A US Perspective
Define Reverse Mortgage
A reverse mortgage is defined as a mortgage that allows the homeowner to release equity from the property without requiring any payments except under specified circumstances. They are designed as a way for seniors to get capital and/or income from the accumulated equity in their homes to pay for lifestyle and basic living expenses.
How Does a Reverse Mortgage Work?
The first reverse mortgages worked essentially opposite of a conventional mortgage and all reverse mortgages retain features that are opposite of conventional mortgages. The lender placed a charge on the property and started making monthly payments TO the homeowner. Interest was calculated on the payments over time, and the total of all payouts plus accumulated interest became the payout balance.
The concept of a reverse mortgage has been expanded. Today under the HUD program a property owner can:
- draw the mortgage principal in a lump sum all at once
- receive monthly payments over a specified term
- or receive monthly payments over their lifetime or joint lifetimes,
- get a revolving line of credit,
- or some combination of these options.
In the HUD program the property owner's obligation to repay the reverse mortgage loan is deferred until either:
- the owner (or survivor of two) dies,
- the home is sold,
- they cease to live in the property (with allowance of up to 364 consecutive days away), or
- a serious breach the provisions of the mortgage such as failure to maintain the property in good repair, pay property taxes, and keep the property insured against fire, etc.
Compare to a Conventional Mortgage
A borrower in a conventional mortgage makes a monthly amortized payment to the lender. Each payment of principal and interest increases the equity in the property by the amount of the principal included in the payment. When the mortgage has been paid in full the property is released from the mortgage.
With a reverse mortgage, the borrower does not need to make payments (unless they want to and if they do there are no pre-payment penalties).
In both conventional and reverse mortgages, title to the property remains in the name of the homeowners, to be disposed of as they wish, encumbered only by the amount owing under the mortgage.
The amount that can be borrowed as a percentage of the market value of the property is significantly less under a reverse mortgage. The lender must ensure that there is sufficient equity in the property to accommodate many years of accrued interest in addition to the principal amount. Over time the amount due in a reverse mortgage goes up, not down like in a conventional mortgage. This is also why reverse mortgages are only given to seniors. A senior has a limited lifetime to defer payments.
Refinancing of Reverse Mortgages
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 in some areas. However most lenders do not like to take a second or third lien position behind a reverse mortgage because its balance increases with time. It is rare to find reverse mortgages with subordinate liens behind them as a result. A reverse mortgage may be refinanced if enough equity is present in the home, and in some cases may qualify for a streamline refinance if the interest rate is reduced.
How Much is the Lein Recorded At?
Generally a reverse mortgage lien is recorded at a higher dollar amount than the amount of money actually disbursed at the loan closing to permit the amount owed to rise over time with accrued interest and principal payments to the property owner. Some borrower confuse the recorded lien amount as the payoff amount, but like in a home equity line of credit the lien represents the maximum lending limit, while the payoff varies and is calculated by adding the actual disbursements to all interest owing.
Reverse Mortgage Calculators
Various websites offer reverse mortgage calculators which can be used to figure out what kind of cashflow stream can be taken from a home.
Qualifications for a US HUD Reverse Mortgage
A reverse mortgage in the United States has some basic requirements:
- the borrower must be at least 62 years of age
- the borrower must occupy the property as their principal residence.
- Reverse mortgages follow FHA standards for property types, meaning most 1–4 family dwellings, FHA approved condominiums and PUD's will qualify. Manufactured housing qualify based on standard FHA guidelines.
- borrowers must complete a FHA approved counseling course to help them understand the reverse mortgage process. This is attested with a certificate of completion for the course.
There are no minimum income or credit requirements because reverse mortgages do not require payments. The borrow can use the loan proceeds anyway they like and, like all borrowed money, are not subject to income tax payment because the funds are not income.
How Much Can Be Borrowed Under a Reverse Mortgage?
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 may be set up as "Tenure" payments, which are paid to borrowers for the rest of their lives, no matter how long they live, or "Term" payments, which last for a predetermined period.
- 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.
Jumbo Reverse Mortgages
There are reverse mortgages for homes valued over the maximum limit called "Jumbo" reverse mortgages, and are offered on higher-valued homes. Jumbo loans are outside the HUD/FHA system and can provide a larger loan amount then the Federal maximums.
The money received 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 some public programs if his or her total liquid assets is then greater than the programs allow.
How Can Funds Be Used From a Reverse Ammortized Mortgage?
When planning the use of funds from a reverse mortgage, plan to cover all property taxes and insurance because a lapse constitutes a default on the reverse mortgage.
Since the funds are from the equity in the home, 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 spend the money.
Reverse Mortgage Disadvantages
Essentially getting a reverse mortgage is a way to keep your home and get the cash out of it to use now. The alternative is to sell the home and invest the proceeds or live on them. Selling would actually free up more cash because 100% of the net proceeds would be available from the sale, while a reverse mortgage must reserve room for many years of accumulated interest and cover for the lender between market value and the maximum loan amount.
Reverse Mortgage use the principle of compound interest against the homeowner. They are the reverse of investing in an interest bearing account and benefiting from the power of compounding.
Compared to conventional mortgages, reverse mortgages often involve higher fees.