In recent years, questions about reverse mortgages, and whether or not they are a practical way to supplement retirement income, have become more frequent. I will explain the specifics of reverse mortgages in more detail for those who aren't familiar with all of the benefits and costs.
What is a reverse mortgage? As you would guess, a lender makes payments to you based on a percentage of your home's appraised value. There are three kinds of reverse mortgages.
-- Proprietary/private: where a private company creates and backs the loan.
-- Single purpose: where the loan proceeds can only be used for a specific purpose, stated by the lender. For example, money from a single purpose reverse mortgage could only be used to cover property expenses, including repairs, energy efficient improvements, taxes and insurance. Single purpose loans are not available everywhere, and are usually offered through local government agencies or nonprofit organizations. This also makes them the least expensive option.
-- The Home Equity Conversion Mortgage: It is the most popular type of reverse mortgage. A HECM is backed by the Federal Housing Authority, or FHA, and is federally insured.
I'll be focusing on HECMs for this post. HECMs allow a homeowner or homeowners, aged 62 and older, who either own their home outright or have a small existing mortgage, to borrow money against the equity of their home. Only single-family houses, occupied by the borrower or two to four unit homes, with at least one unit occupied by the borrower, are eligible. During the application process you're required to meet with a government-approved housing counselor who will determine if you're financially capable of paying the costs associated with the loan.
Because you're taking out a loan against your home's value, you're still the property owner until the loan is due. This means you'll continue to pay property taxes, homeowners' insurance, and maintenance costs. The balance of the loan becomes due when the borrower moves out of the house, or passes away. The house is then liquidated, and the proceeds are used to pay off the balance of the loan.
There are limits to how much a person can borrow using a HECM. A person can only take up to the FHA HECM mortgage limit of $625,500. If the home's value is under that cap, then the borrower is able to access a percentage of home's appraised value. However, owners with a highly valued home and little or no mortgage, may qualify for larger loan advances through a propriety-reverse mortgage, though the cost will likely be higher.
A reverse mortgage is typically structured so that the total loan amount, including interest and fees, will not exceed the value of the home over the life of the loan. However, if the proceeds from your home's sale exceed the balance of the loan, then you, your spouse, or your heirs will receive the difference. Should the sale not cover the loan balance, then, in most cases, the lenders insurance will cover the difference.
The fact that reverse mortgages allow people to stay in their own homes is one of its major benefits, but if you're considering relocating or renting, then this is not your best option. If you become sick and have to move into an assisted living facility for 12 consecutive months, then your home is no longer considered a primary residence, and the bank has the ability to take control over the house. This can become a major problem if only one borrower is listed on the mortgage.
The amount of money you can expect to receive from a reverse mortgage depends on several factors. The major components are your age, value of the home and the length of the loan. If there are two people listed on the mortgage, then the age of the youngest borrower is used. The current interest rate, initial mortgage insurance premium, closing costs and repair costs can also play a role in determining the monthly amount that you can expect to receive.
Current interest rates are important to consider, because they play two very important roles in the reverse mortgage process. First, they help determine a borrower's loan advance amounts. Second, they determine the interest charged on the outstanding balance. It's important to understand that the interest accrues over time, increasing the loan amount. This means that interest payments can take up a decent portion of your reverse mortgage payments, leaving you with less money than expected.
There are several ways to structure payments from a reverse mortgage, but the most common are:
-- Tenure payments: You'll receive equal monthly payments, as long as at least one borrower is living and continues to occupy the property as the principal resident.
-- Term payments: equal monthly payments for a fixed period of selected months.
-- Line of credit: unscheduled payments, in varying amounts, based upon your needs, until the loan is exhausted.
-- Single disbursement lump sum: a single payment when the loan is closed. However, recent rule changes could see payouts reduced by 10 percent to 18 percent, depending on underwriting factors.
Insurance premiums. All FHA backed loans require lenders to collect mortgage insurance premiums. If you withdraw less than 60 percent of the available loan amount, during the first year, the mortgage insurance premium is 0.5 percent of the maximum claim amount. If you take over 60 percent, the mortgage insurance premium increases to 2.5 percent. Borrowers will also pay a 1.25 percent annual premium that based on the maximum claim amount.
Outside of the insurance costs, reverse mortgages also tend to have high fees, including above average origination costs, closing costs and include numerous service fees. Origination fees can get fairly expensive. The maximum allowed origination fee on federally insured loans is 2 percent of the initial $200,000 of a home's value and 1 percent of the remaining value, with a cap of $6,000. As you can see, the costs of a reverse mortgage can quickly eat away at the amount of money available.
A reverse mortgage isn't right for everyone. You should consult a financial professional who is familiar with your situation before you would take this option. Although being able to access the equity in your house without having to make monthly payments is attractive, the costs and fees associated with a reverse mortgage are negatives that must be considered. People should remember they might not be able to bequeath their house to heirs, which could also be a significant deterrent.
Seniors with a high credit score should carefully consider and analyze their options, including traditional mortgages and home equity loans. If you can comfortably make the monthly payments, then a home equity loan might be a way to accomplish the same goal, while also avoiding the fees associated with a reverse mortgage.
Kelly Campbell, certified financial planner and accredited investment fiduciary, is the founder of Campbell Wealth Management and a registered investment advisor in Alexandria, Va. Campbell is also the author of "Fire Your Broker," a controversial look at the broker industry written as an empathetic response to the trials and tribulations that many investors have faced as the stock market cratered and their advisors abandoned their responsibilities to help them weather the storm.
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