Reverse Mortgage Basics
A reverse mortgage is a type of loan that certain eligible homeowners can get to tap into the equity in their home. Unlike traditional loans, they do not require the same sort of underwriting so no income, asset or credit checks are needed. And unlike a traditional loan, there is no monthly repayment for any amounts borrowed. Repayment of the loan’s principal and interest starts only after the homeowner dies or the home is sold.
To be eligible for such a loan, all owners on the property title need to be at least age 62.
For the most part, reverse mortgages, also referred to as RMs, are backed by the federal government through the FHA (Federal Housing Administration) that administers the program.
Myth: The Bank Keeps the House
These types of mortgages have been around for many years (since the late 1970s) and have gone through many changes.
One misconception about these types of loans is that a homeowner loses the house to the bank because of certain terms of such loans when they first came out. In the way way past, banks would take the title to the home. But that is far from the reality for these types of loans now. The property title remains with the homeowner.
How A Reverse Mortgage Limit Is Set
The amount of money that a homeowner gets is based on current age, life expectancy, and appraised value. With this information, the bank will determine the credit line or limit that the homeowner can tap. The lender will apply an interest rate to the amounts outstanding and add it to the balance owed (and subtract the interest accrued from the amount of credit line that is available). Eventually, when the homeowner dies or moves out of the home then the lender will require repayment.
The total amount that is owed is capped as a percentage of the property value which is assumed to appreciate at a certain rate during the owner’s life expectancy.
A homeowner can move out and sell the property and keep the proceeds above whatever the payoff amount is. If the homeowner dies and the property passes to his estate, his heirs can sell the property or refinance it and keep it.
The cost for such a loan can be pricey. Even with recent administrative changes reducing origination fees from the standard 2% of the loan amount, these loans can cost upwards of $12,000 for a $250,000 or $300,000 credit line amount. Although traditional credit and income underwriting are not required, all the other costs associated with a closing like title work, title insurance, recording fees, mortgage insurance and underwriting are still needed.
Why Would A Homeowner Consider A Reverse Mortgage? Comparing Some Options
Why would a homeowner opt for this? Let’s face it. Most folks would prefer not to move into an assisted living facility or a nursing home if they can avoid it. So a reverse mortgage is a good option for those who want to age in place in their home.
It provides a cash flow to help support the costs of running the house. And it taps the equity that a homeowner has built up over time that can be used to pay for essentials like medicine or home renovations to make the home safe and useful for an aging homeowner.
Yes, home equity lines or loans are also an option. They can be even cheaper certainly on the origination side since so many banks offer them with no closing costs. But the homeowner must make a payment each month even if it is just the interest only that is typically required for the first five or 10 years of the line. And if the owner doesn’t have the cash to make that payment, then there is the risk of a foreclosure.
As a former mortgage banker, I would see situations where an elder couple would call me after having refinanced the loan several times. Each time they had to incur closing costs and because their income or credit may have slipped they would only qualify for more costly loan terms that could put them at greater risk of losing the house down the road.
Downsides for A Reverse Mortgage
Setting up a reverse mortgage as a line of credit will not jeopardize Social Security benefits and is not counted as an income source for tax purposes. On the other hand, if the homeowner is receiving Medicaid, then it could be counted as an assessable asset that may limit qualification for such benefits.
Some folks who are facing bankruptcy have opted to go the reverse mortgage route. Jesse Redlener and David Burbridge, attorneys who specialize in these matters, told me of the case where a couple transferred the title from joint ownership (husband and wife) to just the wife. Then they completed the reverse mortgage process. And the husband who now owned no other property filed for bankruptcy. The courts considered this a fraudulent transfer of the property and the assets available for the credit line now became eligible to pay off the husband’s other creditors.
Get More Information From Your Planning Team
The bottom line here is that before making a serious money move you really need to bring in the professionals to help navigate through the minefield. Actions have consequences and this is an area where a good team of advisers (banker, financial planner, attorney) can help.
For more information on reverse mortgages, you may want to call Bob Irving of First Integrity Mortgage, LLC, a licensed reverse mortgage originator.