What is a Reverse Mortgage

Should I get a Reverse Mortgage

What is a Reverse Mortgage?  Good question.  There are lots of definitions and descriptions floating around that create confusion.  I think the easiest way to understand a Reverse Mortgage, is to think about it in terms of a Traditional Mortgage so you can appreciate what is really being ‘reversed’.

In a Traditional Mortgage, you borrow money from a bank for the purchase of a home.  You then make monthly payments against the borrowed amount over the term of the loan.  During this time, the amount owed decreases until the loan is repaid.

A standard Reverse Mortgage, sometimes called a Life Time Mortgage, essentially reverses this transaction.  You receive (rather than pay) monthly payments from your Reverse Mortgage lender and the amount owed goes up (rather than down) over the term of the loan.

In both settings your home is the loan collateral and cash payments are exchanged between the borrower and the bank.  In the first example the borrower is making payments over time to acquire the home while with the Reverse Mortgage the borrower is liquidating the home over time.

In its most simplified form, a Reverse Mortgage is a mirror image or ‘reverse’ transaction.

 

Is a Reverse Mortgage really that simple?

Yes and No, mostly No.

The principles at work in a Reverse Mortgage really are as simple as the example.  However, there are numerous applications or variations that conspire to complicate the discussion.

Here are four factors or levers that de-simplify this market:

  • Fundamental Differences in Reverse and Traditional Mortgages
  • Three types of Reverse Mortgage
  • Cash Disbursement Options and Implications
  • Eligibility Requirements and Implications

 

Fundamental Differences in Reverse and Traditional Mortgages

The most basic and influential difference between a Reverse and Traditional Mortgage is the repayment period.  Repayment on a Traditional Mortgage begins almost immediately.  Typically within 30 or 60 days of closing, the repayment process will begin.  At the end of the term the debt is no more. 

 With a Reverse Mortgage, the debt is not due until the last qualified owner is no longer using the home as a primary residence.  This is most often the result of death or a move into a nursing home facility.  At this time, or sometimes following a 6-12 month family ‘decision making period’, the loan is due in full.

The risk profile and cash flow associated with each loan type differs which impacts their respective fee structures and interest rates.  Consider the interest fees on the traditional mortgage decreases with the loan balance as compared to the Reverse Mortgage in which the interest fees increase with the loan balance.

 

There are three types of Reverse Mortgages

Single Purpose Reverse Mortgage:

The single purpose reverse mortgage is offered by some state or local governments or some non-profit organizations.  It is not available everywhere.  As its name implies, its proceeds may be used for only a specified and lender approved purpose.  This is generally a lower cost loan and most often available only to those with low or moderate equity.

Federally Insured Reverse Mortgage:

Often called Home Equity Conversion Mortgages or HECMs, these are the most common Reverse Mortgages and are backed by HUD.  The use of proceeds from this type of loan is not limited.  Most of the available literature on Reverse Mortgages are associated with HECMs.

Proprietary Reverse Mortgage:

Proprietary Reverse Mortgages are private loans issued and backed by for-profit companies.  The use of proceeds from this type of loan is not limited.  Additionally, the max loan value of $650,500 in place for HUD backing is not imposed in this Reverse Mortgage market.  Loans in excess of this HECM cap are called jumbo Reverse Mortgages.

 

Cash Disbursement Options and Implications

The borrower proceeds may be distributed multiple ways:

Lump Sum – lump sum payout at closing, interest starts accruing on full balance from the start

Tenure – equal monthly payments for as long as homeowner remains in the home.  The outstanding balance (and interest due) grows over time.

Term – equal monthly payments for a number of years, outstanding balance (and interest due) grows over time.

Line of Credit – borrower draws money as needed until line of credit is exhausted.

Combination – any mix of the above options may be deployed.  For example, a borrower could collect the funds as follows:  25% lump sum, 50% via 10 year term, and hold back 25% via Line of Credit.

Only a portion of your total equity may be consumed through the loan principle with the interest you accrue eating away at your remaining equity.  Therefore, a lump sum which aggressively accesses the loan proceeds will consume more of your residual equity through fees and interest changes than would a lengthy term distribution.

 

Eligibility Requirements and Implications

The eligibility requirements for Reverse Mortgages are pretty straightforward, but the implications may be more complicated.

Basic Reverse Mortgage Eligibility depends on the following:

  • 62 years of age (or older) 
  • Primary Residence
  • Sufficient equity in the home
  • No existing mortgage or existing mortgage must be paid with Reverse Mortgage funds
  • Current or Pending Bankruptcies must be court approved
  • FHA Standards for valid property types apply
  • Loan may not exceed $625,500 for HECM Reverse Mortgages

An individual who qualifies based on these terms should enter their information into a Reverse Mortgage Calculator to understand the specific principle and terms for which they qualify.

Here are links to 3 Calculators to assist this process.

Reverse Mortgage Calculator 1
Reverse Mortgage Calculator 2
Reverse Mortgage Calculator 3

One idea to keep in mind is that an older applicant will receive a higher monthly payout than a younger applicant with the same home equity profiles.  This is because the expected payment term is longer for the younger applicant.

So you can see how, even though we started with a simplified parallel between a Traditional and Reverse Mortgage, once we begin to customize the loan experience the results can vary significantly.  These levers are important to keep in mind if and when you explore your Reverse Mortgage options.
 
Reverse Mortgage Pros and Cons

As with most decisions, there are advantages and disadvantages that should be fully considered.  This is certainly the case with Reverse Mortgages.

Advantages of a Reverse Mortgage:

  • Stay in your home
  • Easy to Qualify, no income or credit score requirements once equity requirements are met
  • Access to equity without having to sell your home
  • Access to equity with no monthly payments
  • Proceeds are generally tax free
  • Few Income Restrictions
  • No Medical Restrictions
  • Typically no impact to SSN or Medicare Benefits
  • Retain Home Title
  • Allowance for up to 12 month consecutive nursing home or medical facility stay prior to primary residence status being disallowed, with HECM Reverse Mortgage
  • Non-recourse provisions protect heirs and estate from personal liability extending beyond the full equity value of the home
  • 3 day cancellation allowance – must be received by lender in writing
  • Prepayments are allowed
  • You cannot outlive a Reverse Mortgage
  • Flexible Disbursements

Disadvantages of a Reverse Mortgage:

  • Higher expenses and upfront costs
  • HECMs require counseling session with approved agent to explain loan, associated costs, and potential alternatives; some proprietaries require this as well; counseling fee typically $125
  • Confusing product marketed to Seniors, opportunities for shady tactics
  • State or Local need-based programs may be impacted by Reverse Mortgage payouts.  Your jurisdiction guidelines may vary so be sure to understand the implications in your area.
  • Interest and Service fees are tied to your outstanding loan balance which means they are subject to increase, and will increase at an increasing rate as loan balances continue to grow.
  • Reverse Mortgage interest is not deductible until loan repayment
  • Not recommended for short term loans
  • You may outlive the proceeds of a Reverse Mortgage
  • The Equity not specifically borrowed may be consumed with Reverse Mortgage related interest and fees over the term of the loan
  • Potential for heirs to have a messy reverse mortgage equity situation to unravel
  • Be careful to ensure both spouses are listed on the loan documents.  An unlisted spouse may be forced out of the home if not listed on all the necessary documentation.
  • Total cost of a Reverse Mortgage is unknowable
  • Compound interest works against the borrower

 

Reverse Mortgages and Estate Planning

The impact a Reverse Mortgage can have on your estate is equal parts simple and confusing. 

The easy part is in considering your full estate – home, investments, cash, cars, furnishings, etc.  A Reverse Mortgage will impact only your home, nothing more.  The debt resulting from a Reverse Mortgage cannot touch any of your other assets.  In this way, the debt impact is limited and isolated.

The size of the Reverse Mortgage debt relative to the value of the home is another matter.  Because the loan is not repaid until the end of the term, the size of the debt can grow considerably as interest and fees continue to accrue.  A $100,000 Reverse Mortgage may consume the full value of a $300,000 home within a matter of years, at which time, the bank owns the entire home and it is no longer a functional part of the estate.  The debt is capped or limited to the full value of the home at the end of the loan term.  The home cannot go upside down.  Any appreciation in value would be applied against the Reverse Mortgage debt before being considered a part of the estate.

See the chart below:

What is a Reverse Mortgage

If the heirs wish to pay-off the Reverse Mortgage and retain ownership of the home, this may trigger an exception.  In this instance, the full amount of the loan is due even if this puts the home underwater.

For conservative planning, you should remove the home from consideration when planning inheritances.  Craft your will recognizing that the lender will likely take over the home, but allow for distribution instructions in case the home does retain some value.
 
Reverse Mortgage Cost

Reverse Mortgage Fee structures are front loaded and include maintenance fees that continue to grow until the loan is repaid.  Fees related to a Reverse Mortgage may include the following:

  • Application Counseling (required for HECMs)
  • Origination Fee
  • Title Fees
  • Appraisal
  • Closing Costs
  • Mortgage Insurance Premium – One  Time Fee: 2% of home value at initiation
  • Mortgage Insurance Premium – Annual Fee: 1.5% annually of outstanding loan amount

Also layered into the requirements for Reverse Mortgages is the provision that you must first repay any outstanding traditional mortgages with the initial proceeds from your Reverse Mortgage.  The effect is that you are refinancing your traditional mortgage through your Reverse.  This certainly comes with increased fees and often with higher interest rates.  This alone suggests, to me, that if you have enough equity to justify a Reverse Mortgage, you probably have other and better options.

Finally, because the term of a Reverse Mortgage is unknown, the total cost (and impact) of a reverse mortgage is impossible to calculate.  Consider the total cost of a Traditional Mortgage is simple math – the sum of all scheduled payments.  However, the term on a Reverse Mortgage is unknown.  A surviving spouse (who is included on the Reverse Mortgage paperwork), could remain in the house for many years with interest and fees continuing to accrue to the loan.  The only certainty is that the loan would not exceed the value of the home, which itself is unknowable given the potential for market appreciation.  But even this “certainty” only applies if the home is to be surrendered to the lender.  If the family wishes to re-purchase the home from the Reverse Mortgage holder, they are subject to the full loan payoff amount, even if it exceeds the home’s market value.

The bottom line is that the total cost of a Reverse Mortgage may be impossible to determine on the front end, which makes it a difficult instrument to justify.

 

Are Reverse Mortgage Solutions Right for You?

For most people a Reverse Mortgage is probably not the best solution.  Consider that at its core, the Reverse Mortgage is a product designed to access your home’s equity.  Fortunately there are other products that deliver the same benefits with both less and better defined costs.

 

Alternatives to a Reverse Mortgage
If the Reverse Mortgage fails to live up to the hype, then what alternatives should a home owner consider?  Here are a few.

  • Refinance the existing mortgage – lower your payments by extending the term
  • Home equity loans – access your equity by taking a loan against your home.  Sure, there are monthly payments but discipline and money management are easy trades for control over both the loan term and future of the family home.
  • Home equity lines of credit – access to your home’s equity on an as needed bases similar to the LOC offered through the Reverse Mortgage.
  • Sell the home – a feature of the Reverse Mortgage is that you get to stay in your home, but in most instances it’s a costly act of denial.  You and your spouse may get to stay in the home but at the likely cost of your home as an investment and component of your estate.  
  • Work with your heirs – lots of options here that will require some family sit down time, but strive for options that allow your heirs to shoulder some costs now to help preserve both your dignity and the promise of a larger inheritance in the future.

 

Reverse Mortgage Warning Signs

As part of your research, take note of what the market is trying to tell you about Reverse Mortgages.  Consider the mosaic painted with the following statements:

  • To participate in the Reverse Mortgage program backed by the Federal Government it is mandated that you meet with a counselor who will explain the product, its fees, and discuss potential alternatives.
  • The homepage for a Reverse Mortgage lender includes the term “not just for the desperate” as part of their definition for Reverse Mortgages
  • Leading Financial Institutions Met Life, Bank of America, and Wells Fargo are pulling out of the Reverse Mortgage market
  • The Reverse Mortgage marketing materials mostly play to emotions – keep the house, easy to apply, access to cash, no payments.  Isn’t there a saying about when things sound too good to be true?
  • Reverse Mortgages are easier to get the closer you are to death and the more equity you have in your home.  Certainly this is true for valid reasons of math, but the pretense feels like that slick uncle who has been lustily sizing up the family homestead for years.

 

Is a Reverse Mortgage Ever A Good Idea?

The more I read and consider the implications of a Reverse Mortgage, the more I personally consider it the payday loan of the Mortgage industry.  It is sold on the merits of fast access to your home’s equity without having to make payments or move from your home. 

At some level it sounds like free money, which we know does not exist.  I think if your home’s equity is worth accessing, it is worth accessing correctly and the least cost.

Perhaps someone with a low credit rating who is unable to secure a traditional loan may find themselves painted into the Reverse Mortgage corner but that starts to sound like a desperate situation.   I imagine there is a text book case for Reverse Mortgages but I’ve yet to encounter it. 

If you have a Reverse Mortgage and are pleased with the results, please let me know.  I’d love to understand your experience.

 

Do your homework:

If you want to conduct your own research into Reverse Mortgages, and I highly recommend it, then consider the following Resources:

 

Highly Rated Reverse Mortgage Lenders:

Better Business Bureau Accredited Reverse Mortgage Lenders 

 
Informational Resources:  

Reverse Mortgage, is it too risky?

Reverse Mortgage Consumer Information

Reverse Mortgage Top Ten things to know

Reverse Mortgage Guide

Should I get a reverse mortgage

Beware of Reverse Mortgage

What are Reverse Mortgages

Reverse Mortgages Pros and Cons

Reverse Mortgage Wiki

How a Reverse Mortgage works

Photo: 401(K) 2012