In my last blog, Reverse Mortgages for Beginners, I gave you a 30,000-foot view of the answers to some of the most common questions people just learning about reverse mortgages have.
What I want to do over the next few weeks is to take a closer look at each individual question and answer from that blog. This won’t be a microscopic view (I don’t want to put you to sleep), but a 100-foot view would be good.
This article will answer some additional questions, but it may raise others for you as you read. If so, please stay tuned because I will answer them in future articles. You can also contact me directly. My information is at the bottom of the page. In this article today, I am blending two questions together: What is a reverse mortgage? And how does it work?
The name of the FHA insured reverse mortgage program is the Home Equity Conversion Mortgage (HECM). There are other, non-FHA insured loans available, but to keep it simple, the HECM is the program that I will be focusing on in this article.
What Is a Reverse Mortgage?
A reverse mortgage is a loan specifically designed for people aged 62 or older (55 or older for non-FHA insured loans), that allows homeowners to convert a portion of the value of their home into money they can spend without having to sell the home, give up title, or obligate themselves to a monthly mortgage payment.
As long as the borrowers, or non-borrowing spouse, lives in the home as their primary residence, pays their property taxes and homeowners insurance, maintains the home and keeps their names on title to the home, the loan will not come due. No mortgage payment is ever required as long as these conditions are met.
How Does a Reverse Mortgage Work?
A reverse mortgage is not free money. While it is great not having a mortgage payment, the borrowers must understand the cost. All reverse mortgages are 100% negative amortization. This means the loan balance increases instead of decreases like a normal “forward” mortgage. Interest and mortgage insurance (all FHA loans have mortgage insurance), that are not being paid, are added to the loan balance monthly.
When people understand this, they ask, “What happens if the loan balance exceeds the value of the home?” Great question, I’m glad you asked.
This leads me to the topic of what happens at the end of the loan. While this is technically another question, it fits under the category of how a reverse mortgage works.
The loan is only due and payable when neither borrower (or the non-borrowing Spouse), lives in the home as their primary residence. At this point, the heirs have six (6) months to pay off the reverse mortgage with up to two (2) ninety (90) day extensions possible from HUD.
The only requirement is that the loan be repaid in one payment. There is no requirement that the home must be sold, only that the loan is repaid. While this can happen through the sale of the home, it can also happen any number of other ways (such as with savings, insurance proceeds or refinancing the property). Whatever equity is still in the home will go to the heirs as long as they pay the amount owed on the reverse mortgage within the time frame that HUD allows.
The Home Equity Conversion Mortgage is 100% “non-recourse”. This means that as long as the borrowers are living in the home and keeping current with their property charges and maintaining the home, the loan can never be called due, even if more is owed on the loan balance than the home is worth.
The heirs have options when they inherit a home with a reverse mortgage.
I must give credit to my friend Dan Hultquist who wrote the book “Understanding Reverse” and updates it annually. He has simplified the process down to two questions the heirs need to ask:
- Do you want to keep the home?
- Is there any equity left?
If there is equity left in the home:
- They can sell the home, payoff the reverse mortgage and keep the profit as their inheritance.
- If they want to keep the home, they can simply refinance it with a new mortgage to payoff the existing reverse mortgage and keep the home.
If there is no equity left in the home:
- They can choose to just sign it over to the lender and walk away. In this case the lender will sell the home for whatever they can get for it and the mortgage insurance will cover the difference. Since the bank doesn’t lose any money, they will not come after the heirs or the estate for any additional money.
- If the heirs want to keep the home, they have the option of paying the lender 95% of the current value of the home and they can keep the home in the family. For example, if the home is worth $200,000 at the time the last homeowner leaves, they heirs can keep it if they pay $190,000 no matter how much above the value the balance is.
One last topic that I want to cover under this section is the way the borrower can elect to receive the HECM proceeds. The options available come down to the interest rate chosen.
If a fixed rate is chosen, the borrower can only receive the funds as a one-time lump sum. However, there are FHA rules that limit the amount of money a borrower can receive during the first year of the loan. The HECM reverse mortgage program restricts the amount of upfront funds the borrowers are allowed to draw out at closing to 60% of the available funds unless the money is being used to pay off an existing mortgage or lien on the home. In this case, the borrowers can draw enough to pay off the mortgage or lien, plus up to 10% of the available funds. No line of credit or monthly payment is allowed with a fixed rate. Any remaining available funds will be forfeited.
However, the adjustable rate program allows for much more flexibility. With this option, the homeowners have five options available
1. Line of Credit
The available money is placed into a credit line that can be drawn on whenever the homeowners choose, up to the credit limit. Interest is only charged on the amount of money used.
2. Lump Sum
Just like the fixed rate, the borrower can take all the money that is available to them, (within the 60% cap limits, but any amount left over can be left in the line of credit and are available 12 months after the closing).
3. Tenure Payment
This is where all the money that is available is paid out in equal monthly payments for as long as either homeowner lives in the home.
4. Term Payment
All the money that is available to is paid out in equal monthly payments over a set period of months or years. At the end of this “term”, the payments will stop. However, the loan does not come due, and the borrowers can continue to live in the home.
5. Combination of any of the above options
The borrowers can take an immediate cash advance at the closing of any amount (up to the 60% limit), and either place the rest of the money in a line of credit, receive it as a monthly payment, or a combination of both.
There is a lot more that I could get into, but I wanted to offer just a taste of what the FHA insured Home Equity Conversion Mortgage offers and how it works. I hope you found this article helpful, but please feel free to contact me with any questions.