Reverse Mortgages: How They Work
A reverse mortgage (also called a Home Equity Conversion Mortgage or HECM) is a financial tool that allows seniors age 62 an over to take a portion of the equity in their primary residence as liquid cash to use however they want. No monthly payments are required, which means that the loan balance increases over time. This is it in a nutshell, now let’s look a little deeper.
To be eligible, you must be age 62 or over and you must have enough equity in your primary residence. If you are 62 and you take the lump sum payment option, you would receive somewhere around 62% of the value of the home, minus loan costs and paying off any current mortgage. The older you are, the larger percentage of the home value you can receive. Because no monthly payments are required, there are only minimal income or credit requirements. Generally speaking, if your income is at least double the cost of your property taxes and homeowner’s insurance, you are ok, even if your credit score is poor.
Your home must meet FHA standards, meaning no broken windows, a built-in heat source, no chipping paint, etc. If you are in a condo, the condo must be FHA approved. Most condo complexes are not FHA approved, but there are ways to get them approved. One to four unit homes are acceptable, but a co-op is not. FHA will only recognized a home value up to $625,500. If your home is worth $1,000,000 and you are age 62, you won’t get about 62% of $1,000,000, you’ll get about 62% of $625,500.
You can receive the proceeds of a reverse mortgage in one of four ways: a lump sum with a fixed rate, a line of credit with an adjustable rate, a monthly income with an adjustable rate, or a combination of the last two. The fixed rate lump sum option will get you the most money at the lowest (overall) rate, and will be your option of choice if you are using the reverse to purchase a home, if you have a large mortgage to pay off, or if you have some other pressing need for a large sum of money. Otherwise, you may want to look at the line of credit or monthly income options.
The costs of a reverse mortgage are generally higher than for a standard loan, mainly because there are two kinds of required mortgage insurance (MI): up front lump sum and annual. The up front MI is 2% of the value of your home (again maxed at $625,500). If your home is worth $500,000, that’s $10,000 right there. The HECM Saver is a relatively new product that allows you to practically eliminate the up front MI, but you get quite a bit less money and the interest rate may be a little higher. The annual MI is 1.25% of the loan balance. The loan costs can generally be rolled into the loan itself, if there’s enough equity, such that the only money that would come directly out of your pocket would be the appraisal (about $425) and the required 3rd party counseling (about $125).
The term of the loan is not fixed, like regular loans, but is for the rest of your life, as long as you remain in the home and meet other guidelines. Since you are not making loan payments, your balance increases with the accruing interest as well as the accruing annual MI. Statistically, most HECMs end with equity remaining in the home, and in that case you or your estate would retain whatever money remains after paying off the mortgage, just like with any other loan. If the home ends up being worth less than the balance, that’s when the MI kicks in. It guarantees the lender will receive all that’s due to them, and that you or your heirs are not liable for anything beyond the value of the home.