Reverse mortgage loans are widely misunderstood, and many homeowners and advisors have a strong negative bias against them. Unfortunately, those misconceptions and preconceptions hold back many ideal candidates from ever considering a reverse mortgage.
Today’s reverse mortgage loans are not the same as they were even a decade ago, and it is to your advantage as a trusted financial professional to take a fresh look at them, as they can often be a viable solution to many of the financial challenges that retirees face.
The aim of this piece is to help you understand both common, and somewhat less common, questions about reverse mortgages. Armed with the facts, you will have a much clearer picture of whether a reverse mortgage might be right for older-adult homeowners you advise.
Note: Most, but not all, reverse mortgages today are a Home Equity Conversion Mortgage (HECM), the only reverse mortgage insured by the Federal Housing Administration (FHA). This article refers only to the HECM reverse mortgage.
What is a reverse mortgage loan and how does it work?
A reverse mortgage is a home-secured loan that enables homeowners 62 and older to convert a percentage of their home equity into cash, fixed monthly advances, or a line of credit. A good way to think of it is that the lender is paying your client (the borrower) an advance on a portion his or her home equity, while he or she continues to live in and own the home. Unlike other types of home loans, with a reverse mortgage your client is not required to make any monthly principal and interest mortgage payments. That’s right — the borrower can defer repayment of the loan balance so long as he or she lives in the home, maintains it, and pays the property charges, like taxes and insurance.
Since most people do defer repayment of their reverse mortgage loan balance for the life of the loan, as opposed to making periodic voluntary prepayments, the loan balance usually increases over time, as interest and fees get tacked on.
What are common uses for a reverse mortgage?
There is a wide spectrum of homeowners who use reverse mortgages to their advantage — from the cash strapped, who have a disproportionate amount of their wealth stored in the form of home equity, to the very affluent, who have no foreseeable need for an infusion of cash. Here are some of the common uses:
Refinance a Traditional Mortgage
Most reverse mortgages are refinances, as HECMs must be in the first lien position. Any existing lien against the property, such as a traditional mortgage, must be paid off prior to, or at, closing. The good news is some or all of the reverse mortgage loan proceeds can be used at closing to pay off existing liens. Switching from a payment-required traditional mortgage to a payment-optional reverse mortgage can have a significant impact on your client’s cash flow in retirement. Once the mandatory obligations are satisfied at closing, the borrower can then use any remaining loan proceeds as he or she wishes.
Pay for in-home care or Long-Term Care Insurance (LTCI)
One of the biggest concerns older adults have is running out of money. And one of the biggest drains on savings and retirement cash flow is health-care related expenses. A reverse mortgage can offer the borrower access to funds to pay premiums on Long-Term Care Insurance or offer access to funds to directly pay for in-home care or other health care expenses.
Many borrowers are working with their financial advisors to strategically use home equity to enhance a sound retirement plan. For example, when the there’s a downturn in the equity markets, your client could decide to draw from home equity via a reverse mortgage, as opposed to selling investments at lower prices, to help fund his or her retirement lifestyle for a period of time. This strategy could give the portfolio time to recover, without negatively impacting retirement cash flow, potentially resulting in greater net worth for your client over the long run. And you could benefit by potentially being able to keep more assets under management for a longer duration*.
Establish a rainy-day fund
The reverse mortgage line of credit is a good way for your older-adult clients to establish a stand-by emergency fund. While there are initial costs to establish the reverse mortgage line of credit, almost all of those costs can be rolled into the loan. Post-close related costs can also be rolled into the loan and are only applied to funds that are drawn, not the unused portion of the line of credit.
Whether the loan proceeds are used to pay for home improvements, travel, or a bucket list item, a reverse mortgage can help your clients to enjoy a better retirement.
What are the basic qualifications?
The prospective borrower must:
- Be the homeowner
- Own the property outright or have significant equity (roughly at least 50 percent equity). The borrower can also bring cash to close to make up for any shortfall in equity.
- Live in the home as a primary residence
- Meet minimum credit and income requirements
The property must be one of the following types:
- Single-family residences
- 2- to 4-unit properties, (borrower must occupy one unit)
- Condos in a HUD-approved condominium project
- Condo units that qualify for single-unit approval (SUA)
- Planned unit developments (PUDs)
- Modular homes
- Manufactured homes that meet FHA requirements
How much loan proceeds can my client expect to get?
The amount of loan proceeds your client can get depends on three factors: 1) The age of the youngest borrower (or non-borrowing spouse, if applicable); 2) The expected interest rate on the loan; 3) The lesser of his or her home value or the HECM limit of $1,089,300.
The HUD provides HECM lenders with a HECM Principal Limit Factor (PLF) calculation table, which is used to calculate HECM proceeds based on the above factors.
Generally speaking, a younger borrower, a higher expected rate, and a lower-value home will have a lower principal limit than an older borrower, a lower expected rate, and a higher-value home.
You can get an idea of the amount of loan proceeds someone you advise may qualify for by using our online HECM loan proceeds calculator.
Does my client have to pay taxes on the loan proceeds he or she receives?
Drawing funds from home equity, such as from a reverse mortgages loan, is not a taxable event. By your client drawing part of his or her monthly cash flow from home equity, as opposed to taxable sources like draws from a 401(k), he or she may be able to keep his or her adjusted gross income low*.
What are the ways my client can receive payout of loan proceeds?
Your client can receive payout from the reverse mortgage in variety of ways:
- Single-disbursement, lump-sum payment at closing
- Fixed monthly advances (either for a set number of months or for the life of the loan)
- Line of credit to draw from as needed
- Both fixed monthly advances and a line of credit
Does my client have to pay property taxes with a reverse mortgage?
Yes. The borrower must live in the home as his or her primary residence and is required to pay the critical property charges, like taxes and insurance. The borrower can pay the property charges directly — or a portion of the available loan proceeds can be earmarked for paying the borrower’s property charges over his or her expected lifetime (either released semi-annually to the borrower or the lender/servicer can pay the property charges directly).
When do reverse mortgages become due and payable? How is the debt typically satisfied?
The loan typically becomes due and payable when the last surviving borrower permanently moves out of the home or passes away. If an eligible non-borrowing spouse is still living in the home, the due and payable status of the loan may be deferred (applies only when the last borrower moves out the home because of death or mental or physical illness). The loan can also become due and payable if the borrower(s) does not fulfill his or her obligations under the terms of the loan, such as he or she fails to pay the property taxes, insurance, or other charges.
At loan maturity, the sale of the home will always satisfy the loan, even if the loan balance exceeds the value of the home. This is because all reverse mortgages are non-recourse loans — the home stands for the debt, and neither the borrower(s) nor heirs can be held personally liable for any balance deficiencies at the time of loan maturity. If the home sells for more than the loan balance, the borrower(s) or heirs can pocket the difference.
What options do heirs who inherit a reverse-mortgaged home have?
If your client’s heirs do want to keep the house, the heirs can pay off or refinance the loan balance or they can purchase the home with a short payoff of 95 percent of the appraised value of the home.
If your client’s heirs do not want to keep the home, the heirs can sell the home and keep any profit. If the loan balance is more than the home is worth, they can sign a deed-in-lieu of foreclosure, which allows them to walk away from the home and not be stuck with a bill.
Is a reverse mortgage borrower required to pay MIP?
Yes. Similar to other FHA loans, with a HECM reverse mortgage, your client will be required to pay up-front MIP (mortgage insurance premium), which is 2% of the lesser of the home’s value or the 2023 HECM limit of $1,089,300, as well as an annual MIP, which 0.5 percent of the outstanding loan balance on an annual basis. These premiums are usually financed into the loan and not paid out of pocket – their purpose is to fund the non-recourse feature, which protects your client and his or her heirs from owing a bill if the loan balance is higher than what the home sells for when the loan matures.
Can a reverse mortgage be used to purchase a new home?
Yes. Your client can generate the required home equity by bringing funds to closing — the remainder of the purchase price will be financed via the HECM loan. The down payment money must come for your client’s liquid assets (e.g., bank accounts, CDs, retirement accounts) or from the documented sale of other assets he or she may have (e.g., proceeds from the sale of his or her present home, for example).
Once the loan is established, the benefits and features are essentially the same as if your client were to have refinanced a traditional mortgage on an existing home using a HECM.
Do reverse mortgages have a fixed or adjustable interest rate?
Reverse mortgage interest rates can vary by lender and whether the borrower selects a fixed or variable product. When the single-disbursement, lump-sum payout option is selected, a fixed interest rate will apply. The variable interest rate, available when either the fixed monthly advances and/or line of credit payout option is chosen by the borrower, is composed of two parts: an index and a lender margin (both are stated in the mortgage contract). Fairway uses the weekly average of the Constant Maturity Treasury (CMT) as the index. To find out what the current reverse mortgage interest rates are, please reach out to a Fairway retirement mortgage specialist.
Why is the reverse mortgage line of credit ideal for financial planning purposes?
A reverse mortgage line of credit is pledged funds that the borrower can easily convert into cash when needed. Any unused funds left in the line of credit do not accrue interest or mortgage insurance. And unlike a Home Equity Line of Credit (HELOC), the reverse mortgage line of credit cannot be canceled, reduced, or eliminated due to market conditions; drawn funds do not require any monthly principal and/or interest mortgage payments (must pay the property charges, like taxes and insurance); and the unused portion of the line of credit grows over time at the same compounding rate as the loan balance (meaning the borrower will have greater borrowing capacity over time).
Will a reverse mortgage affect my client’s government benefits?
If the government benefit is a means-tested benefit (an assessment of whether the individual has the means to live without the government benefit), then yes, reverse mortgage disbursements could impact the benefit for those individuals. Medicaid is one such means-tested benefit — it’s based on state thresholds for income and/or assets. So large draws that are placed in a borrower’s bank account could jeopardize that individual’s Medicaid benefit*.
Your client’s Social Security and Medicare benefits will generally not be affected by disbursements from reverse mortgages. Regardless of how much your client has in a his or her bank account, he or she will still qualify for basic Social Security and Medicare*.
What consumer protections are in place to educate prospective borrowers on the pros and cons of reverse mortgages? How does the program ensure prospective borrowers have sufficient capacity and willingness to pay the required property charges?
The Department of Housing and Urban Development (HUD) has added layers of consumer protection to help ensure reverse mortgages are a sustainable solution for borrowers. Here are details on some of those protections.
Counseling is Required
As part of reverse mortgage requirements, the borrower must attend a counseling session. The main objectives of the counseling session are to make sure the borrower fully understands the loan program and to helps them to determine if it is a good fit. Counseling is conducted by U.S. Department of Housing and Urban Development (HUD)-approved independent third parties. The session can be done in person or over the phone. This safeguard makes sure the borrower is advised by someone other than the loan originator.
All borrowers and co-borrowers must attend the session—and there are other situations where others must attend as well, such as a Power of Attorney for an incompetent borrower. The borrower’s family members are also encouraged to attend.
Unfortunately, a too-common occurrence prior to HECM program made effective in 2015 was borrowers who would likely struggle to meet property charge obligations with assets beyond home equity took out a HECM as a single-disbursement lump-sum payout and failed to earmark a portion of the loan proceeds for property charge payments for their life expectancy. This approach, obviously, could put the homeowner in jeopardy of eventually defaulting on the loan after they spend their loan proceeds. A consumer safeguard implemented in 2014 and effective in 2015 is that there must be a more detailed assessment for potential HECM borrowers to ensure they have a willingness and sufficient capacity to pay property taxes, homeowner’s insurance, maintenance and upkeep, and HOA dues.
Let’s start a conversation!
The more you know about reverse mortgages, the more likely you’ll be to recommend use of them in your financial toolkit. To learn more, contact a retirement mortgage specialist at Fairway Independent Mortgage Corporation.
About Author: Harlan Accola
Harlan Accola is the National Reverse Mortgage Director at Fairway Independent Mortgage Corporation. He has been in the mortgage industry for over 20 years and has worked with all types of loans, but his specialty has always been working with the 62+ age group and reverse mortgages. Harlan is the author of Home Equity and Reverse Mortgages: The Cinderella of the Baby Boomer Retirement. Accola may be reached at HarlanA@fairwaymc.com.
*This advertisement does not constitute tax and/or financial advice from Fairway.
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