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How does a reverse mortgage work?
The majority of reverse mortgages are originated under the federally insured Home Equity Conversion Mortgage program, or HECM.
What is a reverse mortgage?
A reverse mortgage gives a borrower the ability to convert equity in a home into cash. No repayments are required until the borrower no longer uses the home as a principal residence, dies, or fails to pay in a timely fashion real property taxes, insurance and/or condominium dues. A reverse mortgage can also be used to purchase a primary residence, using cash on hand to pay the difference between the reverse mortgage proceeds and the sales price. Similarly, a reverse mortgage can be used to “buy up” to a primary residence of greater value, using the cash proceeds from the sale of an existing home to pay the difference between the reverse mortgage proceeds and the sales price of the more expensive home.
Under the HECM program, the borrower must be 62 years of age or older, own the property outright or with considerable equity, occupy the property as a principal residence, and have the financial resources to continue making payments of real property taxes, insurance, condominium association dues, etc. Only single family homes (including HUD-approved condominiums) or two-to-four-unit homes with one unit occupied by the borrower qualify. Any low mortgage balance must be paid off at closing with proceeds from the reverse mortgage.
What payments can the borrower receive?
If the loan has an adjustable interest rate, the borrower has a number of options: equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence; equal monthly payments for a fixed number of months; a line of credit from which the homeowner can borrow at such times and in such amounts as the borrower desires, until the line of credit is exhausted; or some combination of the above. Fixed interest rate mortgages only permit a single lump sum disbursement.
How much money can be borrowed?
The amount varies by borrower and depends on: the age of the youngest borrower or non-borrowing spouse; the expected mortgage interest rate; and the lesser of the appraised or sales value and the initial mortgage insurance premium. The maximum loan amount is $625,500.
When must the loan be repaid?
Unlike “regular” mortgages, borrowers do not make monthly payments. The loan must be paid in full when the borrower no longer uses the home as a principal residence, e.g., fails to occupy for at least one year or sells, dies, or fails to pay real property taxes and/or insurance.
What are the options when repayment is due?
The borrower or the borrower’s estate will not owe more than the loan balance or the property value, whichever is less. The home can be deeded to the lender, and nothing further is owed. In the alternative, if the house is worth more than the balance outstanding on the reverse mortgage, the house may be sold and its proceeds used to pay off the loan. If the house is not promptly sold and the loan satisfied, any equity in the property may be lost to foreclosure.
A reverse mortgage can be pricey
In addition to the usual closing costs, a reverse mortgage will include mortgage insurance premiums, both at closing and annually. The mortgage insurance premium to be paid at closing will be 0.5 percent or 2.5 percent, depending on disbursements. Over the life of the loan, the borrower will be charged an annual mortgage insurance premium equal to 1.25 percent of the mortgage balance.
In addition, the reverse mortgage lender can charge both an origination fee and a servicing fee. The lender can charge an origination fee of up to $2,500 if the home is valued at less than $125,000. If the home is valued at more than $125,000, lenders can charge 2 percent of the first $200,000 of the home’s value plus 1 percent of the amount over $200,000. Origination fees are capped at $6,000. Origination fees can be financed and included in the loan proceeds.
Servicing fees may also be charged. A reverse mortgage lender may charge a monthly servicing fee of no more than $30 if the loan has an annually adjusting interest rate and $35 if the interest rate adjusts monthly. Each month, the monthly servicing fee is added to the loan balance.
Because reverse mortgages do not require any monthly payments, a reverse mortgage may be an attractive option for retirees with lots of equity in their home, but not enough funds in their 401(k) or IRA. Each potential borrower must obtain credit counseling from a reverse mortgage counselor to qualify for a reverse mortgage.