We’ve discussed the history of reverse mortgages and we’ve talked about the newest changes to the FHA-backed reverse mortgage HECM program, but just how does a reverse mortgage work? In some ways, it’s like any other mortgage – borrow money by placing a lien on your home. The question most often asked is “Who owns the home?” It’s the same as a regular “forward” mortgage – the home owner retains title and ownership of the equity in the property. Just like a forward mortgage, you must continue to pay taxes on the property and keep the property insured.
When you bought your home, you borrowed money and paid it back monthly when you made your mortgage payments. You’ve put a lot of money into your home and now you’re older – at least 62 years old – and you want to try to get some of the equity back out of the home. Maybe you don’t want to take money out of your home right now – you just want to get rid of the monthly mortgage payment. A reverse mortgage can help you to do these things – to reclaim some of the equity without making monthly mortgage payments.
That sounds pretty good – does it matter why I want the money? The proceeds may be used for any legal purpose. After all mandatory payments (current mortgages and liens, closing costs, etc.) are paid, the remaining money can be taken in a lump sum, in monthly payments, left on a line of credit, or some combination of all of these methods.
How much can I borrow? The amount of the loan depends mainly on three factors – the age of the youngest borrower, the value of the home, and the interest rate on the loan. The older you are, the more money available to you. This is figured on actuarial computations – determining the number of years that you are likely to remain in your home. For example, you are more likely to remain in your home an additional 30 years at the age of 62 than you are at the age of 85. The value of your home is determined by an appraisal.
Why does the interest rate matter? With a reverse mortgage, the borrower is not required to make a payment on the loan. What happens to the interest that is accruing on the loan? It is added back to the balance on the loan along with the FHA insurance. Remember, FHA is insuring these loans much the way it does when a borrower wants to buy a home with only a minimal down payment. So, your loan balance is always increasing. If the interest rate is higher, more money will be added to the balance of the loan. The hope is that your home will increase in value enough to be worth more than the balance of your loan when you leave your home. This is why the amount that you are eligible to borrow (the Principal Limit) is less than it would be for a forward mortgage. Typically, at age 62, the Principal Limit would be about 52% of the home’s value using today’s interest rates. At 82, that amount is about 67% of the home’s value.
If I’m not making payments, how does the loan get paid back? You could, at any time, make a payment to your loan if you would like – but it is not required. When the last borrower on the loan permanently leaves the home, the loan will become due. Like any other mortgage, if a family member wants the home, that person can pay off the mortgage or refinance the loan. If not, the home can be sold and the loan paid off. If the value of the home is more than the loan balance, the additional proceeds would be paid to the homeowners or their heirs. If not – and this is what is unique about a HECM – the homeowners or their heirs are NOT responsible for any deficit balance. That is because a HECM is a non-recourse loan. With a HECM, this is one of the benefits of the FHA insurance.
Some things to remember:
- The homeowner is responsible for keeping real estate taxes, property insurance, homeowners’ association dues, etc. current and for keeping the property in good repair. Failure to do so can result in the loan becoming due and payable.
- Before anyone can get a HECM loan, the homeowners must complete counseling by a third party provider. This is important to insure that the borrowers understand the loan and are of sound judgment to commit to the loan.
Sounds like it’s too good to be true? Like any loan, a HECM is not right for everyone, but for a lot of homeowners, it can be a very good financial tool to use the home equity to enhance quality of life as they age.
Some fun facts:
- A HECM loan’s maturity date is the 150th birthday of the youngest borrower on the loan.
- If the loan servicer is late in sending a regular monthly payment from the HECM to the borrower, the servicer may owe the borrower a late fee!
How Does A Reverse Mortgage Work? Investopedia http://www.investopedia.com/articles/personal-finance/103014/how-does-reverse-mortgage-work.asp
Reverse Mortgages https://www.consumer.ftc.gov/articles/0192-reverse-mortgages