Reverse Mortgage

A Loan for Seniors to
Free Up Equity in their Property

A reverse mortgage (or lifetime mortgage) is a loan available to seniors, and is used to release the home equity in the property as one lump sum or multiple payments. The homeowner's obligation to repay the loan is deferred until the owner dies, the home is sold, or the owner leaves (e.g., into aged care).

In a conventional mortgage the homeowner makes a monthly amortized payment to the lender; after each payment the equity increases within his or her property, and typically after the end of the term (e.g., 30 years) the mortgage has been paid in full and the property is released from the lender. In a reverse mortgage, the home owner makes no payments and all interest is added to the lien on the property. If the owner receives monthly payments, or a bulk payment of the available equity percentage for their age, then the debt on the property increases each month.

If a property has increased in value after a reverse mortgage is taken out, it is possible to acquire a second (or third) reverse mortgage over the increased equity in the home. But in certain countries (including the United States), a reverse mortgage must be the only mortgage on the property.

New law protects senior borrowers

The Housing and Economic Recovery Act of 2008 contains a provision intended to help seniors by reining in fees and fraud associated with reverse mortgages. Reverse mortgages were created largely for seniors who are cash-poor and house-rich - meaning they have a lot of equity in their homes but little or no savings.

This type of loan allows homeowners 62 or older to borrow against their equity. But unlike traditional home loan products, no payment is due on a reverse mortgage until the homeowner moves, sells or dies. The maximum a senior will be able to borrow through a reverse mortgage is $417,000 (or $625,000 in a high housing cost area). The range now is $200,160 to $362,790.

Most important, the law reduces fees. It cuts the origination fee to 2 percent of the first $200,000 borrowed and 1 percent for any amount after that. The maximum origination fee can't exceed $6,000.

Except for title insurance, hazard, flood or other such products, lenders are prohibited from requiring borrowers to purchase insurance, annuities or other similar products as a condition of getting a reverse mortgage.

Part of the reason the housing act included a provision for reverse mortgages was out of concern that seniors were inappropriately - and sometimes fraudulently - being sold other financial products.

In some cases, seniors have been encouraged to use the proceeds of their reverse mortgages to buy annuities or long-term care insurance. Although only 1 percent of older households have reverse mortgages, the market has grown in recent years, increasing from 6,600 loans in 2000 to 107,000 in 2007, according to research by AARP's Public Policy Institute.

Still, the high fees scare off many borrowers. The fees and costs associated with reverse mortgages are often significantly higher than traditional home-loan products - sometimes as high as 4 percent to 8 percent of the loan amount.. The housing act requires the government to conduct a study to look into the costs associated with reverse mortgages.

For more information about reverse mortgages, try these Web sites:

Reverse mortgages in the United States

Requirements

To qualify for a reverse mortgage in the United States, the borrower must be at least 62 years of age. There are no minimum income or credit requirements, but there are other requirements and homeowners should make sure that they qualify for the loan before they invest significant time or money into the process. For most reverse mortgages, the money can be used for any purpose; however, the borrower must pay off any existing mortgage(s) with the proceeds from the reverse mortgage and, if needed, additional personal funds. A pending bankruptcy which has not been finalized may, however, slow the process. Some types of dwellings do not qualify, while others (like mobile homes) have special requirements (such as being on an approved permanent foundation and built after 1976) in order to be approved. Before borrowing, applicants must seek third party financial counseling from a source which is approved by the Department of Housing and Urban Development (HUD). The counseling is a safeguard for the borrower and his/her family, to make sure the borrower completely understands what a reverse mortgage is and how one is obtained.
Reverse mortgage proceeds
The amount of money available to the consumer is determined by five primary factors:
  • The appraised value of the property, whether any health or safety repairs need to be made to the house, and whether there are any existing liens on the house.
  • The interest rate, as determined by the U.S. Treasury 1 year T-Bill, the LIBOR index or 1 Year CMT.
  • The age of the senior (The older the senior is, the more money he/she will receive).
  • Whether the payment is taken as line of credit, lump sum, or monthly payments. Line of credit will maximize the money available, while lump sum provides the cash immediately, but the interest fees are the highest. Monthly payments are set up as a "Tenure" payment. Borrowers receive them for the rest of their lives no matter how long they live.
  • The value of the property, and whether that value is higher than the national loan limit set by HUD.
All these factors contribute to the Total Annual Lending Cost (TALC) as defined by the US Federal Government Regulation Z, the single rate which includes all the loan costs. The specific formulas to calculate the impact of the factors listed above can be found in Appendix 22 of the HUD Handbook 4235.1.

There are reverse mortgages for homes valued over the maximum limit. These are called "Jumbo" reverse mortgages, and are generally offered as proprietary reverse mortgages. For homeowners of higher-valued homes, a Jumbo loan can provide a larger loan amount. However, these loans are currently uninsured by the FHA and their fees are often higher.

The money received (loan advances) from a reverse mortgage is not taxable and does not directly affect Social Security or Medicare benefits. However, an American Bar Association guide to reverse mortgages explains that if borrowers receive Medicaid, SSI, or other public benefits, loan advances will be counted as "liquid assets" if the money is kept in an account (savings, checking, etc.) past the end of the calendar month in which it is received. The borrower could then lose eligibility for such public programs if his or her total liquid assets (cash, generally) is then greater than those programs allow.

It is important to note that the homeowner must ensure that taxes and insurance are kept current at all times. If either taxes or insurance lapse, it could result in a default on the reverse mortgage.

Once the reverse mortgage is established, there are no restrictions on how the funds are used. In addition to the tenure monthly payments, the borrower has the option of moving the entire amount of money into investments, or they can simply take the money and spend it as they wish.

Among the options of interest bearing instruments, the borrower can keep them with the lender and (These accounts grow by the same percentage as the interest rate of the loan), move the funds to a directed account with a financial specialist (This option is risky unless you direct the investment options of the financial specialist), or withdraw the funds and manage their investment themselves.

HECM for Purchase
The Housing and Economic Recovery Act of 2008 provided HECM mortgagors with the opportunity to puchase a new principal residence with HECM loan proceeds -- the so-called HECM for Purchase program, effective January 2009. The program was designed to allow seniors to purchase a new principal residence and obtain a reverse mortgage within a single transaction by eliminating the need for a second closing. The program was also designed to enable senior homeowners to relocate to other geographical areas to be closer to family members or downsize to homes that meet their physical needs, i.e., handrails, one level properties, ramps, wider doorways, etc.
Costs and interest rates
The cost of getting a reverse mortgage from a private sector lender may exceed the costs of other types of mortgage or equity conversion loans. Exact costs depend on the particular reverse mortgage program the borrower acquires. For the most popular type of reverse mortgage in the U.S., the FHA-insured Home Equity Conversion Mortgage (HECM), there is an insurance premium of 2% of the loan and an origination fee in addition to normal closing costs, which are typically several thousand dollars, but vary depending on the third-party costs (appraisal fees, title searches, etc.) which must be undertaken. The origination fee is capped by the FHA. The cap is 2% of the first $200,000 and 1% thereafter, with an overall cap of $6000. Thus a $200,000 loan would have approximately $8,000 in costs beyond the normal closing costs added onto the loan at the outset. Other programs skip the insurance premium but still require the origination fees and closing costs. In addition, a monthly service charge (between $25 and $35) is usually added to the total amount of the loan.

In all of these cases, the costs of a reverse mortgage can typically be financed with the proceeds of the loan itself, with the costs and fees being rolled directly into the principal balance of the loan, rather than paid by the borrower in cash. While this does permit borrowers with little or no available cash to get a reverse mortgage, it means that the initial loan principal will be increased, and consequently, that the fees will begin accruing interest. Since there are no payments made during the course of the loan, the compound interest accrued on the principal plus fees are added to the principal of the loan.

Interest rates on reverse mortgages are determined on a program-by-program basis, because the loans are secured by the home itself, and backed by HUD, the interest rate should always be below any other available interest rate in the standard mortgage marketplace for an FHA reverse mortgage. Prior to 2007, all major reverse mortgage programs had adjustable interest rates. Such adjustable rate reverse mortgages are still being offered which are adjusted on a monthly, semi-annual, or annual rate up to a maximum rate.

Several lenders now offer FHA HECM reverse mortgages that have fixed interest rates. Some of these mortgages have interest rates that are similar to the current FHA/VA rate plus the mandatory mortgage insurance premium. Some fixed rate reverse mortgages limit the cash proceeds to half of that offered by adjustable rate reverse mortgages. The borrower(s) will be required to take out the entire amount offered at closing.

Some state and local governments offer low-cost reverse mortgages to seniors. These "public sector" loans generally must be used for specific purposes, such as paying for home repairs or property taxes, but most of them often have more favorable interest rates and fewer or no fees associated with them. These programs are typically very restrictive in terms of qualification and location, and many regions, states, and areas do not have such programs at all.

HUD counseling
To apply for an FHA/HUD reverse mortgage, a borrower is required to complete a 45-minute counseling session with a HUD-approved counselor. The counselor will explain the legal and financial obligations of a reverse mortgage. After the counseling session, the borrower receives a "certificate of counseling" that is required before the loan application can be processed.
Related taxes
The American Bar Association guide advises that generally,
  • the Internal Revenue Service does not consider loan advances to be income,
  • annuity advances may be partially taxable, and
  • interest charged is not deductible until it is actually paid, that is, at the end of the loan.
  • The mortgage insurance premium is deductible on the 1040 long form.
When the loan ends
The loan ends when the homeowner dies, sells the house, or, depending on the loan conditions, moves out of the house for 12 consecutive months (for example, to go into an assisted living home or due to physical or mental illness the borrower is not able to live in the property on which the loan has been taken). At that point, the reverse mortgage can be paid off with the proceeds of the sale of the house, or if the borrower has died, the property can be refinanced by the heirs of the homeowner's estate with a regular mortgage. If the proceeds exceed the loan amount including compounded interest and fees, the owner of the house receives the difference. If the owner has died, the heirs receive the difference. For cases where the proceeds are not sufficient to pay off the loan, then the bank (or insurance which the bank has on the loan) absorbs the difference.

The technical term for this cap on debt is "non-recourse limit." It means that the lender does not have legal recourse to anything other than the value of the home when the loan is to be paid off.

In most cases when the borrower moves out of the property or dies, as long as the borrower (or his estate) provides proof to the lender that he/she is attempting to sell the home or obtain financing to pay off the outstanding debt, the investor will allow him up to one year to do so. After the one year extension period is up, the lender cannot provide any further extension of time to the borrower (or estate).

Volume of loans
Home Equity Conversion Mortgages account for 90% of all reverse mortgages originated in the U.S. As of February 2007 the federal cap of 275,000 HECM loan guarantees had been issued since the program's inception in 1989. Legislators subsequently suspended the cap until September 1, 2007 allowing additional HECM loan guarantees to take place.

Program growth in recent years has been very rapid. The National Reverse Mortgage Lenders Association (NRMLA) reports that 55,659 HECM loans were endorsed through the first nine months of fiscal year 2006, an 83% increase over the 30,404 loans endorsed during the same period in the prior fiscal year.

Section 255 of the National Housing Act, which governs the HECM program, limits the aggregate number of outstanding HECMs to 250,000. The cap could possibly be reached in 2007 or 2008, and efforts are currently underway to remove or increase the limit.

Other options
A significant drawback to reverse mortgages are the high upfront costs. This upfront cost is tempered by the lower interest rate over time, but some seniors choose other options to draw on their home equity, particularly if they don't plan to remain at the property more than five years.

Other options which can free up home equity but avoid the high upfront costs of a reverse mortgage include: 1) intra-family loan or sale-leaseback and, 2) selling and moving to a less expensive dwelling or location. However, when selling the homeowner incurs high closing costs including, typically, a 6% commission, moving costs, and purchase costs on the new dwelling. Currently, there is a coordinated government program called "Aging in Place" intended to assist homeowners wishing to remain in their home and/or neighborhood. Studies conducted by various agencies, including AARP, show that over 80% of elderly homeowners do not want to move.

No cost and low cost reverse mortgages are available for those homeowners who anticipate moving from the home in the near future. These 'no cost' mortgages do carry higher interest rates than the standard monthly FHA HECM (reverse mortgage). For example, they may select a home equity line of credit (HELOC), requiring interest-only payments for 10 years. These loans typically have very low (or zero) upfront costs. HELOC interest rates are usually based on the prime lending rate and are therefore often higher than the FHA monthly HECM, which is based on the one-year constant maturity U.S. Treasury rate.

There now exists another alternative to the reverse mortgage called a TIC ROOF offered by Fractional Equities, llc. The following is a comparison of a TIC ROOF(TM) (Tenant-in-Common Residential Owner Occupied Fractional-ownership) agreement to a reverse mortgage.

A TIC ROOF™ converts the equity you have stored away in your home into cash that you can use to modify your home (or for anything else, for that matter) without having to resort to borrowing money. No debt, no interest, no payments and no danger of foreclosure! And just like all of those years that you shared ownership of your home with the mortgage company, you now share it with Fractional Equities, llc when they purchase a just enough of your home to provide that cash that you need. The rest of the property remains yours and, best of all, you retain the unlimited use and complete control of your home that you’ve always had and you don’t ever have to move out! Conclusion: In some situations a reverse mortgage is a reasonable way to finance modifying your home. However, it remains a government supervised solution that adds another loan to your life. (The government has to guarantee the loan or investors wouldn’t take the risk…)

How To Get Started: It begins with the process of qualifying your home (there is no credit check or income verification!) If your home qualifies,an offer is made to purchase an undivided fractional interest in your property with cash and fully discloses the fees and conditions. (Then once the transaction is complete, you have a check, the continued unrestricted use of your home and the resources you need to spend your final years at home where you belong.)

Demand
As recently as December 2007 the Senate Committee on Aging spent time discussing the aggressive marketing and sales techniques being used by mortgage institutions to attract senior homeowners into purchasing reverse mortgages. As larger populations of seniors are turning 63 every year, the demand for reverse mortgage loans is on the rise. There was a 56% increase in these types of loan in 2006 from the prior year. The Federal government in December 2007 removed the restrictions on the number of outstanding reverse mortgage loans they would underwrite at any given time. Prior to the new legislation, the original limit was 275,000.

See also

External links

Real Estate Finance