Reverse mortgages are increasing in popularity to help older homeowners live a more comfortable retirement.
There is a lot of confusing information out there about reverse mortgages. This guide was created to give you a way to quickly understand what a reverse mortgage is, how it can help and what you can expect going through the loan process.
What’s a reverse mortgage?
A reverse mortgage is simply a mortgage that allows homeowners 62 or older to leverage the source of their most substantial portion of their net worth, which is their home equity.
Reverse Mortgages are also known as Home Equity Conversion Mortgage (HECM).
They can turn that home equity into tax-free tangible funds and stay in the home with flexible payment options.
They don’t have to make a monthly mortgage payment if they choose not to. That’s very different from a traditional mortgage.
Does it make sense for somebody that’s in their sixties or seventies to take out a 30-year mortgage?
Or even a 20-year mortgage and have that cash flow burden of mandatory monthly payments on a mortgage later in life.
Reverse mortgages or home equity conversion mortgages (HECM) provide liquidity, accessibility, and, most importantly, flexibility to enable you to be in control of your mortgage.
You’re using the asset that you’ve built up in your home to allow you to age in place.
A reverse mortgage borrower usually wants to age in place. They want peace of mind and some financial stability and comfort.
You’ve worked hard your whole life, saving money, accumulated wealth, and at the same time, they’ve made payments into their home for the past 15 or 20 or 30 years.
They’ve put themselves in an equitable position now where they have equity and don’t understand how to utilize it.
This is how reverse mortgages work. It helps you convert the equity in their home into funds to add to their existing retirement portfolio.
You strengthen your portfolio as a whole because now you’re incorporating the most significant portion of your net worth, which is your home equity, the majority of the time.
How Does A Reverse Mortgage Work
You must have the necessary income and credit requirements.
Now those requirements are very different from a traditional mortgage because this is a loan designed for seniors.
So, there are less stringent income and credit requirements. But a lender will look at credit and income to make sure that you’re at least able to pay property taxes and your homeowner’s insurance.
In 2015, the Department of Housing and Urban Development (HUD), which oversees all reverse mortgages, said we need to make sure that people can pay their property taxes and insurance.
And they developed what’s called the financial assessment.
A lender will run you through a financial assessment to ensure that you’re credit and income-worthy to qualify for a reverse mortgage or home equity conversion mortgage.
Often, people come to a lender thinking reverse mortgages may be the right fit.
A suitable lender will turn away many clients if it’s not the right fit for the right person.
Not only will a lender do a financial assessment, but they also discuss their retirement goals.
If a reverse mortgage is the right fit, great, and if not, a lender may be able to help them out with a traditional mortgage as well.
As far as other qualifications, you must have sufficient home equity. You must have about 50% equity in your home.
So, if you have a $400,000 home, you must have at least $200,000 in equity roughly to qualify.
There’s no minimum value requirement. There’s just an equity requirement of about 50%.
So let’s say your house is worth 100,000; as long as you are in a 50% equity position, meet the age, credit, and income requirements, then you qualify.
Reverse Mortgage Misunderstandings
Reverse mortgages have evolved over the years.
Ten years ago, reverse mortgages were a loan of last resort.
If you needed money, had some equity in your home, and were over 62, you could take out a HECM reverse mortgage without any credit or income qualifications.
So you had the wrong people taking out the wrong loan for the wrong purpose.
HECM reverse mortgages are not meant to be a patch. It’s not a short-term fix for a long-term situation.
It’s meant to work hand-in-hand with your other assets to strengthen the overall portfolio.
The American dream is you pay off your home down to zero. Then, you leave all the equity in your home to your children and grandchildren, and that’s their inheritance.
Using and structuring a reverse mortgage properly where the funds are used hand-in-hand with the overall retirement portfolio, you can leave more to your heirs.
And that’s essential!
It would be best if you worked with a reverse mortgage professional to structure the loan property. I discuss why this is important later in this article.
Is a Reverse Mortgage Right For You
You bought a house and raised your family in that house. In doing so, you created this huge asset with many tax benefits.
Education about what a valuable asset your home equity can be for your retirement is critical.
So here’s an effective strategy. If you need to draw, let’s say 4% per year from your retirement portfolio to live your everyday lifestyle, and you’re working with an advisor.
Together you’ve determined that your money will last until, let’s say, 92 years old — just throwing a number out there.
So the strategy a wealth advisor can use is if they have a client taking 4% per year to live their everyday lifestyle. They are projected to run out of money at 90 or 92.
Over these ten years, the economy has been growing. But, unfortunately, it’s likely going to slow, or it’s going to start to regress.
What if the market goes down 10% or 20%, but you still need to draw that 4% to live your everyday lifestyle.
Now, instead of your retirement running out at 90 or 92, it could run out at 80 or 82.
So, incorporating a tax-free strategy using the equity in your home is a way to protect and preserve the overall retirement portfolio.
If you were to get a reverse mortgage, it could help ensure that you don’t outlive your money.
Lifespans are longer now than they ever before.
The number one risk in retirement is not knowing how long your funds will last. No one knows when they are going to pass away.
So, what is the best way to plan for retirement? You could live to one hundred.
The National Reverse Mortgage Lenders Association (NRMLA) did a study that showed that seniors across the country had amassed almost $7.2 trillion in untapped equity.
The reverse mortgage market penetration is minuscule. As a result, lenders have only originated HECM reverse mortgages for a small portion of those who actually could qualify.
That is due to a lack of education.
Do You Qualify For a Reverse Mortgage
The borrower has to be at least 62 years of age or older. They have to be the homeowner, and the property has to be the primary residence. And they have to have at least about 50% equity in the home.
There are tax, income, and credit requirements, as well. No different than a traditional mortgage.
You’re going to need what you are going to need to spend in retirement.
So what’s the alternative? It will likely be tapping into the other areas of your retirement portfolio.
It’s all about education. Homeowners aren’t aware of what a powerful financial planning tool the equity in their home can be, primarily because of the tax benefits.
It’s all tax-free money.
Yes, it is a loan. You are borrowing against an asset.
However, you’re also helping to protect and preserve the money that’s in your retirement portfolio.
The less you withdraw from that portfolio, the more that portfolio is going to grow.
A significant benefit will be using a holistic approach and utilizing a combination of both.
You’re using your portfolio to make your retirement more fulfilling and make your overall portfolio stretch further.
You have to look at your home equity as the asset that it is. A lender can help to educate you on your options.
Here’s what a reverse mortgage can do, you will be able to gain access to about fifty percent of the value of your home, and you can receive payment in a few ways.
Option number one is a tenure payment.
A Tenure payment is an income annuity from the wealth in your home.
If you want to receive that in equal monthly payments for the rest of your life, a lender will let you know what that number is.
You’re going to get a check every month guaranteed for the rest of your life!
Option two is a Term. You want to take the money for a specific amount of years that you determine.
If you want to receive this money for ten years, a lender will tell you how much you’re going to receive over ten years.
These terms are used more often in social security deferment.
You can maximize your retirement portfolio by delaying social security as long as possible.
You could receive a bigger check if you’re able to defer until 70 years old.
You can turn on a reverse mortgage if you are at least 62 and trying to delay till 70.
A borrower can receive money from the wealth in their home for eight years. Then the funds turn OFF after that.
You have the option to pay off the loan balance in a monthly payment or defer payback until the youngest borrower dies.
Option three is a lump sum payout. Again, the lender will tell you how much money you qualify for.
You Can use the funds to pay off some bills or even consolidate some debt.
Line Of Credit
Option four, and the most dynamic way to use a reverse mortgage, is by using a line of credit.
Using a reverse mortgage line of credit is not like a traditional HELOC or traditional home equity line of credit since it provides you with a growth rate.
The growth rate is half a percent over the current interest rate.
For example, current interest rates are about four percent, no different from traditional mortgages.
The growth rate is going to be 4.5%. So you can take the money, and if you don’t need the money now, let it sit until you need it.
And your line of credit is going to continue to grow over time.
So if you’re 60 something and you take a line of credit and don’t need it, you can wait until you’re in your eighties when long-term care potentially starts to kick in.
Healthcare costs start to increase.
Now, you’ve been growing it for 10, 15, 20 years, compounding growth, 4.5% every year. So you will be able to borrow a lot more money from the value of your home.
Unlike any other line of credit, a reverse mortgage line of credit is federally insured and guaranteed.
If you go to the bank and take out a traditional line of credit right now, and the market crashes.
What happened to those lines of credit at that time? They were frozen or turned off.
Unfortunately, the bank can call your line of credit due at any time, and it’s up to them to make that decision.
The FHA guarantees a reverse mortgage line of credit. It can never be frozen, and it can never be taken from you.
And that growth rate is guaranteed.
The growth rates are flexible and are going to move as interest rates move.
Use Multiple Options
You can also incorporate all three options.
Let’s say you need monthly cash flow, and we turn a monthly stipend on, and you receive a check every month if you have some short-term needs.
You take a small lump sum payment to pay off debt or pay off a car or have a rainy day fund.
You also can incorporate the line of credit.
Now what you’ve done is put the wealth in your home, your most significant asset in most cases, to work for you.
Now you can incorporate that into your overall portfolio.
Reverse Mortgage Lenders
An NMLS license, which is the mortgage license, allows a lender to originate a traditional mortgage and a reverse mortgage.
But you have traditional mortgage loan officers that can originate both.
They’ve used reverse mortgages as another source of income.
That gives the consumer a poor customer experience when somebody is stumbling their way through the product.
They don’t understand the intricacies of the product and how it works and, more specifically, how senior housing wealth fits into retirement planning.
They’re not studying it like lenders with an NMLS are studying it.
It’s best if somebody who originates reverse mortgages exclusively for a living can have a conversation with the borrower or their wealth manager.
Together they can strategically discuss how and where your housing wealth fits into retirement.
Any mortgage loan officer could originate reverse mortgages if they wanted to. But, unfortunately, you have many people originating them without a plan or strategy.
And you have borrowers entering into reverse mortgages that are structured incorrectly, which leads to headaches down the road.
Should people take a lump sum cash payout with a reverse mortgage? Likely the answer is no.
Here’s a little secret. In the reverse mortgage industry, a lender gets paid on the loan amount.
So the higher the reverse mortgage loan amount, the more money you take as the consumer, the more money the lender will make.
You also have greedy loan officers structuring these loans in a way that’s best suited for them, not necessarily the consumer.
Over the years, that’s been a stain on the reverse mortgage industry.
There is a lot of education that goes into what a reverse mortgage is and how it works.
When should I take a reverse mortgage? Should I wait to take a reverse mortgage out later in my retirement?
Those are discussions that need to be had with a reverse mortgage professional.
You don’t want to go to any lender to speak about a reverse mortgage.
You want to make sure that you’re talking to a reverse mortgage professional to get solid advice.
If you have a financial advisor or financial consultant, they should be brought into the conversation.
It would be best if you also considered bringing your family into the conversation.
This is a big decision whether or not to use your home as an asset and incorporate that asset into your retirement.
There’s a lot of education needed and a lot of planning that goes into that decision.
Reverse Mortgage Interest Rates
The borrower typically has two options for the interest rate of a reverse mortgage: a fixed interest rate and a variable interest rate.
Fixed Interest Rate
A fixed interest rate is the most popular of both rate types as about 67% of reverse mortgages have used this option since 2009, according to HECMCounselors.org.
The good thing about this option is that your interest rates do not change throughout the life of the loan.
Variable interest Rate
Although a variable rate can be a more flexible option, variable interest rates can vary during the life of the loan.
The borrower may benefit from more disbursement options and interest-only being charged on funds that have been withdrawn. Still, they have the risk of their rate increasing quickly.
Understanding reverse mortgage interest rates can be highly confusing. Therefore, it is best to sit down with a reverse mortgage professional and your wealth advisor to decide the best option for your overall long-term strategy.
Reverse Mortgage Closing Costs
Fortunately, the borrower typically can roll in the closing costs with the reverse mortgage financing to limit up-front charges that would have to pay out of pocket.
Closing cost and fees may include:
- Mortgage Insurance Premiums (MIPs) – This mortgage insurance premium is backed by the department of housing and urban development (HUD). It covers you if the lender goes out of business, your loan balance exceeds the price of your home, or foreclosure.
- Loan Origination Fee – This is an FHA-regulated fee that covers the lender’s expenses.
- Lender Servicing Fee – Lenders may charge a fee for administering the loan and monitorinhttps://fha.gov/g property taxes and insurance.
- Typical Loan Servicing Fees – This may include title insurance, recording fee, document preparation fees, credit report fees, pest inspection fee, flood certification fee, the survey fee, courier fee, and a Settlement/Escrow/Closing Fee.
Understanding closing costs can be confusing and something that your lender should thoroughly explain during the loan process.
Refinancing a Reverse Mortgage
You have to wait 18 months since you originally took out the reverse mortgage, and there has to be a clear benefit to the borrower.
Reverse mortgage borrowers and seniors, in general, are a protected group. Contact the consumer financial protection bureau if you feel like your lender is mistreating you.
The underwriter wants to ensure they are protected, and we are doing right by the borrower.
So, has it been 18 months? Then to what are the benefits? Are you just getting an extra few thousand dollars?
In that case, there isn’t a clear benefit. There has to be a very clear benefit.
There are guidelines that a lender can deal with to help you out in that situation.
Purchase A New Home With A Reverse Mortgage
This type of reverse mortgage allows the borrower to purchase a new home with a reverse mortgage.
Most realtors don’t even realize that this product exists.
Typically, these transactions often occur when seniors downsize, sell a previous home, and pay cash for the next home.
Or even worse, they’re taking out a 30-year mortgage when they’re 70 years old.
So here’s an example, a recent client went to a lender and had an appraised value of $400,000 on the home.
It was too much home for them now.
They wanted to right-size without sacrificing the luxuries that they wanted.
They owed $100,000 on the existing mortgage. So they sold their house, and they pocketed $300,000.
Now, they buy a new $300,000 house.
Put down the 50% equity requirement to qualify for a reverse mortgage.
There are no monthly mortgage payments.
You put down 50%; you pay property taxes, the homeowners insurance, and keep up with the general upkeep of the home.
And now you can buy a $300,000 home, only putting down $150,000.
You can live in that home for the rest of your life and never make a monthly mortgage payment.
Few know about this way of structuring a reverse mortgage.
Proprietary Reverse Mortgage
A proprietary reverse mortgage or jumbo reverse mortgage is a type of reverse mortgage that allows borrowers with higher home values to access a larger principal limit than with a traditional reverse mortgage.
Traditional reverse mortgages limit borrowers to $822,375 as of 2020. Jumbo reverse mortgages give borrowers access to $3 million for homes valued up to $10 million.
You also get the added benefit of using a proprietary reverse mortgage starting at 55 instead of 62 with traditional reverse mortgages.
When Is A Reverse Mortgage Due
You’re not making a monthly mortgage payment to pay down your loan balance. So really, whatever works best for you?
Does making a payment to pay down the loan balance work best, or does deferring payback work best.
However, if the youngest borrower passes, the home goes to their heirs.
One misunderstanding that comes up all the time is that somehow a lender or the government will take your home.
That’s not the case at all.
Remember, you’re still the homeowner. You leave the home to whomever it is that you want to leave the house to.
Now your heirs have a decision to make. Do they want to keep the home, or do they want to sell the home?
Your heirs are adult children, and so they don’t want your home in many cases. So they’re going to sell the home.
Through the sale proceeds, they pay off the loan balance from the reverse mortgage plus interest accrued during the life of the loan.
The additional equity is the heirs to keep, and that’s their inheritance.
Options For Your Heirs
The value of the home will increase over time in most cases.
The heirs will still walk away with some inheritance, and you have been able to live in your home throughout your life.
The heirs can also decide to keep the home and pay off the reverse mortgage through their proceeds.
Sometimes that’s through a life insurance policy.
So you have a life insurance policy that’s going to cover your mortgage loan balance. The kids can then decide to keep the home and pass that home on to future generations or sell the home.
The general misconception is that if I take a reverse mortgage, I will leave less to my heirs.
Protections for Heirs
You’ve been in the reverse mortgage for 25 or 30 years, and you chose to defer your monthly mortgage payment.
You have to pay the interest, but the value of your home has stayed the same, and you have a $200,000 home, and you owe $250,000 on it.
All reverse mortgage has reverse mortgage insurance, which makes reverse mortgages ‘non-recourse.’
Because they’re non-recourse, the heirs cannot be passed the debt they have to pay back.
FHA insurance will cover that difference.
Reverse Mortgage Foreclosures
You had people that we’re taking money out a reverse mortgage; that money was gone just as quick as they got it.
Then what happened was they had massive defaults on their taxes and insurance.
They were spending through the money they accessed from their home because it was no more than a short-term solution.
They also took it without having a strategy of what they were going to do with that money.
It just sat in an account, and it got spent.
Then what happened was you had many people that were defaulting on their property taxes and homeowners insurance.
Well, if you don’t pay your property taxes and insurance, what’s going to happen?
You’re going to be foreclosed on. So there were many foreclosures of people that were in reverse mortgages.
It wasn’t necessarily because they were in a reverse mortgage.
Remember, it’s just a mortgage. You still own the home.
You have to pay the insurance company and the government directly.
That’s how the negative stain of reverse mortgages came about.
There were many foreclosures because the product wasn’t used properly.
A reverse mortgage is very misunderstood and widely confused. However, a suitable lender can educate, inform, and empower borrowers, their families, and advisors to make well-informed decisions.
Here at Enjoy Being Retired, we want to make an impact every day in the lives of our readers. We are helping them to live a better retirement and to achieve peace of mind.
And that’s our driving force every day.
We hope that the reverse mortgage guide was informative and gave you the necessary information you need to move forward on your retirement journey.