Four different categories of reverse mortgages exist. Carefully evaluating each of the four types of reverse mortgages is essential in determining which one aligns with your needs and circumstances.
Home Equity Conversion Mortgages
Home Equity Conversion Mortgages (HECMs) are the most prevalent type of reverse home loans, backed by federal insurance.
These loans allow eligible borrowers who meet age and home-equity criteria to access funds from their residences, with higher property values resulting in larger payments.
Unlike conventional mortgages with 15 or 30-year terms, HECMs generally do not have income requirements for qualification.
The funds obtained from a HECM can be utilized for any purpose. The amount you can borrow depends on several factors, including:
Age of the youngest borrower.
Appraised value of your home.
Interest rates at the time of obtaining the HECM.
- Evaluation of your capacity to cover homeowner's insurance, property taxes, flood insurance, maintenance, and other expenses.
It's important to note that, similar to conventional mortgages, reverse mortgages come in different types.
Prior to applying for a Home Equity Conversion Mortgage (HECM), you are required to meet with a counselor from an independent government-approved housing agency to review your options.
The counselor will not only go over the terms of the mortgages you're considering, but will also discuss other government and nonprofit agency programs that may align with your goals.
During the counseling session, the counselor should provide information about the costs associated with each reverse mortgage program, including payment options, fees, and other expenses that could impact the overall cost of the loan over time.
The Department of Housing and Urban Development maintains a list of approved counselors who may charge a fee of approximately $125. However, even if you cannot afford the fee, you are still entitled to receive the counseling services.
Cost is an important factor to keep in mind when considering a reverse mortgage, as loan closing costs for these types of loans are often higher compared to conventional home loans.
Before deciding to pursue a Home Equity Conversion Mortgage (HECM), it's crucial to think about how long you plan to stay in your home and how much equity you truly need to access. Evaluating these factors in relation to the closing costs is essential before proceeding.
If you still choose to move forward with a HECM, it's important to carefully review the terms and conditions.
The Department of Housing and Urban Development (HUD) states that the lender may set aside a portion of the principal limit to cover property taxes, special assessments, hazard and flood insurance premiums.
Here are the ways you can receive your payments:
Monthly cash advances over a set period.
A combination of a credit line and monthly payments.
A single disbursement.
A line of credit on which you can draw when you need the money. This limits the interest charged on the loan since you control how much money you borrow against equity.
- Fixed monthly cash advances for as long as you own the home.
Similar to traditional home mortgages, Home Equity Conversion Mortgages (HECMs) offer both fixed and variable interest rates. The interest is applicable to the money disbursed to the homeowner throughout the loan period.
Adjustable rate loans are applicable to lump-sum, line of credit, and monthly disbursal loans, and are tied to a funds index like the London Interbank Offer Rate (LIBOR).
As the interest rate fluctuates, adjustments are made to either the monthly disbursement amount or the borrower can opt for a fixed disbursement based on available funds.
In the case of a line of credit, the credit line size can increase with a decrease in the interest rate, and it cannot be canceled or reduced.
Fixed rate options only apply to lump sum payments.
It's important to be familiar with the rules and limitations associated with HECMs, as they may vary. For example, HECMs often impose limits on the amount of money that can be received in the first year of the loan.
Additionally, reverse loans typically require the borrower to reside in the mortgaged dwelling as their primary residence.
If the borrower leaves the home to enter a nursing home or other long-term care facility for more than a year, the reverse loan is usually required to be repaid.
Repayment may also be necessary if the borrower lives elsewhere for more than half of the year, regardless of the reason.
Example of HECM
If you're aged 62 or older, have at least 50% equity in your home, and need additional funds for retirement, a Home Equity Conversion Mortgage (HECM) reverse mortgage could be a viable option.
Qualified individuals or married couples can anticipate receiving a percentage of their home value through a HECM, typically ranging from 40% to 60%.
The lower end of the range, around 40%, is generally applicable to those closer to the age of 62, while individuals in their 80s are more likely to qualify for the higher end of the range, around 60%.
For example, if you're 62 and own a mortgage-free home valued at $100,000, you may qualify to receive $40,000 through a HECM.
If you still have an outstanding mortgage balance of $25,000 on your home, the $40,000 can be used to pay off the mortgage, leaving you with $15,000 to address other expenses such as credit card debt.
Additionally, by eliminating monthly mortgage payments, you can free up an additional $400-$500 per month in your budget.
When you eventually leave your home due to death or relocation, there are important considerations to keep in mind.
The $40,000 you received through the reverse mortgage is actually a loan, and as of 2018, the fixed interest rate for that loan ranged between 4.5% and 5%, with variable rates slightly lower.
For instance, if you continue living in the home for another 10 years with a 5% interest rate, the balance on the $40,000 reverse mortgage would increase to $65,880.
However, if the value of your home appreciates and you sell it for $120,000 during that time, your estate would still have $54,120 remaining after settling the $65,880 balance.
On the other hand, if you reside in the home for 20 years, the balance on the $40,000 loan would grow to $108,505. In the same scenario, your estate would be left with only $11,495 after settling the balance.
These figures highlight the impact of time and interest on the loan balance and the potential implications for your estate.
HECMs for Purchase
A HECM for Purchase is an FHA program that enables individuals aged 62 and older to buy a new home using loan proceeds from a reverse mortgage.
It typically requires a significant down payment, ranging from 40% to 55% of the purchase price, and is designed to assist seniors in relocating or downsizing.
This option is popular among older individuals who wish to move to a more affordable home, such as a warmer location or a home that accommodates their physical needs.
With HECM for Purchase, you can own a home without having to make monthly mortgage payments.
The down payment amount is determined by a formula that considers the age of the youngest person (in the case of a married couple), the home value, and the loan interest rate.
When you purchase a home and obtain a reverse mortgage in a single transaction, you only need to pay one set of closing costs. In contrast, if you were to buy the home first and then seek a reverse mortgage, you would incur two sets of costs.
A reverse mortgage does not require monthly mortgage payments, although you have the option to make payments if you choose to do so.
If you decide not to make any payments, the interest on the loan accumulates over time until you, or a surviving spouse, move out of the home or pass away.
At that point, your heirs will be responsible for repaying the reverse mortgage, or they may need to deed the home to the lender to settle the debt.
Similar to conventional HECMs, HECMs for Purchase also require you to pay taxes, insurance, and homeowner's association fees, and to maintain the home in good condition according to the same rules.
The main challenge of obtaining a HECM for Purchase is meeting the required loan-to-value ratio for a reverse mortgage. In 2018, with favorable interest rates, homeowners were typically able to borrow between 40% and 55% of their home's value.
For example, let's consider a scenario where a couple, both aged 62, sells their $100,000 home in one state and purchases a new home closer to their children with the same value.
According to the formula for determining the down payment, they would need a loan-to-value ratio of 50%, which amounts to $50,000, in order to qualify for a HECM for Purchase reverse mortgage on the new home.
This means they would require a reverse mortgage loan of $50,000 at a fixed interest rate of 5%, and they would not be required to make any monthly mortgage payments.
However, the outstanding loan amount would accrue interest at 5% annually, resulting in a balance of $75,000 after 10 years.
If the couple were to pass away or relocate to an assisted-living facility at that point, their estate would be responsible for repaying the $75,000 balance on the reverse mortgage.
If the home's value has increased to $125,000 after 10 years and is sold, $75,000 would be used to cover the remaining balance on the reverse mortgage, and the remaining $50,000 would be returned to your estate.
On the other hand, if the home's value has decreased and it is sold for $75,000, the proceeds would be used to pay off the loan, and no funds would be returned to the estate.
Proprietary Reverse Mortgages
Proprietary reverse mortgages are private loans without government insurance, unlike HECMs. One advantage for homeowners is that proprietary reverse mortgages often offer larger loan advances for those with higher-valued homes.
Unlike HECMs, which are limited to properties worth $679,650 in 2018, proprietary reverse mortgages have no such limit.
HUD does not regulate proprietary mortgages, so there is no government requirement for counseling before applying for a loan, although the lending agent may request it.
Furthermore, proprietary reverse mortgages only allow for a lump-sum payment, unlike HECMs which offer multiple payment options.
Proprietary reverse mortgages are commonly used for homes that exceed the appraised-value cap imposed on HECMs.
Single-Purpose Reverse Mortgage
Single-purpose reverse mortgages are considered the most cost-effective option among reverse mortgage types, as they are limited to a single, predetermined use.
These types of reverse mortgages are often provided by state or local government agencies or nonprofit organizations.
The funds obtained from a single-purpose reverse mortgage can be utilized for specific purposes, such as roof replacement, plumbing repairs, tax payments, or other significant expenses.
These loans are typically tailored for homeowners with low to moderate incomes and may not be available in all areas.
They are particularly beneficial for homeowners who may not qualify for other types of reverse mortgages, providing them with a viable financial solution.
In conclusion, reverse mortgages offer unique opportunities for homeowners to tap into the equity of their homes and access funds for various purposes. From federally-insured Home Equity Conversion Mortgages (HECMs) to proprietary reverse mortgages, each type has its own advantages and considerations.
HECMs provide government-backed protections, while proprietary reverse mortgages may offer higher loan advances for more expensive homes. Single-purpose reverse mortgages may be a cost-effective option for specific uses, but availability can vary.
It's important for homeowners to carefully evaluate their financial situation, consider all available options, and seek professional guidance from experts like MakeFloridaYourHome to make informed decisions when considering a reverse mortgage.