How Do Reverse Mortgages Work? To fully appreciate how reverse mortgages work, let’s explore the various types available and how each type offers distinct features and benefits. Let’s define what a reverse mortgage is. A reverse mortgage loan is similar to a traditional mortgage. They aim to allow homeowners to borrow money using their home as security. Reverse mortgages are specialized types of home loans only available for homeowners who are 62 and older.
Why were these types of loans created?
The federal government created loan options to tap into home equity to solve the burden of rising economic necessities for aging American citizens. Reverse mortgage lenders offer financial relief to older homeowners burdened by increasing costs of economic necessities. The fundamental process allows homeowners to borrow money based on the equity in their homes. In essence, seniors can finance their golden years by leveraging their primary real estate investment, their home.
There are three different types of reverse mortgages widely used.
- FHA-insured reverse mortgage loans
- Proprietary reverse mortgage loans, or jumbo reverse mortgages (not government-backed), are designed for higher home-valued properties.
- Single-purpose reverse mortgage loans: offered by state, non-profit, and local government agencies
The functional purpose of reverse mortgages
There are two general categories of reverse mortgages: federally-backed and proprietary reverse mortgage loans. Two government agencies insure reverse mortgages. Firstly, the Federal Housing Administration (FHA) and, secondly, the U.S. Department of Housing and Urban Development (HUD). Without a doubt, the most common type of reverse mortgage is a Home Equity Conversion Mortgage (HECM loan).
Lastly, proprietary reverse mortgages, or non-HECM loans, are specialized to assist struggling elderly homeowners for a single purpose. Struggling homeowners of moderate to low-income levels troubled by debts and at risk of foreclosure due to property tax obligations or home repairs can benefit from a non-HECM loan. In most cases, these loans come with higher interest rates. However, through its Home Equity Conversion Mortgage (HECM) program, FHA has guaranteed well over 1 million reverse mortgages since 1992.
How do reverse mortgages work regarding loan eligibility?
- Age requirements- Borrowers must be 62 years or older
- Meet all loan approval requirements and complete the required counseling session.
- The mortgaged property must be the borrower’s primary residence.
- The home value/amount of equity must be significantly larger than the remainder of the existing mortgage loan balance.
- The borrower must reserve funds to pay for all expenses relating to the upkeep and maintenance of the property.
- To qualify, the borrower cannot owe any federal debts to the government, like unpaid taxes.
Benefits and Drawbacks of Reverse Mortgage Financial Products.
Fund Disbursement
Borrowers have options for distributing their available funds. Most borrowers choose either a lump sum payment or a line of credit. Overall, a borrower’s age influences interest rates and the loan amount. To begin with, the younger an applicant is, the longer their life expectancy. In turn, the older the applicant, the more significant the loan amount. It all comes down to loan-to-value (LTV).
Property Requirements
Property requirements for loan eligibility requirements are relatively straightforward. Houses, townhouses, manufactured homes, and HUD-approved condos built on or after June 15, 1976, are eligible. Vacation homes and second homes are not.
Fees
More often than not, lenders recommend, and sometimes require, homeowners to reserve funds for property taxes, homeowner’s insurance, flood insurance, home repairs, and homeowners association fees.
Unlike a home equity loan or a HELOC, borrowers don’t need an income or good credit to qualify, and reverse mortgage loans do not require ongoing monthly mortgage payments. Generally, home equity lines of credit (HELOCs) are less expensive loan options than reverse mortgages, and the funds work similarly to credit cards.
HECM Fees
Despite interest accrual, borrowers with reverse mortgages and HECM loans never owe more than the appraised value of their property. That said, HCEM loans come with hefty fees and commitments. One of which allows lenders to charge either $2,500 upfront or 2% of the first $200,000 of the property’s value, whichever is greater, plus an additional 1% of any amount that exceeds $200,000. There is a limit of $6,000 for an origination fee. In other words, be aware of the expense of HECM loans. Homeowners must speak with a HUD Councilor for HECM loan approval, and we recommend paying close attention to the out-of-pocket fees associated with these loans.
How do reverse mortgages work concerning federal benefits and taxes?
In most cases, the loan amount offered through a reverse mortgage doesn’t affect Medicare coverage or Social Security benefits. Concerning the IRS, income received from a reverse mortgage isn’t taxable. Since reverse mortgage income qualifies as a loan advance, taxes do not apply.
How does reverse mortgage loan payoff work?
Regarding loan payoff, the amount of money spent from a reverse mortgage loan is repaid either upon death (due six months after), relocation, or the sale of the property. Often, an elderly borrower relocates to retirement facilities that offer services to them when independent living becomes tiresome. Once the homeowner relocates, the co-borrowers, family members, spouses, or heirs are responsible for repaying the loan.
Fees and Interest associated with different types of reverse mortgages
In a nutshell, reverse mortgages function directly opposite of a traditional mortgage. As we all know, regular mortgages work by initially borrowing a lump sum of money accompanied by agreed-upon monthly payments designed for repayment. When the homeowner makes their payments, home equity accrues, and the loan amount decreases. On the other hand, reverse mortgage loan amounts are determined by the current home value minus any existing loan obligations. Instead of reducing the loan amount, these loans accumulate monthly because additional interest increases the principal loan balance. In short, reverse mortgages cash out home equity each month, and the interest accrues to the principal balance.
Reverse mortgages come with upfront expenses such as servicing fees, closing costs, and origination fees, making them an expensive option to access funds. HCEM loans require mortgage insurance premium payments (MIP) – Initially, there is a 2 percent initial MIP at closing, followed by an annual MIP equal to 0.5 percent of the annual loan value.
Beware of reverse mortgage loan fraud.
The Consumer Financial Protection Bureau (CFPB) recommends unsuspecting seniors to be aware of fraudsters and mortgage scams. Because of the rampant targeted deception of the senior community, the CFPB has developed a plan for protecting older adults from fraud and financial exploitation. Concerned borrowers can vet potential lenders at HUD.
Are there other financial products to consider?
When it comes to tapping into home equity, borrowers have options. Lenders offer a variety of loan options. Including cash-out refinancing loans, home equity lines of credit (HELOC), straight home equity loans, and many refinancing options. All of which come with fixed-rate and adjustable-rate options.
Given that credit scores will play a role regarding loan eligibility, it’s best to speak with a mortgage professional, precisely one that has been HUD-approved, to determine if a reverse mortgage is the best action plan since the homeowner’s family members and friends will likely impact them after the homeowner vacates the property. Many retirees need supplemental income to cover medical expenses and the rising cost of living, and lending professionals help determine current interest rates and decide if a loan refinance may be a better option.
Now that we’ve set the stage let’s unveil the mechanics of loan options and connect with a mortgage lender who can help.
The steps are simple:
1. Schedule a Call: An experienced loan officer can discuss your lending needs and guide you through the possibilities.
2. Get Approved: We’ll help you through the mortgage application process and facilitate the steps for approval.
3. Exhale: Put your feet up and feel secure knowing you made the best decisions about your home loan.
With proper guidance, you can get your first home, accommodate your growing family, and start that renovation project—whatever goal is on the horizon. An alliance with Mortgage Insiders will give you the confidence to know that your mortgage loan is setting you up for financial success. Mortgage Insiders offers today’s latest financial news and mortgage trends. Check out their channel for current events.
