Understanding Reverse Mortgage – What is It?

Reverse Mortgages allow homeowners aged 62 and over to turn a proportion of their home equity into, for instance, a tax-free lump sum, a regular monthly payment or funds received on a cash request basis. This means they do not have to sell their property, give up the title or negotiate a new monthly payment on their mortgage. With Reverse Mortgages, payments are “reversed”. In other words, lenders no longer receive payments, as is the case with regular mortgages. Instead, monthly payments are made to the homeowners.

How much cash can I access?

How much of your home equity you can turn into cash will depend on your age. For couples, the amount will depend on the youngest homeowner’s age. Other factors will include the market value of your property, current interest rates and, if your loan is part of a government program, the lending limit which applies to the area in which your property is located. As a rule, the older you are and the more equity you have built up in your property, the more cash you are likely to receive.

Do I qualify for a Reverse Mortgage?

To qualify for a Reverse Mortgage, your property will need to be a single family home, a 2-4 unit home (one unit needs to be occupied by the homeowner), an HUD- (Housing and Urban Development) approved condominium, or a manufactured home built after June 15th, 1976, that complies with FHA requirements. Although co-ops do not usually qualify, Reverse Mortgages are available to co-ops in New York.

What are the different payment options?

You may opt to receive the cash released through a Reverse Mortgage as a lump sum, as fixed monthly payments for an agreed period of time or for as long as you remain in your home, or as a line of credit. You can also choose a combination of these options. The vast majority of homeowners tend to opt for a line of credit, which enables them to access some of the loan proceeds whenever they require cash.

Does the growth factor which applies to the unused balance of the line of credit mean I will be paid interest?

No, you will not be paid any interest. The growth factor reflects how much your property has appreciated (increased in value) in one year but also the fact that you are one year older. The growth factor is approximately equivalent to the interest you are paying on the loan.

Am I allowed to spend the cash released from a Reverse Mortgage on anything I want?

The cash released through a reverse mortgage can be used for any purpose. You may wish to use it to cover living expenses once you are retired, carry out home improvements, pay for health care expenses, pay off your debts, go on vacation, or any other expenses.

How is interest calculated on a Reverse Mortgage?

When you take out a reverse mortgage, you are only charged interest on the cash that you receive. A variable interest usually applies to reverse mortgages, although fixed-rate alternatives are available. Variable rates are usually calculated using an index, such as the one-year Treasury Bill or the LIBOR (London Interbank Offered Rate). A margin of 1 to 3 percent is usually added to the index chosen to arrive at the interest rate you will be charged. Because interest compounds over the life of the loan and is not paid immediately, your available loan proceeds are not reduced.

Can anyone get a Reverse Mortgage?

In order to be eligible for a Reverse Mortgage, you need to own a house, be aged at least 62 and have built up sufficient equity in your property. Your income and health status are not taken into account.

I already have a home loan. Can I still get a Reverse Mortgage?

You may still be eligible for a reverse mortgage even if you already have a home loan. However, in order to qualify, you will need to pay off your current loan so that the reverse mortgage is in a first lien position. Your current loan can be paid off with a reverse mortgage, your savings or financial assistance from family or friends.

For instance, let’s assume you still owe $75,000 on your existing mortgage and you qualify for $110,000 under the reverse mortgage program (this figure will depend on your age, the value of your property and current interest rates). In this case, you would be able to pay off your current mortgage and still be left with $35,000 to spend as you wish.

However, if you were only eligible for $55,000 under the reverse mortgage scheme, you would need to find $20,000 to be able to get a reverse mortgage. Also, you would use all the cash from the reverse mortgage to pay off your current home loan. On the plus side, you would no longer have to make monthly mortgage payments.

If you are unable to pay off your current mortgage, you may wish to consider financial assistance from family or friends or consider applying for a grant. However, you will not be able to take out a new loan.

If I take out a reverse mortgage, will I be charged a monthly servicing fee?

Whether or not you are charged a monthly servicing fee will depend upon the reverse mortgage you take out under the FHA HECM program. Servicing fees range from $30 to $35 per month and cover the cost of servicing your reverse mortgage.

The approximate cost of servicing a reverse mortgage throughout its life is shown in the Servicing Fee Set Aside (SFSA). The SFSA is calculated using the homeowner’s life expectancy, expressed in months, and the servicing fee charged every month. The SFSA is not a closing cost and does not affect the initial loan balance. It is instead put aside from cash accessible to you. The SFSA is equal to your monthly servicing fee and is charged to your loan balance.

Please note that some reverse mortgages are not subject to a monthly servicing fee or a Servicing Fee Set Aside. For more information, you are advised to contact your lender or an HUD-approved reverse mortgage counselor.

Will a Reverse Mortgage affect the Government Assistance I receive?

Government assistance, such as Social Security payments or Medicare benefits, will not be affected if you opt for a reverse mortgage. If you are a Medicaid recipient, however, the funds you receive from your reverse mortgage must be used immediately. If not, the funds will be considered an asset and will affect your eligibility for Medicaid payments. For instance, if you apply for funds to carry out home improvements, your Medicaid entitlements will not be affected provided you spend all the funds in the same calendar month. If you don’t, the remaining funds may be considered an asset. Currently, individuals who have more than $2,000 ($3,000 for couples) in liquid funds, including bank funds and savings bonds, are not eligible for Medicaid payments. If you require further information, you are advised to consult a Medicaid expert or your local Area Agency on Aging.

Is Counseling necessary?

Before applying for a Reverse Mortgage, you will have to consult an independent counselor who will ensure you fully understand the advantages and disadvantages of reverse mortgages. Counseling is essential to ensure consumer protection and will also enable you to discuss other financial alternatives.

Counseling is available from your local HUD-approved counseling agency or from national agencies. These include the National Foundation for Credit Counseling (866-698-6322), Money Management International (877-908-2227), the Consumer Credit Counseling Service of Greater Atlanta (866-616-3716) and the National Council on Aging (800-510-0301). Counseling, which is compulsory prior to applying for a reverse mortgage, may take place over the phone or may take the form of a face-to-face interview.

Counselors are legally bound to:

a) review alternative options which are available to homeowners and which may be more advantageous than a reverse mortgage. These include housing, social services and other health and financial alternatives.

b) look at the other options for home equity conversion which are currently available or could become available in the future, such as property tax deferral programs.

c) study the financial consequences of taking out a reverse mortgage.

d) consider the tax consequences affecting the prospective borrower’s eligibility under state or federal programs and the impact on the estate or his or her heirs.

When will I have to pay back my Reverse Mortgage?

Your reverse mortgage will need to be repaid when the property it applies to is no longer your principal residence, when you (or the remaining spouse) pass away or if you sell the property. In other words, you do not make any payments on a reverse mortgage while it remains outstanding. Because the balance on a reverse mortgage cannot exceed the value of a property, should you decide to sell your home any funds left will go to you or your estate.

In which circumstances is a Reverse Mortgage not recommended?

Reverse mortgages carry substantial upfront costs. If you are not planning to remain in your home for more than 2 or 3 years, you are strongly encouraged to look at less costly options. These include home equity loans, interest-free loans or grants available through your county government or a local non-profit organization. If you are struggling to pay the taxes due on your property, you may wish to consider a tax deferral program. A reverse mortgage is also unsuitable if you are planning to pass your property down to your children, because in most cases it will have to be sold to pay off the reverse mortgage.

Home Equity Conversion Mortgages (HECMs) are the most popular types of reverse mortgages. Introduced in 1989, HECMs are guaranteed by the federal government through the Federal Housing Association (FHA), which is part of the U.S. Department of Housing and Urban Development.

The total amount a homeowner may receive through an HECM will depend on their age, the current value of their property as well as interest rates. In other words, the older an individual is and the higher the market value of their property (and the more equity they have built in their home), the more funds they will be able to access.

The maximum amount of cash a homeowner can release under the Home Equity Conversion Mortgage program is $625,500. In other words, even if your property is worth more than $625,500, the maximum amount you will be allowed to receive will be $625,500. If your property is worth less, the amount you are allowed to access will be determined by the value of your property.

When you take out an HECM, you are required to pay a certain number of upfront fees. Most of these fees, however, are capped by the FHA. You will, for instance, be charged a Mortgage Insurance Premium (MIP) which represents 2 percent of the maximum claim amount (either the value of your property or $625,500, whichever is lower). Thereafter, you will be charged an annual premium representing 0.5 percent of the loan balance. The MIP payment goes to the FHA, which guarantees all HECM loans. In other words, should the company that manages your loan go out of business, the FHA will take your HECM over and will ensure you still have access to your loan funds. The MIP also guarantees that you cannot owe more than the value of your property when your HECM becomes payable.

The vast majority of reverse mortgages in the U.S. are taken out under the HECM program, which states that the maximum allowable origination fee is 2 percent of the first $200,000 of maximum claim amount, plus 1 percent of the balance above that. In the case of a home worth $250,000, the origination fee would be 2 percent of the first $200,000 ($4,000) plus 1 percent of the remaining $50,000 ($500), for a total of $4,500. Origination fees are capped at $6,000.

Apart from these fees, you will also be charged standard closing fees, such as title insurance, attorney fees, recording fees, and so on.

1. Discovering Reverse Mortgages

Homeowner hears about reverse mortgages (newspaper article, leaflet, word-of-mouth, etc).

2. Getting further information

Homeowner gets in touch with a reverse mortgage lender or the National Reverse Mortgage Lenders Association to find out more about reverse mortgages.

3. Receiving counseling

Counseling is compulsory prior to applying for a reverse mortgage and may take place over the phone or may take the form of a face-to-face interview. Counseling is available from your local HUD-approved counseling agency or from national agencies. These include the National Foundation for Credit Counseling (866-698-6322), Money Management International (877-908-2227), the Consumer Credit Counseling Service of Greater Atlanta (866-616-3716) and the National Council on Aging (800-510-0301).

Counselors are legally bound to:

a) review alternative options which are available to homeowners and which may be more advantageous than a reverse mortgage. These include housing, social services and other health and financial alternatives.

b) look at the other options for home equity conversion which are currently available or could become available in the future, such as property tax deferral programs.

c) study the financial consequences of taking out a reverse mortgage.

d) consider the tax consequences affecting the prospective borrower’s eligibility under state or federal programs and the impact on the estate or his or her heirs.

4. Loan Application and Disclosure

Homeowner completes a loan application form and chooses a payment plan (fixed monthly payments, lump sum, line of credit or a mixture of these). Under the Truth in Lending Act, the lender then informs the homeowner of the total cost associated with the loan. The homeowner supplies: a) Social Security number; b) copy of property deed; c) details of current mortgage(s); d) counseling certificate.

5. Property Appraisal

An appraisal, paid for by the owner, is carried out to establish the market value of the property. The appraiser also assesses the state of repair of the property to make sure it conforms with FHA guidelines. If structural defects are discovered, the borrower will need to have these rectified.

6. Underwriting

After all relevant information and paperwork have been received, the lender can finalize the loan details with the homeowner, such as the chosen payment option and the schedule for loan interest rate adjustments, and send the loan application for final approval. It usually takes between 4 and 8 weeks for a loan application to be underwritten.

7. Closing

Once the loan application has been approved, the lender will calculate what interest rates will apply and will prepare closing documents. Closing costs are generally incorporated into the loan. The homeowner will be invited by the lender or the title company to sign the loan documents.

8. Disbursement

Following the signature of the loan documents, the homeowner can cancel the loan, provided this is done within three working days. Otherwise, the funds will be issued. The funds will be disbursed as per the payment option selected by the homeowner. Any debt on the property will be paid off and a new lien will be placed on the house. The loan proceeds can be used at the homeowner’s discretion. The person who looks after the account (the loan servicer) is responsible for arranging monthly payments (if this was the chosen option), advancing line of credit funds at the homeowner’s request, collecting repayments on the line of credit and issuing statements on a regular basis.

9. Loan Repayment

As long as the loan is running, no monthly mortgage payments are made by the homeowner. The loan is only repaid when the property is no longer the homeowner’s main residence. The loan can either be paid off by the homeowner or the estate (or heirs), and the property may or may not be sold off. The debt cannot exceed the value of the property or its sale price.

The costs associated with reverse mortgages are similar to those which apply to home purchase loans or which are charged when an individual decides to refinance their mortgage. These costs include an origination fee, an up-front mortgage insurance premium (in the case of an FHA Home Equity Conversion Mortgage, or HECM), an appraisal fee and other usual closing costs.

These fees and costs tend to be capped and in most cases can be incorporated into the reverse mortgage. A brief description of each type of fee is shown below.

Origination fee

The origination fee is the up-front fee charged by the lender to process the reverse mortgage application. It is typically expressed as a percentage of the total loan.

The vast majority of reverse mortgages in the U.S. are taken out under the HECM program, which states that the maximum allowable origination fee is 2 percent of the first $200,000 of maximum claim amount, plus 1 percent of the balance above that. Origination fees are capped at $6,000.

Mortgage Insurance Premium (MIP)

Under the HECM structure, borrowers will be charged a Mortgage Insurance Premium (MIP) which represents 2 percent of the maximum claim amount (either the value of their property or $625,500, whichever is lower). Thereafter, they will be charged an annual premium representing 0.5 percent of the loan balance. The MIP payment goes to the FHA, which guarantees all HECM loans. In other words, should the company that manages the borrower’s’ loan go out of business, the FHA will take their HECM over and will ensure they still have access to their loan funds. The MIP also guarantees that they cannot owe more than the value of their property when their HECM becomes payable.

Appraisal Fee

The cost of carrying out a property appraisal is usually $300-$400. The role of the appraiser is primarily to establish a current market value for the property.

A property appraiser also ensures the property does not have any major structural damage, such as the presence of termites or foundation defects. Under federal regulations, a reverse mortgage can only be granted if the property is found to be structurally sound and fulfills all home safety codes.

Should a defect be discovered, remedial work will need to be carried out. The appraiser will visit the property a second time in order to confirm that the work has been completed satisfactorily. The cost of carrying out a second appraisal is usually $50-$75. Homeowners may be able to include the cost of the repairs in their loan and complete the work after the reverse mortgage has been granted.

Closing Costs

Homeowners who successfully obtain a Reverse Mortgage are frequently charged the following closing costs:

Credit report fee: this determines whether any federal tax liens or other judgments have been issued against the potential borrower. The credit report usually costs less than $20.

Flood certification fee: this establishes if the property has been built on a federally designated flood plain. This fee is usually below $20.

Escrow, Settlement or Closing Fee: this usually involves a title search as well as other necessary closing procedures. The cost ranges from $150 to $450.

Document Preparation Fee: this fee covers the costs of finalizing the closing documents, such as the mortgage note as well as other recordable documents and ranges from $75 to $150.

Recording fee: this is the fee payable in order to record the mortgage lien with the County Recorder’s Office. Recording fees range from $50 to $100.

Courier fee: this fee corresponds to the cost of transporting documents between the lender, the title company, etc. Courier fees usually amount to less than $50.

Title Insurance: this type of insurance protects lenders or borrowers against losses arising from problems with the ownership or legal title of a property. The cost depends on the size of the loan (the greater the loan amount, the more expensive title insurance is).

Pest Inspection: this is carried out in order to establish whether the property is suffering from an infestation of wood-destroying organisms (e.g. termites). Having a pest inspection carried out usually costs less than $100.

Survey: this is performed in order to accurately ascertain the boundaries of the borrower’s property and to ensure neighboring homeowners have not encroached on his land. The fee charged by a surveyor is typically below $250

Servicing Fee Set-Aside

This fee corresponds to the expected costs of servicing a borrower’s account. It is deducted from the available loan proceeds when closing takes place.

The loan servicer is entitled to charge a monthly servicing fee under federal regulations. This fee usually ranges between $30 and $35. The funds set aside will depend primarily on the borrower’s age and life expectancy. It is not uncommon for the set-aside fee to represent several thousands of dollars.

Please note that the set-aside fee is not a charge and that the only sum which will be added to your loan balance is the monthly servicing fee (this is typically $30-$35).

The reverse mortgages on offer nowadays contain a series of safeguards aimed at reassuring customers that they remain homeowners and, as such, conserve the rights they have on their property. Also, taking out a reverse mortgage does not put them, their property or their family in any financial risk. These various safeguards come under the FHA HECM and follow the code of Best Practice.

The main consumer safeguards which apply to reverse mortgages are listed below.

1) Counseling

Any reverse mortgage applicant must consult an independent counselor before his or her application can be accepted. The main responsibilities of counselors are to review the transaction, clarify any queries the borrower may have and discuss other alternatives.

2) Standard Interest Rates and Caps

Under the FHA’s Reverse Mortgage program, you can either opt for a fixed interest rate or choose a rate which is adjusted each month or each year. Interest rates are set using either the 1-year U.S. Treasury Constant Maturity Rate, which is released by the Federal Reserve each week, or the London Interbank Offered Rate (LIBOR). A margin is then added to the rate by the lender. Caps, which last throughout the life of the mortgage, apply to the adjustable rates, whether these reset monthly or annually.

The rate applicable to conventional reverse mortgages is based on the LIBOR index. A margin is also added to the rate by the lender.

3) Caps on Fees

A cap on origination fees applies to reverse mortgages. This fee can be incorporated into the mortgage, which means a potential borrower will not incur major upfront costs when taking out a reverse mortgage.

4) Advance Disclosure

Because of Federal Reserve Board requirements, any potential reverse mortgage applicant must be informed about the full costs involved in taking out such a mortgage. The Total Annual Loan Cost (TALC) must include the total costs associated with the loan throughout its expected life.

5) No Maturity Date

Reverse mortgages provide a great deal of protection to homeowners, as they give borrowers a lifetime right to remain in their property. As a result, they offer an invaluable degree of stability should the borrower’s financial circumstances deteriorate. A reverse mortgage is a permanent arrangement and it cannot become due during the borrower’s lifetime.

6) No Prepayment Penalty

Under the FHA’s Reverse Mortgage program, the loan does not need to be repaid until the borrower ceases to occupy the property. However, the borrower may repay the loan in full at any time without incurring any penalties.

With some conventional reverse mortgages, a penalty may be payable if you decide to pay off the loan in the first 12 months.

7) No Cancellation Penalty

Borrowers have a right to cancel their loan free of charge, provided the cancellation takes place within three days of closing. This “right of rescission” can be used in any circumstance.

8) Asset Protection

The amount payable when the life of the reverse mortgage comes to an end will be the sum of the funds paid to the borrower (or advanced to cover the fees) plus any accrued interest. Provided the property is sold to repay the reverse mortgage, the amount repaid will not be greater than the value of the property. Should a decision to retain the property be made, the total amount repayable would correspond to the actual balance on the account.

9) No Shared Appreciation

Although reverse mortgages previously allowed borrowers to obtain additional funds provided they relinquished a percentage of the future value of their property, this is no longer possible. Reverse mortgages no longer contain an “equity sharing” or “shared appreciation” option.

Reverse mortgages, whether conventional or those insured by the government (Home Equity Conversion Mortgages) all have a number of common features. These include:

●      You must be aged 62 or over and own a property, although the minimum age can vary with some traditional reverse mortgages.

●      You always remain the owner of (i.e. retain title to) the property. The lender will never assume ownership of your property, even if you (or the last surviving spouse) permanently ceases to occupy the property.

●      You are still responsible for paying the taxes and insurance on the property. You must keep the home in a good state of repair. A specific set-aside from your reverse mortgage can be organized if you are having difficulties meeting these payments.

●      The loan is repaid when you (or the last surviving spouse) permanently cease to occupy the property. Either you, your heirs or your estate must arrange for the loan to be paid back. This can be achieved by either using private funds or disposing of the property. Once the loan has been repaid, any remaining proceeds following the sale of the property will go to you, your heirs or your estate.

●      How much of your home equity you can turn into cash will depend on your age. For couples, the amount will depend on the youngest homeowner’s age. Other factors will include the market value of your property, current interest rates and the upfront costs. If your loan is part of a government program (HECM), the lending limit will depend on the county in which your property is located. As a rule, the older you are and the more equity you have built in your property, the more cash you are likely to release.

●      You can either settle the loan fees yourself or they can be paid out of the loan proceeds. As a result, getting a reverse mortgage does not have to be costly. In general, you are only required to pay for the property appraisal, which in most cases only costs around $350.

●      The amount you owe (the loan balance) increases when you obtain funds from your line of credit or when you receive a monthly payment. A monthly servicing fee as well as interest on the loan balance are also charged by the lender.

●      The loan does not have to be repaid until the property is no longer your main residence (or the last surviving spouse’s). Under the government-insured HECM plan, you may spend up to 12 consecutive months out of the property (this may differ for other products).

A “non-recourse” feature applies to all reverse mortgages. This means that the total balance owed on the reverse mortgage cannot be greater than the property’s appraised value, provided the property is sold by the borrower or heirs to repay the loan. Should the balance exceed the property’s appraised value, the lender (or, in the case of an HECM product, the federal government) will cover the loss.