ARLO™ explains what a reverse mortgage is in simple terms

Reverse Mortgage (Definition) A reverse mortgage is a home loan for borrowers typically aged 62 and older that allows you to convert a portion of your home equity into tax-free cash without required monthly mortgage payments. You retain title and are responsible for continuing to pay property taxes and homeowner’s insurance. Interest accrues and is added to your balance and can be repaid at any time. Most borrowers repay the loan when they sell their property, move out, or pass away.

HECM reverse mortgages are insured by the Federal Housing Administration (FHA) and are “non-recourse loans,” meaning you or your heirs never owe more than the home’s value when it’s sold. Funds can be taken as a lump sum, in monthly payments, as a line of credit with a growth feature, or in a combination of all. 

 

Reverse Mortgage Terms You Should Know (A-Z)

Reverse mortgages use many of the same terms as forward mortgages. However, some terms are exclusive to reverse mortgages that you may not have encountered yet, and we want to help by defining some of the more frequently used terms. This list is not exhaustive, but it will provide you with an excellent starting point for understanding the more common reverse mortgage terms you may encounter during a transaction.

 

3-day right of Rescission

All refinance transactions must comply with federal law, which permits a 3-day right to rescind (or cancel). If a borrower rescinds the loan within these three days, the lender must cancel it. Even after a borrower has signed their final loan documents, the loan cannot be funded until this mandated rescission period has elapsed.

 

Amortization Schedule

The amortization schedule is an estimate provided to each borrower that shows how interest and mortgage insurance are likely to accrue on the reverse mortgage loan over its life. Unless you are receiving a full draw at the close of the loan and have a fixed-rate reverse mortgage, this schedule is only an estimate, as it cannot account for any future draws you may wish to take or interest rate changes. Use this for comparison purposes only.

 

Affidavit of Heirship

This document is used by administrators and title companies to determine ownership of real property in cases where a deceased relative’s estate is involved, especially if the property was not specified in the decedent’s will. This is often required in states with strong heirship laws (i.e., Texas).

 

Appraisal Management Company (AMC)

This company employs an appraiser to evaluate your home. The AMC hires the appraiser, and, in this manner, the lender has no direct conflict or pressure on the appraiser and can remain compliant with HUD and federal Appraiser Independence Laws by allowing the appraiser to appraise the home free from any possible pressure from anyone associated with the loan transaction, as required by law.

 

Asset Dissipation

HUD allows lenders to consider the dissipation of cash assets in a bank account when determining income for loan qualification purposes. HUD has a formula the lender uses to determine how much of the borrower’s assets can be used as annual income based on their age(s). That amount may be added to their other income and used to qualify borrowers for the loan.

 

Case Number

HUD assigns a case number to each property when the borrower begins a new FHA loan. Lenders use the Case Number for several purposes. That number runs with the property even if the borrower chooses a new lender.

 

Community Property

Property held jointly by married individuals or acquired by either spouse while married is generally considered community property.

 

Conditions (Underwriting)

Your loan must be underwritten by an FHA-approved underwriter with a “DE” (Direct Endorsement) qualification. The underwriter will determine any additional items not present in the loan file that are needed to close the loan, and those items become “conditions” to close. You must satisfy the underwriting conditions to receive and close your loan documents.

 

Condo Approval

HUD must approve property in a condominium project to be eligible for the HUD HECM program. The project must either already appear on HUD’s list of approved projects, or the documentation must be submitted to obtain project approval, or the lender cannot close a loan in that project (some exceptions do apply – speak to your lender about your project).

 

Counseling Agency and Counseling Certificate

The counseling agency is a third party that HUD approves to educate borrowers about the reverse mortgage from an educator, not a lender. Once a borrower has completed the counseling session and demonstrated a general understanding of the loan program, the counselor will give the borrower(s) a Counseling Certificate indicating successful session completion. A lender cannot get the HUD Case Number to proceed without this certificate number.

 

Deferral Period

Reverse mortgages are due and payable when the last borrower on the loan passes or permanently leaves the property. In the case of eligible non-borrowing spouses, though, they are given a deferral period if the borrower passes before the non-borrowing spouse and can remain in the home for as long as they live under the same terms as a borrower (must pay the taxes, insurance, and any other property charges as due and must live in the home as their primary residence).

It is important to note that a non-borrowing spouse cannot access any funds in the line of credit during the deferral period.

 

Financial Assessment

In 2014, HUD implemented Financial Assessment guidelines that outlined the qualification requirements for reverse mortgage borrowers. Those guidelines include credit requirements, as well as income and debt requirements. HUD’s guidelines do not use debt-to-income ratios, and credit scores are not considered; instead, terms such as residual income, family size, and asset dissipation are used.

 

Good Faith Estimate

The Good Faith Estimate, or GFE, provides an estimate of all settlement charges. This will be one of the disclosures you will see in your counseling session and one of the forms that the lender should provide you when they send you a loan application package. 

Remember that when you receive a proposal, lenders often use various versions of the same form. Once it reaches the application stage, they must use the federally approved forms, and all charges must be clearly stated. Be sure to compare all fees on each estimate.

 

HUD/FHA

HUD is the Department of Housing and Urban Development, and FHA is a division of HUD, the Federal Housing Administration. People often use “HUD” and “FHA” interchangeably when discussing the reverse mortgage program, as it is a HUD program that FHA operates.

 

HUD-1 Settlement Statement

The final closing statement, which outlines all the details of your transaction, including all charges, is the HUD-1 Settlement Statement.

 

Mortgage Insurance Premium (MIP)

With every HUD/FHA-insured loan, borrowers are required to pay an initial mortgage insurance premium and an annual renewal premium. The insurance premiums are not paid out of pocket but are initially paid from the loan proceeds and then accrued on renewals. The initial premium is 2% of the maximum claim amount, which is the lower of the value or the HUD maximum lending limit (currently $1,209,750). The renewal is .50% of the outstanding balance of the loan.

 

Interest Rates

People often need clarification on the various rates they hear quoted for reverse mortgages, especially regarding the lines of credit programs. There is the initial rate, the expected rate, the capped rate, an index rate, and a margin. The index is the instrument used to set the basis for the rate, which is beyond the lender’s control.

The LIBOR is no longer in use and has been replaced by the SOFR (Secured Overnight Financing Rate). However, borrowers still see mostly Constant Maturity Treasuries as of this writing. To this rate, a margin is added. Lenders cannot control what the index will do in the future, and most will remain relatively stable in the long run. Therefore, borrowers should pay attention to the margin, as this will determine the ultimate interest rate charged for the life of the loan.

The initial rate is the rate that combines the index and the margin for the first period of the loan. Whether for one month on a monthly loan, three months, or one year, that rate may change as soon as the initial period is over. The expected rate is not charged to the borrower.

It is determined using a longer and higher index. HUD uses this only to determine how much money borrowers will receive on their reverse mortgage loan.  Interest rate caps are the preset limits that kick in and keep the interest rate from rising above certain levels.

 

Lender Credit

When marketing and HUD guidelines permit, lenders may be able to cover some or all of the borrower’s costs on certain loans. Lenders must disclose when they are paying fees for the borrower on their behalf in the form of lender credits.

In other words, they must show the actual charges incurred and then demonstrate that they paid those charges on behalf of the borrower. 

 

Life Expectancy Set Aside

The HUD financial assessment guidelines require borrowers to meet specific guidelines for income, credit, and other considerations. However, approval would be entirely in the borrower’s worst interests if borrowers are within a point. In that case, HUD will allow lenders to still approve borrowers in some instances by setting aside funds from the loan to cover property taxes and homeowners’ insurance.

These set-aside funds are set aside for the youngest borrower’s life expectancy. They are known as a LESA, a Life Expectancy Set Aside. They result in borrowers receiving less money for discretionary purposes, but many like them. They only accrue interest once used to pay taxes and insurance. There is no cost to the borrower for this service.

 

Mandatory Obligations

When determining the amount of money available to borrowers at closing or within the first 12 months, HUD reviews the borrowers’ mandatory obligations, including the current eligible liens on the home, any outstanding property taxes, insurance premiums, and the costs associated with obtaining the reverse mortgage. Eligible liens would be current mortgages that were not cash-out transactions obtained within the last 12 months.

 

Non-Borrowing Spouse (Eligible and Ineligible)

An eligible non-borrowing spouse is the spouse of an eligible borrower who lives in the subject property but is inactive due to either age or other factors (credit, etc.). Suppose the spouse passes while the eligible non-borrowing spouse still lives in the property. In that case, the loan goes into a deferral period. The non-borrowing spouse can remain in the home under the loan terms (but cannot access any remaining funds on the line of credit).

An ineligible non-borrowing spouse does not meet the HUD requirements (I.e., does not occupy the home) and, therefore, is not eligible for the deferral treatment in the case of the passing of the occupying spouse.

 

Promissory Note/Deed of Trust/Mortgage/Loan Agreement

These three legal documents outline the transaction between the borrower and the lender. Lenders have no more rights than those granted to them by borrowers in these documents, and borrowers must adhere to their agreements; therefore, it is essential to read and understand these documents. 

The Promissory Note is a promise by the borrower to repay the lender for the borrowed money. It outlines the amount the borrower is borrowing, the interest rate, and the repayment due date to the lender.

There are two notes and two deeds for every adjustable-rate reverse mortgage transaction, one to the lender and one to HUD in case HUD needs to step in and advance funds on behalf of the borrower. Fixed-rate reverse mortgages have just one note and one deed/mortgage.

The Deed of Trust or Mortgage (depending on which instrument is used in the state where the property is located) secures the loan. The instrument is recorded and creates a lien on the property, which allows the lender to foreclose on the loan in the event of the borrower’s default.

This is the same right all lenders of forward loans have as well. You need to read the documents and understand what can create a default, which includes:

The Loan Agreement outlines the overall reverse mortgage transaction, including advances, mortgage insurance, and rights and obligations of both the borrower and the lender.

 

Power of Attorney

Power of Attorney is a legal document that authorizes one person to act on behalf of another in certain circumstances. It is essential to note that HUD has specific requirements for using a Power of Attorney, depending on the reason for its use.

 

Principal Limit/Principal Limit Factor

The Principal Limit in a reverse mortgage is the loan amount you will receive based on your age, interest rates, the maximum lending limit, and property value. The Principal Limit Factor is the percentage of the home’s value or the maximum lending limit, whichever is less, that determines the Principal Limit you will receive based on the formula set by HUD or the investor for the program you are interested in.

 

Probate

Probate is the legal process of proving or verifying a will or giving the courts time to determine what to do with a deceased individual’s property/assets when there is no will. Often, real estate must go through probate to avoid any claims of heirs or debtors later.

 

Primary Residence

For a reverse mortgage, your primary residence is one at which you live most of the year and at which you are legally registered to vote (if you are registered), where your bank accounts and other legal documents are directed, and where your legal identification labels your residence (i.e., your driver’s license). If you have a reverse mortgage on this property, you must notify your lender if you plan to take extended leaves away from the home.

 

Repair Set Aside

repair set-aside occurs when the lender sets aside funds from your reverse mortgage to pay for repairs to your home that cannot be completed before the loan closing. They must be completed within 6 months, and the lender will set aside 1.5 times the amount of the repair cost.

It is important to note that if you have a fixed-rate loan, there is no second draw available, so unlike the adjustable-rate options where you would have access to the unused repair set aside funds after all repairs are completed and paid, any funds not used on the fixed rate program are not available to borrowers (they are also not used and therefore unborrowed and not added to the balance owed).

 

Residual Income

Residual income is the amount of money left over for use by the borrower(s) after all required debts are paid each month, and the lender uses a fourteen-cent ($0.14) per square foot maintenance factor for each borrower for utility costs. For example, if a borrower’s home is 1500 square feet, the maintenance and utility factor is $210 monthly. It is added to all other debts (cars, credit cards, taxes, insurance, etc.).

The total is subtracted from the borrower’s income, and the amount left is the residual income. It must meet HUD requirements for the family size of the region where the home is located.

 

Short to Close

Short to close refers to the amount owed that exceeds the Principal Limit (loan amount) for which a borrower is eligible under the reverse mortgage. A reverse mortgage can still be accomplished when someone is short to close if they can cover the difference with their seasoned funds or a gift from a family member.

 

Solar Power – Uniform Commercial Code UCC Filing

Borrowers who have solar power in their homes often have leases because they do not own the equipment. A lease is a lien on the property. The lease must be released to do a reverse mortgage, even though it can be re-recorded later.

Most solar companies will cooperate with borrowers who wish to obtain reverse mortgages. Still, not all will; you must check with your solar company. The companies will file a “UCC Filing,” a notice of lien on your property that they must abandon so that the HUD mortgage has priority.

Again, they can refile after the reverse mortgage closes. Still, not all companies will cooperate, and it is best to know this before you spend money and time processing a loan and paying for an appraisal if your company will not.

 

Total Annual Loan Cost (TALC)

This disclosure is used for reverse mortgages and is not seen in forward loans. Because reverse mortgages are front-loaded (fees are charged at the start of the loan and added to the balance owed), they can be quite costly, especially when used for short-term financing.

The TALC shows borrowers the cost of financing over the years, and borrowers can readily see the actual cost reducing over time as the initial cost is spread out. This may help you determine if the loan is right for your needs based on how long you intend to keep the loan.

 

Trusts (Trustor, Trustee, Beneficiary)

A trust is a fiduciary arrangement established by a trustor that allows a third-party Trustee to hold assets on behalf of a beneficiary(ies). The third-party trustee can be anyone the trustor wishes, including themselves or family members (often for the benefit of other family members). The trustor is also known as the donor party because they are the individual(s) who granted the assets to the trust.

When using a trust for a reverse mortgage, the trust must meet HUD requirements, so the lender will have the trust reviewed by an attorney. If changes are required, most trusts can have an amendment drawn to correct any terms that violate HUD requirements, subject to review, approval, and drafting by the borrowers and their attorneys.

 

Third-Party Closing Costs

A third-party cost refers to any costs in your reverse mortgage that the lender or HUD does not charge. Lender costs are those charged by the lender and paid to the lender, who has control over and receives that payment. HUD’s cost is the Mortgage Insurance Premium, payable directly to HUD.

Third-party costs are charges from others, such as title companies, appraisers, and county recorders, that are not lender fees and over which the lender has no control, as the lender does not receive those funds. The lender may not charge anything whatsoever above the actual cost of the charge from that third party. A line-by-line list of closing costs is available here.

 

Verification of Funds and Seasoning of Funds

When cash assets must be used to close a loan transaction, those funds must be verified as belonging to the borrowers. The borrower must be able to produce at least 3 bank statements showing they had the funds in their account with no large deposits.

This verifies that the borrower has liquid assets and that the funds are “seasoned” in their account, meaning they are not recent borrowings. HUD only allows the use of unverified funds for down payments or closing costs, as this could indicate a new obligation not considered in the qualification criteria.