Reverse Mortgages – Are They Good For Your Clients?
by: Thomas D. Begley, Jr.
Reverse mortgages are increasing in popularity. These instruments can be a very useful tool for some people if properly used, but can actually be harmful in certain situations.
What is a Reverse Mortgage?
A reverse mortgage is a device where the borrower taps into the equity of their home and borrows money without the need to make monthly or other periodic mortgage payments. It is designed to enable people to meet the gap between their living expenses and income by withdrawing a portion of the equity in their homes. Most reverse mortgages are made through the Federal Housing Authority’s Home Equity Conversion Mortgage Program (HECM).
The biggest advantage to the cash-strapped borrower is that no monthly payments are required. The borrower can remain at home indefinitely, so long as he is able to pay the costs of carrying the home such as real estate taxes, insurance, utilities, etc. Proceeds from the reverse mortgage can be used for those purposes. Repayment occurs when the borrower sells the home or dies. The lender is repaid at that time and any excess goes to the borrower or his heirs.
Types of Reverse Mortgages
Under a reverse mortgage the borrower can withdraw a lump sum or take out periodic payments. The problem with a lump sum is that interest on the lump sum starts immediately. For most borrowers it is better to make withdrawals on a monthly basis. Interest is charged only on the amount actually withdrawn. However, most fixed rate reverse mortgages require immediate withdrawal of all of the equity to which the borrower is entitled in a lump sum.
To qualify for a reverse mortgage, the borrower must be at least 62 years of age, own the property outright, and live in the home. Eligibility is based primarily on the value of the borrower’s home, so that income and credit requirements need not be met. If the borrower were obtaining a home equity loan or line of credit, he would have to meet income and credit tests.
The amount to which the borrower is eligible depends on the age of the youngest borrower, the home’s appraised value, and the interest rate. The maximum loan amount under HECM is $625,500. Factors determining the amount that can be withdrawn include the age of the youngest borrower, the appraised value of the home, and the interest rate. The older the borrower, the higher the home appraisal, and the higher the interest rate, the more the borrower can withdraw.
The problem with reverse mortgages is that they are expensive. Total costs include the following:
- Origination Fee. Origination fee equal to 2% of the first $200,000 of the home’s value plus 1% of the excess.
- Service Charge. There is a monthly service charge of up to $35 added to the loan balance monthly.
- Closing Costs. Borrowers must pay typical closing costs, including title insurance, recording fees, etc.
- Mortgage Insurance. One of the factors that makes reverse mortgages expensive is that there is an upfront mortgage insurance premium of 2% of the home’s value and a monthly insurance premium equal to 0.5% of the mortgage balance. Again, note that the 2% mortgage insurance premium is based on the home’s value, not the loan amount. The monthly insurance premium is based on outstanding mortgage balance.
NOTE: The origination fee is based on the home value, not the mortgage amount. The total is limited to $6,000. Currently, some lenders waive the origination fee.
When Not to Consider a Reverse Mortgage
- Change of Residence. If the borrower expects to move within a few years, the upfront costs of the reverse mortgage become prohibitive.
- Die in Home. If the borrower expects to die at home, the heirs may receive little, if anything. In some cases this is a consideration. In some situations, children may be willing to serve as the lender on the reverse mortgage without all of the upfront fees in order to preserve their inheritance.
- Public Benefits Eligibility. Any lump sum cash received from a reverse mortgage may make the borrower ineligible for public benefits such as SSI, Medicaid, certain state prescription drug benefit programs, utility assistance, or other means-tests benefits. This is because the home itself is not a countable asset, but the proceeds of the reverse mortgage are countable, if the funds remain in the borrower’s bank account on the first day of the following month or the first day of any month thereafter.