Our Social Security payments may not grow as rapidly as our costs for food and shelter. Or, with no heirs, we may decide we want to enjoy life more than we can with just our available cash. However, whether it is the Fonz, Betty White or Magnum telling us how great reverse mortgages can be, they need to be researched carefully to be certain they are filling a financial need without creating too much risk.
As the Baby Boomer generation gets further into retirement, we see the number of FHA-approved reverse mortgage loans increase (up by over 16 percent just from 2016 to 2017).Understanding how they work, all the fees involved and how one could impact your spouse and loved ones make this one decision you do not want to face unprepared.
A reverse mortgage is one financial tool available to seniors, especially those who are ‘house rich and cash poor.’With a reverse mortgage, you are taking part of the built-up equity out of your home and converting it to cash.
However, contrary to regular mortgages and home equity loans, with a reverse mortgage, you do not have to repay the loan until your home is no longer your principal place of residence, or you fail to meet one of the loan obligations.You are not turning ownership over to the bank; you are borrowing part of your equity, and the interest on that loan continues to come out of the remaining equity.
Three types of reverse mortgages: there are single-purpose reverse mortgages, proprietary reverse mortgages and Home Equity Conversion Mortgages (HECMs).
- Single-purpose reverse mortgages may be offered by certain state and local governments and non-profits. The lender specifies how this low-expense option’s proceeds can be used: for home repairs or property taxes, for example. These are most often available to low- or moderate-income homeowners.
- Because there is a cap on the value of HECMs, proprietary reverse mortgages are more appropriate for higher-valued homes carrying small mortgages. These are offered by private companies, as private loans.
- Home Equity Conversion Mortgages (HECMs) can be used for any purpose. Because seniors can be vulnerable to manipulation on something as important as their homeownership, the federal government approves these reverse mortgages through HUD’s Federal Housing Administration or FHA. The FHA’s involvement increases the safety of these mortgages that seniors use to supplement their Social Security and other resources as needed.
You can also use a reverse mortgage to buy a house if you have sufficient cash to pay the difference between what the reverse mortgage brings, and the cost of the house plus its closing costs. However, you would need to examine where terms and conditions differ from the traditional use of a reverse mortgage.
Our focus will be on FHA-backed HECMs. If you opt for reverse mortgages other than HECMs, be certain to ask the same questions raised about HECMs to protect yourself and your home. A reverse mortgage lender can obtain an HECM for you if it is an FHA-approved lender.
Requirements: The FHA requires you to be age 62 or older and own your home, either outright or with a low mortgage balance that will be paid off with part of the proceeds of the loan. (That does not need to have been an FHA mortgage.) You must have the ability to pay ongoing property taxes and insurances, and you must live in the home. The FHA also requires that you get free or low-cost counseling before getting the loan to be sure you understand the terms and conditions.
Houses must be single-family, or a 2-to4-unit home where you live in one unit. Some condominiums and manufactured homes may also qualify if they meet HUD/FHA requirements. Upon moving away from the home for any reason or selling it, the cash, accumulated interest and other HECM fees must be repaid, typically out of proceeds from the sale of the house. Any excess funds would go to your estate or your spouse. No debt is passed on to heirs, but any equity can be.
Interest: The interest rate can be variable or fixed. If variable, the payout can be in different versions of installment payments or as an open line of credit that is drawn upon as needed. If fixed, it will be a lump sum payout at mortgage closing, with interest accruing if you need the money right away or not.
A reverse mortgage offers seniors continued independence if they find themselves constrained by finances from staying in their homes. As long as they pay real estate taxes, utilities and required insurance premiums, and live in the home as their primary residence, they will make no payments on the portion of the equity that they borrowed. Neither their Medicare benefits or their Social Security payments will be affected.
In contrast, with a home equity line of credit they would have to pay back principal and interest on any funds taken from the house’s equity. However, a reverse mortgage is not ‘free money.’ The interest on your reverse mortgage – plus other fees – are compounding and subtracting from your remaining equity, so you have less and less to leave to anyone.It is a loan that you or your heirs will have to pay back, usually through the sale of your home, once the last borrower passes away or leaves the home.
Regardless, having access to funds through a reverse mortgage has been called‘using your home to stay in your home.’ It means being able:
- to cover emergencies that exceed one’s resources from regular Social Security and other income;
- to stay on in the house as the surviving spouse, despite the loss of the other spouse’s income;
- to afford a caretaker for a loved one’s at-home care;
- to cover the critical maintenance costs of the house, such as for a new roof, water heater, A/C unit or other unexpected expense; and
to pay for required cosmetic and other improvements which protect the value of the asset.
As we look at taking out a reverse mortgage, first we will want to examine its cost in the form of all the fees that can lessen the payout amount we will receive. We then will want a degree of ease in obtaining all relevant information, in how to cancel if need be, and in receiving support from whoever is proposing the mortgage.
We will want information on the company behind the mortgage: is it licensed in our state, does it offer online tools and advice, and what products does it offer? Are independent reviews available of the service offered, are local agents available, is the company fully accredited and how long has it been in business?Lastly, does the company offer any form of guarantee?
Your first decision once you have opted for a reverse mortgage is to determine the type of mortgage you are seeking: a single-purpose reverse mortgage from a state or local government, a private proprietary reverse mortgage or a Home Equity Conversion Mortgage (HECM) from an FHA-approved lender.
Building a list: Reverse mortgages are not issued by the traditional banks whose names we know, although we might remember some television commercials with celebrity spokespeople. An online search will garner a list of names of companies who are paying to advertise and get their name at the top of the Google listing. You may also find companies recommended on the various online review sites. Best of all, if you have a trusted advisor with specific knowledge of reverse mortgages or know someone who has obtained a reverse mortgage and is satisfied with the process, that referral (for or against) is invaluable.
Whatever means you use to develop your list of names, realize you are at the first step of qualifying the company as a potential lender for you. First confirm the lender is licensed to do business in your state by searching the NMLS (Nationwide Multistate Licensing System), the financial services industry's online registration and licensing database. Next, check the National Reverse Mortgage Lenders Association (NRMLA) to ensure they are members. While most companies are members, and it is not a total guarantee, the association does set up standard practices that members are supposed to follow. Also check the website of the U.S. Department of Housing and Urban Development (HUD) to be sure they are FHA-insured companies if you are seeking an HECM.
Vetting: Next, identify websites that provide responsible moderated reviews. For example, search online for ‘Consumer Financial Protection Bureau Consumer Complaint database.’ Also look up the lender’s Better Business Bureau report to confirm it is fully accredited. While the number of complaints on those websites will vary by the size of the company, they do serve to indicate a trend about a company and how it responds to consumer complaints.(Large companies receive more complaints than small companies simply because they have more total customers.) Do not rely on the raving reviews on lenders’ websites.
HUD offers a list of free or low-cost fee-based counselors who specialize in reverse mortgages. These counselors cannot recommend specific lenders, but they have listings of FHA-approved lenders and can explain exactly what you should and should not pay, including maximums, which will allow you to rule out any lenders who are acting unethically.
Obtaining quotes: With a list of at least three vetted potential lenders, go through the entire process of obtaining a quote for a loan using a theoretical valuation of the equity in your home. (Equity will be the estimated market value of your home minus the balance of your mortgage, if any.) Be certain the quote includes all the relevant fees, in detail. Gauge the way the lender deals with you throughout this process regarding respect, willingness to explain, transparency and availability.
Once you have quotes that you can compare side-by-side, confer with your heirs and any family you leave behind who could be affected. Ideally, your house will be in the name of both you and your spouse. If your spouse is a co-borrower on the loan, that qualified spouse will be able to stay in the house under an HECM loan, but this is not guaranteed if the spouse is not a co-borrower. However, once both of you have left the home, your heirs should be aware of their options of how to settle the debt remaining on the house and what protections are available.
Two areas are priorities for seniors as they consider taking out a reverse mortgage: age-friendliness and health-related value.
Age friendliness: Reverse mortgages are complicated, particularly because they function the opposite of the familiar traditional mortgage. Increasing age may make the process harder to understand, and understanding it is key because of the implications it has on your primary asset (your home), your heirs and anyone else living in the home. However, the older you are, the more you will be able to take out as a loan from your equity as the lender will assume fewer years before you will leave the home.
Health-related value: Your health is relevant when taking out a reverse mortgage since your loan would come due when you left your home, whether to assisted living, to go live with someone or due to death.If a reverse mortgage lets you to stay in your home, being able to do so has tremendous value to someone in ill health.
What a reverse mortgage costs will depend on what type of loan you choose, the amount of money you want (or are able) to take out and the lender you select. A reverse mortgage is typically more expensive than other kinds of home loan.
As the opposite of regular mortgages, interest and mortgage insurance charges based on the current loan balance are added to that balance each month, much as with a credit card. As the balance increases, so do the monthly value of interest and mortgage insurance charges.This makes the interest rate that much more critical.
While fees will vary with the different forms of reverse mortgages, a general idea can be gleaned from the most common fees for HECMs. These include a series of upfront fees linked to establishing the loan, plus ongoing expenses.Upfront fees can be paid by you in cash or rolled into the loan. (Rolling them into the loan is more expensive as it will increase all the fees and interest that are based on the total loan amount.) Ongoing fees will typically be added to the loan each month, to be settled at the time the house is sold.
As upfront fees:
- Appraisal fee: the lender hires an appraiser to estimate the value of your home.
- Closing costs: these include fees for a credit report, title search, escrow and loan settlement, document preparation, recording, title insurance and pest inspection.
- Loan origination fee: the lender charges this fee for processing your loan, based on the value of your home.
- Initial Mortgage Insurance Premium (MIP): the FHA charges this fee for mortgage insurance to guarantee your loan.
- Points: as in a traditional mortgage, an upfront payment the lender may propose to lower your interest rate.
As ongoing fees:
- Loan interest: either a variable or fixed rate of interest on the loan, which is added to the loan amount but not paid while you live in the house.
- Mortgage insurance: a percentage of the outstanding mortgage balance paid to the FHA for guaranteeing your loan, but not paid while you live in the house.
- Servicing fee: a monthly fee a lender can charge for managing your loan.
This vast array of fees makes it difficult to compare offers from competing reverse mortgage lenders. Also, lenders put costs in different places: a low-cost lender may charge higher interest rates, while those charging lower interest rates will load the upfront charges.
The complexity of the impact of the various fees is one more reason why consulting with an FHA counselor and selecting an FHA-approved reverse mortgage increases your protection if you take out a reverse mortgage. A free downloadable online publication entitled “Reverse mortgages: A discussion guide” by the Consumer Financial Protection Bureau is an excellent explanatory resource.
The decision to take out a reverse mortgage is a difficult one. While it can bring some financial relief, its implications are long-term. Therefore, you want the greatest amount of support possible in determining costs, application processes, possible cancellation procedures and access to the lender’s representatives.
Cost: Comparing the cost of a reverse mortgage is complex and involves much more than just the interest rate, although that rate is important. Ideally, you will want to look at a full comparison of an identical loan amount from at least two or three potential lenders so that you can see the impact of all the different costs and fees involved.
Ease: More than anything, you want to avoid any sales pressure as you are going through the analysis process with different lenders. With a short list of reputable potential lenders, you should expect easy access to all the information you need through each company’s website and its representatives. Clarity and transparency are key. In their absence, walk away.
Cancellation: On a loan that uses your home as a guarantee, by federal law, you have three calendar days to change your mind and cancel the loan.Documents may refer to this as the ‘right of rescission.’ The process to do so should be explained to you at the loan closing. Be certain you have specific written instructions for that particular lender’s cancellation procedure, including who to contact and how: names, phone and fax numbers and addresses.
Customer support: Having an online calculator readily available on its website is a good place for an online lender to start. Then as you shop for a reverse mortgage, through phone calls, applications and quotes, potential lenders should provide customer service that focuses on facilitating the processing for you, not on hard selling. Company representatives should be courteous, knowledgeable and easily reached. Anything less is an indicating of how you will be treated in the future, once they have made the loan.
Because so many senior homeowners are looking into reverse mortgages, the Federal Trade Commission (FTC) and other agencies are taking more steps than ever to provide tools and resources to protect them from unscrupulous lenders.
However, part of that responsibility lies with the seniors as well. Whether lenders falsely claim to be part of the federal government (because they are offering an FHA-approved loan) or pressure seniors to purchase any goods or services with the proceeds, the ruses used to defraud seniors are endless. As a result, it is important to investigate a lender’s licensing, accreditations and reviews, in fact, anything that appears the least bit out of line.
While reverse mortgages do have a role to play in helping cover financial necessities, they are not the only ones available to seniors. Seniors might consider refinancing their existing mortgages over a longer period than remains now, to lower monthly payments. They might take out a home equity loan, a lump sum which usually has a fixed-rate interest that is tax-deductible on loans up to a certain value. HELOCs, or Home Equity Lines of Credit, typically come with adjustable interest rates, again tax-deductible to certain loan values.
If feasible, seniors could downsize by selling their home and purchasing something smaller that costs less and is less expensive to maintain. And, more creatively, they might sell their home to their children and lease it back, paying rent with some of the proceeds and providing the children with a series of tax benefits. Whatever the option, talk to a trusted financial advisor about the best way to make use of the equity you have worked so hard to build in your home.