Reverse Mortgage: An Overview for Homeowners
You’ve probably seen commercials from celebrities boasting the appeal of reverse mortgages. For many seniors in need of extra money to live on, a reverse mortgage may seem like a retirement dream come true. But is it that simple? Let’s take a look…
What Is a Reverse Mortgage?
A reverse mortgage is a type of loan for homeowners age 62 and older. It allows a borrower to receive payments in exchange for part of their home equity. You might choose a reverse mortgage if you’re struggling to make ends meet and need a source of extra income.
There are three main types of these mortgages, which I’ll cover below, along with some answers to other important questions. And toward the end, you’ll find a list of the pros and cons of reverse mortgages. It’s important to watch out for scams in this industry.
Types of Reverse Mortgages
Home Equity Conversion Mortgage (HECM)
This is the most common type of reverse mortgage. It is offered only by lenders approved by the Federal Housing Administration (FHA). All borrowers must receive HUD-approved counseling before closing. You can then use the loan for any purpose.
Proprietary Reverse Mortgage
This is a private loan. It’s not federally insured by the government. This type of reverse mortgage will typically give the borrower a larger loan, but with much higher interest rates than an HECM.
Single Purpose Reverse Mortgage
The least common of all, this kind of reverse mortgage is usually offered by state and local governments, or nonprofit organizations. The borrower can only use this money for a specific purpose, like property tax payments or home repairs.
How Does a Reverse Mortgage Work?
In a traditional mortgage, you borrow money to buy a home. You make monthly payments to the lender to decrease the balance of your loan. Over time, your equity in the home grows. And once you’ve paid it off in full, you have complete ownership of your home.
In a reverse mortgage, you borrow money against the value of your home. Common requirements for qualifying for a reverse mortgage include…
- Being 62 years old or older
- Owning your property outright or having paid down most of your debt on it
- Living in the home as your main residence
- Paying off an existing mortgage with money from the reverse mortgage
- Meeting with a government-approved housing counselor to discuss and approve eligibility requirements.
In exchange for equity in your home, you’ll receive money. It can come as a lump sum, in monthly payments or as a line of credit.
The value of your home determines the amount of money that you qualify for. Other factors, such as your age, can play a part, though.
As far as paying back the loan, that’s usually not required for as long as you live in the home. The loan doesn’t mature until the borrower passes away, moves out or sells the home. In many cases, the home will need to be sold to repay the loan. Any leftover funds often go to the borrower’s heirs.
How Much Does a Reverse Mortgage Cost?
Reverse mortgages are generally more expensive than other types of loans. Their fees can cost you thousands of dollars. Here are some of the fees you might see…
- Mortgage Insurance Premium (MIP)
This is a fee in an HECM reverse mortgage to guarantee a non-recourse loan. The MIP is a fee paid by a borrower to the FHA. The insurance covers any losses incurred on the loan. This protects the lender and the borrower if the balance of the loan exceeds the value of the home when the loan matures. Borrowers must pay an initial premium of 2% of the property’s value or max claim (whichever is less). The current max claim is $822,375. There is an annual renewal on 0.5% of the outstanding balance of the loan.
- Origination Fee
Charged upfront by your lender, the origination fee covers the cost to originate and process your loan. The cost is often a percentage of your home’s value. A lender might charge 2% of the first $200,000 of your home’s value plus 1% on value beyond that. That can cost you up to $4,000 for a $200,000 home!
- Servicing Fee
A servicing fee is a monthly expense charged by your lender to service and administer the loan.
- Interest Rates
Interest varies based on the lender, the type of loan, and whether you get a fixed or adjustable-rate mortgage.
- Closing Costs
- Credit Report Fee
- Flood Certification Fee
- Appraisal Fee
- Title Insurance
- Recording Fee
- Document Preparation Fee
These fees can add up, and they’re easy to overlook. Many borrowers pay the fees with the money they receive from the loan, reducing their pool of available money.
Pros and Cons
- Provide income for bills and living expenses
- Can be used to pay off an existing mortgage
- Provide tax benefits
- Balance continues to increase with accumulating interest and fees
- Often requires the sale of the home to repay loan
- Can result in the loss of the home with failure to meet ongoing requirements
- Requires borrower to continue paying property taxes, homeowners insurance and HOA fees
- Borrows against the equity of your home, a key source of retirement funds
Avoiding Reverse Mortgage Scams
Homeowners should be cautious when seeking mortgage products. Reverse mortgages can carry high risks. And you should be especially wary of fraudsters.
Scammers often target older Americans through local churches, investment seminars and media advertisements. If you’re considering a reverse mortgage, watch out for some of the common scams below.
- A family member or caregiver coercing a senior homeowner into applying for a reverse mortgage
- Using a senior homeowner’s identity, Social Security number, or other person information to get loan money
- Foreclosure scams that target senior homeowners at risk for foreclosure
Perpetrators can use a dishonest appraiser to inflate the value of the home and get a reverse mortgage on it. The perpetrator has the homeowner transfer the title of the home over to them. The victim is left with no home or reverse mortgage income.
- Free home scams
These scams present seniors with the opportunity to live in a home for free while the perpetrator takes out a reverse mortgage on it. The scammer keeps all the funds and leaves the person living in the home burdened with debt.
When Compounding Interest Works Against You
At Investment U, we value the power of compounding dividends and total returns over time to increase wealth. To see how this works, consider trying out our free Investment Calculator.
A reverse mortgage loan compounds year after year… just like a regular mortgage. But with a reverse mortgage, your balance only increases, because you’re never making payments on the loan.
The balance of your loan compounds with interest and fees. Your equity in the home decreases as the reverse mortgage continues. At the end of your loan, you may have little to no equity left in your home.
Home equity is often a homeowner’s most valuable asset. It can be a precious source of retirement security. Reverse mortgages can be useful for extra income, but homeowners should consider the high risks.
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