Reverse Mortgage: What’s It Really All About?

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FHA Reverse Mortgage: What You Should Know

Since the reverse mortgage was signed into law in 1988, it has gone through several transformations, with its uses expanding to help seniors supplement their retirement income, consolidate their debts, pay for emergencies, or even purchase a new home.

While there are a few different types of reverse mortgages, the most common one is the FHA Home Equity Conversion Mortgage (HECM), which provides various protections for homeowners and offers the most flexible way to receive and use their funds.

What Is A Home Equity Conversion Mortgage And How Does It Work?

The HECM is a reverse mortgage loan insured by the Federal Housing Administration (FHA) for borrowers at least 62 years old. This government-insured loan allows homeowners to convert their home equity into cash.

The HECM loan first pays off the existing mortgage (if there is one) and closing costs, then the rest of the money can be used for anything and there are no longer monthly mortgage payments required. However, homeowners are still responsible for paying their property taxes, homeowners’ insurance, HOA (if applicable) and must continue to maintain the home. If the borrower decides not to make a monthly loan payment, interest for that month is added to the loan balance.

Monthly loan payments are optional, but a borrower can opt to make monthly payments since there are no prepayment penalties on HECMs. Monthly payments go toward the interest first, and then toward the fees and principal.

The HECM comes due when the borrower moves out of the home, sells the home or passes away. Heirs can sell the home or purchase the home for the amount due or 95% of the appraised value – whichever is less. They can also choose to sign the deed over to the lender and walk away from the home (should the loan balance exceed the home value).

How Is A HECM Different From A Home Equity Loan or a HELOC?

A home equity loan, or home equity line of credit (HELOC), also issues cash based on equity but requires monthly payments as funds are used. With a HELOC, the lender can also reduce, freeze, or cancel the line at their discretion. With a reverse mortgage, once the line of credit is in place, it cannot be cancelled (as long as the borrower meets their obligations) and monthly payments on the loan are optional.

HECM requirements.

  • HECM Counseling – Because of the complex nature of the reverse mortgage, HUD requires all borrowers to complete a reverse mortgage counseling session. The HUD-approved, third-party counseling session ensures you understand how the loan works, the costs associated with it and any other finance options you may have. Counseling may cost up to $200, last up to 90 minutes, and is usually done over the phone.
  • There are three factors that determine how much you can borrow with a HECM:
    • The age of the youngest borrower
    • The qualifying rate on the chosen program
    • The value of your home.
  • A reverse mortgage is available only on your primary residence (single family residence, 1-4 unit property, or
    FHA approved condo).
  • Borrower must continue to pay all property charges (taxes, insurance, HOA dues, etc.)

Financial Assessment

To ensure borrowers are in a good financial position to take on the financial obligations of the loan (paying property taxes, homeowners’ insurance and home maintenance costs, any debt showing on their credit, and a residual income number), HUD also requires the borrower to undergo a financial assessment during the process.

Payment Options

There are two types of HECMs: a fixed-rate HECM and an adjustable-rate HECM. The fixed-rate option has an interest rate that stays the same throughout the life of the loan and offers only one way to receive payment – in a lump sum. The adjustable-rate option has an interest rate that may fluctuate throughout the life of the loan and offers multiple payment options – a lump sum, monthly payments, a line of credit or any combination of the three.

  • Lump Sum – all of your reverse mortgage proceeds will be delivered in one lump sum payment, available with both a fixed-rate or adjustable-rate HECM loan.
  • Monthly Payments – receive your proceeds in monthly payments. You can receive the monthly payments for a set amount of time, known as term payments, or you can choose to receive monthly payments throughout the life of your loan, known as tenure payments (only available for the adjustable-rate HECM).
  • Credit Line – A reverse mortgage line of credit is a payment option that puts your proceeds into a line of credit that you can access whenever you need, similar to a home equity line of credit (HELOC). If you don’t use the money right away, the available funds in your line of credit can continue to grow in value over time, at the same interest rate as the loan. As long as you have the loan, the line of credit cannot be suspended or called due. The line of credit payment option is only available with an adjustable-rate HECM.
  • Any Combination – you can also combine different payment options. A combination of payments is only
    available with an adjustable-rate HECM.

Pros And Cons?

It’s important to remember that reverse mortgages are complex loans and careful consideration is required before applying. Understanding the HECM’s benefits, as well as its drawbacks, will help. In the right situation, a reverse mortgage can be a great addition to your retirement plan for several reasons. Here’s how you can benefit:

PROS:

  • You can use your reverse mortgage proceeds for anything you want, including consolidating your debts, supplementing your income, or making home improvements.
  • You remain the owner of the home. Your name stays on the title.
  • Credit score is not a factor when considering eligibility for a HECM.
  • Since the HECM is insured by the FHA, borrowers are better protected from declining home values.
  • Access to equity without added payment, cash flow flexibility, and preservation of retirement assets.

CONS:

While reverse mortgages can be a helpful financial tool in retirement, they aren’t the best option for everyone.
Here’s why:

  • HECM loans typically have higher fees than traditional mortgages.
  • Life is unpredictable. If a medical emergency or other incident keeps you out of the home for more than 12 consecutive months, your loan could come due.
  • While your heirs do have options, the burden of dealing with the loan falls on them if you pass away. You may also be leaving them less equity.
  • If you choose a payment plan that doesn’t last the life of the loan, you could outlive your proceeds.

The Bottom Line: A HECM Can Be A Great Option

A HECM is a loan that allows seniors to use the equity in their home, while not requiring monthly payments of principal and interest. It is a financial tool that can be used to support and enhance your retirement plan. Working with a reverse mortgage professional to understand and learn how it can be used in your individual retirement plan is key.

 

 

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