Navigating the Tricky Terrain of Reverse Mortgages

By Nicole Del Percio

A reverse mortgage is when a homeowner relinquishes equity in their home in exchange for regular payments to supplement their income. The lender pays you based on a percentage of your home’s value.                              

According to the Wall Street Journal, less than 2% of homeowners have a reverse mortgage. So why are we talking about it? Many of us are at an age where our parents might be thinking about their retirement and the income they will need. As they consider supplementing their income, they need to consider all of their options and the financial consequences. For some a reverse mortgage seems like a financial relief because they can tap into the equity in their home without selling. While this may seem like a lifeline, reverse mortgages are not without risks.

How do you qualify for a reverse mortgage?

• Must be at least 62
• Your home must be your primary residence (meaning you live there the majority of the year)
• You own your home or have a low balance
• You cannot have any federal debt i.e. owe federal income taxes or federal student loans
• You must have the cash on hand or agree to set aside part of the reverse mortgage funds to cover the closing costs, taxes, and insurance.
• The home must be in good condition
• You will need to go through the Department of Housing and Urban Development  (HUD) approved counseling 

Are there different types of reverse mortgages?

Yes! There are three different types: 

1. Those that are insured by the Federal Housing Administration (FHA).  The most common reverse mortgages are Home Equity Conversion Mortgage. HECM are FHA insured so they have some additional guidelines in place to protect borrowers.
2. Proprietary reverse mortgage loans are not FHA-insured; These are private loans not bound by the Federal Housing Administration. They are often referred to as jumbo reverse mortgages because they can lend larger amounts of money.
3. Single-purpose reverse mortgages that are offered by state and local governments and some non-profits. These are the least expensive option, however, they can only be used for specific purposes that the lender specifies. 

Payment Options

There are three main payment options; each option has its pros and cons that you will need to weigh based on your needs. 

1. Through a line of credit (adjustable interest rate)
   • Lower cost than a lump sum payment because you’ll only pay interest and fees on the money you use
2. Monthly payout-(adjustable interest rate) Two different options: Term or Tenure
   • Monthly payout to supplement income
   • Can be combined with a line of credit
3. Lump sum payout (fixed interest rate)
   • The amount available may be lower than other payout options
   • Higher cost because you are paying interest and fees on the entire loan

What’s the catch?

This type of loan can put a retiree at financial risk. The reverse mortgage like a regular mortgage accrues interest on the outstanding debt. Money taken by the homeowner does not need to be repaid until the homeowner leaves the house, sells the house, or dies. Once one of these events occurs, the loan balance, interest, and any fees are due in full.  As payments are made to you and interest accrues over time, your equity decreases, and the lender acquires a larger portion of the equity.

Loan Amount

How much you can borrow depends on your age, the interest rate, and the value of your home. The borrowing limit is better for those who are older and have high-priced homes.

If you are married or co-borrowing with another person, the principal limit is based on the youngest co-borrower.

Reverse Mortgage Fees

Fees will depend on the loan type and lender you use. The rules and regulations are complex, and a loan contract can have vague language about lending practices.  You will want a lawyer to review all documentation so you can understand all of the contract fees, interest, repayment, and default rules. According to the Consumer Financial Protection Bureau, some of the one-time upfront costs include:

• Origination Fee (cannot exceed 6k)
• Closing costs (appraisal, title search, surveys, inspections, recording fees, mortgage taxes, credit checks and other miscellaneous fees)
• Mortgage Insurance premium

Ongoing fees

• Interest
• Servicing fee 
• Annual mortgage insurance premium (.5% of outstanding balance)
• Property charges (homeowners insurance, property taxes, and other kinds of required insurance)

Stipulations

Unexpected events may trigger immediate repayment or foreclosure. A homeowner with a health scare who is hospitalized for an extended time may have their house deemed uninhabited. If this happens, the loan becomes due. If the funds are not immediately available, the lender will sell the house to recoup the money paid out, including fees. Any equity left goes to the homeowner or their heirs. 

Government Programs 

Certain government programs are based on liquid assets. If a homeowner has money from their reverse mortgage, it may affect eligibility. Programs such as Medicare and Supplemental Social Security Income can be affected.

Reverse Mortgage Alternatives 

If you are unsure about a reverse mortgage but still need cash, you can look at a few different alternatives to consider. Make sure to evaluate all options before settling on a reverse mortgage.                                 

A home equity loan (HEL) allows you to borrow money using the equity in your home as collateral. With a HEL you receive the money in one lump sum, and the loan is usually fixed-rate. This is a second mortgage secured by your home equity.

A home equity line of credit (HELOC) is an open-ended line of credit that allows you to borrow repeatedly against your home equity. There is typically a fixed term to draw on the funds, typically 10 years. HELOCs typically have variable interest rates and change over time, and you will only pay interest on the funds that you have pulled.

With both the HEL and HELOC, there are monthly payments, and lenders will evaluate your income and credit when reviewing your application.

If neither of these options is palatable, you could also look at downsizing. Again this may only be an option if it is a seller’s market, allowing you to purchase a smaller less expensive home, leaving you the excess cash to cover living expenses.

There is not a one-size-fits-all solution to how much income you will need in retirement, however, a rule of thumb is 70% of your annual pre-retirement income. 

Reverse mortgages can offer relief to retirees by providing access to the equity tied up in their homes. However, it is imperative to view these arrangements with caution and a clear understanding of the potential pitfalls. The accumulation of interest, reduced inheritance, high fees, government assistance implications, market fluctuations, and ongoing responsibilities are all factors that need to be considered.

Before opting for a reverse mortgage, one should consult with a financial advisor, legal experts, and family who can help evaluate and navigate whether this aligns with long-term goals. While a reverse mortgage might be a lifeline for some, the associated risks can affect not only the current homeowner but anyone who may be set to inherit the home.