in the 7th, after 20 years, her available line of credit would be more than $820,000.
Of course, this is not income; if you borrow the money, you owe it, and it will accrue interest. You or your heirs must pay it back when the property sells. But where else can you ensure you will have between $660,000 and $800,000 available in 20 years?
Lump sum restrictions
The fixed-rate requires you to take a lump sum draw. This means you must take the total draw of all the money available at the loan’s close. You cannot leave any funds in the loan for future draws, as no future draws are allowed with the fixed rate.
Since 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.
Tip #1. Shop interest rates & closing costs
As for pricing, reverse mortgage lenders are the ones who set the rates and the fees at which the loans will closed. This does not mean that they can do anything they want. Most of the time, the pricing is driven by the secondary market – the value of the loans when they are ultimately sold to investors.
When the loans are very valuable, lenders have much more options to enhance pricing to consumers than when the market is not actively purchasing the loans. But the only way for consumers to know is to shop around. And don’t just compare a couple of fees.
Look at the whole picture. Some people mistakenly go with one lender because they see one fee, like an appraisal fee of $100 less, when the lender charges a margin of .50% higher.
The margin is added to the index to determine the rate at which interest accrues and a half percent higher margin can cost borrowers tens or thousands of dollars over the life of a loan, so it is important to look at everything and not be stuck on one small feature.
Education is key. Knowing your goals will help you procure the best loan for you. A very low margin will accrue the least interest once you use the line. Still, if you are looking for the most significant line of credit growth, a higher margin grows at a higher rate.
Getting the least fees on your loan may not help if you plan to be in your home for 20 years if, in those 20 years, the interest will cost you tens of thousands of dollars more, thus ruining your goal to preserve equity.
Knowing what you want from your reverse mortgage will help you choose the best option to meet your long- and short-term goals.
Tip #2. Weigh the costs vs. benefits
As I stated earlier, we do not recommend reverse mortgages for everyone. If the loan does not meet your needs and you will still be scraping to get by, you must face that fact before you choose to use your equity.
If the loan doesn’t make your life easier and you will have to sell in a few years, consider making that move before you begin to erode your equity. The next move becomes that much more difficult.
The reverse mortgage is supposed to be the last loan you ever need. If you know you are not in your forever home, consider using your reverse mortgage to buy the right house instead of using it as a temporary solution — one that is not a proper solution at all.
By and large, most borrowers can benefit when they research and plan carefully. You need to know how these loans work, your plans, and which options will best achieve your goals.
How much can you get from a reverse mortgage?
The money you can receive from a reverse mortgage loan is based on the youngest borrower’s age, current interest rates, and your home’s appraised value. The Loan to Value on a reverse mortgage is the Principal Limit Factor. Those percentages vary with age and rate and are based on actuarial tables. The older you are, the higher the loan to value will be. Similarly, the lower the interest rates, the higher the loan-to-value.
Who owns the house on a reverse mortgage?
You always own your home when you have a reverse mortgage. You are not selling your property to the lender for a reverse mortgage. You are just taking out a loan that works differently than a traditional or “forward” loan.
How does a reverse mortgage get paid back?
A reverse mortgage does not require monthly mortgage payments. Therefore, the loan is paid back when it reaches maturity or if the homeowner decides to sell their home or pay it off through other means. When a reverse mortgage borrower passes away, the heirs to their property can either pay off the balance to keep the property or sell the home to pay off the loan balance. Suppose an heir inherits the property with a balance that exceeds the current market value. In that case, they can choose to pay the loan in full at 95% of the current market value, even when that is less than the amount owed, if they want to keep the property but are not required to pay back the loan balance or even attempt to sell the property if they do not wish to. They can sign the property to the servicer to handle it from there. The mortgage insurance fund covers any loss on that sale.
Can I sell my house if I have a reverse mortgage?
Can you lose your home with a reverse mortgage?
Is a reverse mortgage a good idea?
Why should you not get a reverse mortgage?
You should wait for a reverse mortgage if you want to sell your home soon. The reverse mortgage is not intended to be a short-term financing instrument. The upfront costs for mortgage insurance, etc., make it less appealing to use in that manner.
What are the disadvantages of a reverse mortgage?
A reverse mortgage loan has some disadvantages compared to other loan products. Suppose you obtain a reverse mortgage and want to move out of the property and retain it as a rental property. With a reverse mortgage, the property must be your primary residence. In that case, you must refinance or pay off the reverse mortgage. Another downside to the reverse mortgage is that the closing costs are higher than a traditional loan because of the mortgage insurance on the HUD-insured HECM product.
- Reverse mortgages allow seniors to borrow against the equity in their homes without making monthly mortgage payments. The most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM), which the Federal Housing Administration insures.
- To qualify for a reverse mortgage, you must be at least 62 years old, and the Principal Limit of the loan is determined based on the age of the youngest borrower.
- The amount of funds available from a reverse mortgage is based on the age of the youngest borrower, home value, and current interest rates.
- The loan must be repaid when the last surviving borrower dies or leaves home permanently or if they stop paying property taxes or homeowner’s insurance.
- There is never a payment due on a reverse mortgage or a prepayment penalty. Any remaining equity will go to the borrower’s heirs or beneficiaries.
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