One of the biggest concerns retirees face is generating enough income to last throughout the years. While Social Security can help with some expenses, it may not be enough to cover all of them.
One strategy to supplement retirement income is a reverse mortgage. It's sold as a simple way to generate essential income from your property, but it's a lot more complicated than it appears.
Here's what to consider when considering a reverse mortgage.
What is a reverse mortgage?
A reverse mortgage is a loan taken out against your home's equity, which you don't have to repay until you no longer live in the home. This type of loan can help retirees access their home equity without having to sell or take on more debt.
It's important to understand that a reverse mortgage is different from a regular mortgage. As the name suggests, a reverse mortgage lender pays the homeowner instead of the mortgagee making payments to the bank.
Reverse mortgages allow homeowners to stay in their homes. However, the loan must be repaid upon the borrower's passing, permanent relocation, or sale of the property.
The Home Equity Conversion Mortgage (HECM---also known as a Federal Housing Administration (FHA) reverse mortgage---is only available through an FHA-approved lender. Supported by the federal government, it is widely recognized as one of the most common options for reverse mortgages.
How reverse mortgages work
Most reverse mortgage owners no longer have a balance on their traditional mortgage. However, for those who haven't yet paid off their balance, it may affect their borrowing power, resulting in a lower monthly payment.
How much can a homeowner borrow?
Homeowner borrowing limits (principal limits) are based on several factors, including:
- The youngest borrower's age or eligible non-borrowing spouse
- Current interest rates
- The HECM mortgage limit ($1,089,300 in 2023)
- The home’s value
Amounts increase with the homeowner's age, property value, and interest rate (lower interest rate + higher monthly payments). One type of interest rate to be aware of is the variable-rate HECM. Amounts can potentially go up with variable rate HECM.
Variable-rate HECM options
- Fixed equal monthly payments: for a designated period, previously agreed upon
- Equal monthly payments: at least one borrower must be a primary resident
- Line of credit: accessible until it runs out
- Line of credit + fixed monthly payments: accessible while you live in the home
- Line of credit + fixed monthly payments: for a designated period of time
Fixed interest rate option
Opting for a fixed interest rate HECM results in a lump-sum payment when your loan closes. This option is best for those who don't want their payments fluctuating with the market.
Reverse mortgage interest accrues monthly. You will still have to pay homeowners insurance and property taxes and maintain your home, so it's important to plan for these expenses.
Who is a reverse mortgage suitable for?
First, it's important to understand that a reverse mortgage is not the same as a home equity line of credit (HELOC). The reason is that with a reverse mortgage, you don't need income or a good credit score to qualify as you do with a home equity loan.
A reverse mortgage is the only option for older homeowners who want to access their home equity without selling their property. It's also a good choice if you have limited income and are looking for financial security in retirement.
It's important to note that reverse mortgage loans aren't suitable for everyone and should only be taken out as part of a well-thought-out retirement plan. Before making any decisions, it's best to speak with a financial advisor who can help you understand the implications and advantages of taking out a reverse mortgage.
It's also important to consider other options, such as downsizing or refinancing your traditional home loan. These options may be more beneficial for certain individuals, depending on their particular situation.
Reverse mortgage requirements
Property requirements
You may qualify for a reverse mortgage if you own a house, manufactured home, condominium, or townhouse that was built on or after June 15, 1976. However, cooperative housing owners cannot obtain reverse mortgages under FHA regulations since they possess shares of a corporation instead of the real estate they inhabit.
Age, equity, and fee requirements
You must be at least 62 years old to apply for a reverse mortgage and either own your home outright or have considerable equity of at least 50%. You'll also need to pay various fees (controlled by the federal government) associated with taking out the loan, including:
- closing costs
- up-front mortgage insurance
- an origination fee
- ongoing mortgage insurance premiums
- servicing fees
- interest
Counseling session requirement
Prospective reverse mortgage borrowers are mandated by the U.S. Department of Housing and Urban Development (HUD) to successfully undergo a HUD-approved counseling session. This requirement ensures compliance while providing valuable guidance to borrowers.
The roughly ninety-minute session typically costs about $125. The purpose of the course is to give prospective borrowers all the facts they need to know to make an informed decision.
Some of the main topics include the potential effects reverse mortgages can have on borrowers' Medicaid and Supplemental Security Income (SSI) eligibility.
Collateral requirements
All borrowers must continue paying their homeowners insurance, property taxes, and HOA fees (if applicable) and maintain their homes.
If you happen to reside outside the house for a period longer than one year, even if you end up in a long-term care facility, you will be required to repay the loan. Typically, this is executed by selling the house.
How much does a reverse mortgage cost?
While the closing costs for a reverse mortgage may not come cheap, most HECM mortgages offer the option to roll these expenses into the loan. This means you don't have to pay upfront, but keep in mind that doing so will reduce the available funds at your disposal.
Here are all of the HECM fees:
- Origination fee: The greater of $2,500 or 2% of the initial $200,000 of home’s value + 1% of amount > $200,000. Capped at $6,000.
- Mortgage insurance premiums (MIP): 2% MIP at closing + an annual MIP equal to 0.5% of outstanding loan balance. Eligible to be financed into the loan.
- Servicing fees: Max $30 for fixed-or-annually-adjusted rate loans; $35 for monthly-adjusted rates.
- 3rd-party fees: Common for credit checks, appraisal and home inspections, title search and insurance, or recording fees.
Beware of unethical actors
With a potentially lucrative product like a reverse mortgage and a vulnerable population of borrowers, scams are prevalent. Unscrupulous vendors and contractors target seniors seeking financial salvation, offering reverse mortgages to pay for home improvements. However, they may not deliver on promised quality work and instead steal the homeowner's money.
Seniors have unfortunately been taken advantage of by their loved ones, caretakers, and unscrupulous salespeople in various ways.
Some have misused their power of attorney to reverse mortgage their homes and steal the proceeds. Others have convinced them to purchase financial products, like annuities or whole life insurance policies, that they can only afford by obtaining a reverse mortgage.
These actions are often driven solely by the best interests of the advisor, relative, or caregiver, rather than the homeowner. These are just a few examples of the reverse mortgage scams that can ensnare unsuspecting homeowners.
Is it possible to refinance a reverse mortgage?
It's possible to refinance a reverse mortgage. However, it should be considered carefully due to the origination fee, upfront mortgage insurance premium, and additional closing costs.
It is advisable to reserve this option for specific situations, such as adding a spouse to the loan, increasing equity, or significantly reducing the interest rate.
Owing more than the home's value
Although it is possible for your loan balance to exceed your home’s value, lenders cannot pursue borrowers or their heirs if the property is underwater when the loan matures. Borrowers’ mortgage insurance premiums contribute to a fund that safeguards lenders against losses in such situations.
Final word
A reverse mortgage can be an excellent way to supplement your retirement income. However, like any financial decision, it's important to do your research and understand the pros and cons before making a move.
The best course of action is to speak with a trusted expert who can steer you in the right direction. Armed with the right information and guidance, you'll be well-equipped to make the best decision for your situation.
