reverse mortgage

 

A reverse mortgage (known as lifetime mortgage in the United Kingdom) is a loan available to seniors (62 and over in the United States), 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).^[1]

In a typical 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 is 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, 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 first and only mortgage on the property.^{[citation needed]}

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 that has not been finalized may, however, slow the process. Some types of dwellings, such as lower-value mobile homes, do not qualify. Before borrowing, applicants must seek free financial counseling from a source that 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.

The American Association of Retired Persons (AARP) has proposed a plan for keeping closing costs low for seniors who qualify for reverse mortgages.^{[citation needed]} The plan must be approved by the federal government and is controversial for a number or reasons. One possible disadvantage is that homeowners will be limited to Bank of America,GMAC Mortgage, Countrywide, or Wells Fargo^{[citation needed]}.

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 10 year T-Bill or the LIBOR index.
• The age of the senior—the older the senior is, the more money he/she will receive. The HUD/FHA amortization table subtracts the senior’s current age from 100 years, and divides the maximum loan amount by the difference. The other reverse lenders also factor age in the same way, although each one has a slightly different way to determine expected life span.
• 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.
• The location of the property, and whether the maximum loan amount is subject to the maximum loan limits.

All these factors contribute to the Total Annual Lending Cost (TALC) as defined by the US Federal Government Regulation Z, is the single rate that 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.^[2]

There is also a type of reverse mortgage for homes valued over the maximum Fannie Mae limit. These are called "cash" accounts, and are proprietary loan products. The money received (loan advances) are not taxable and do not directly affect Social Security or Medicare benefits. However, an American Bar Association guide^[3] to reverse mortgages explains that if you 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.^[4]

A borrower can elect to move available funds into a "set-aside" account, similar to a typical escrow account, to pay for his or her future property taxes and/or homeowners insurance. Currently, most reverse mortgage borrowers do not exercise this option and instead elect to be responsible for the payment of taxes and/or insurance on their own. 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.

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 that 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 a 2% 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.) that must be undertaken. Thus a $200,000 loan would have $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, and some programs waive the initial costs if the borrower borrows all or most of the maximum amount that he or she is eligible to receive. 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.

Interest rates on reverse mortgages are determined on a program-by-program basis, but are typically similar to interest rates offered by Adjustable Rate Mortgages (ARMs). All major reverse mortgage programs have adjustable interest rates that are adjusted on an annual, semi-annual, or monthly basis. Because reverse mortgages have no fixed duration, typically there are no reverse mortgages with fixed interest rates. There are now some new reverse mortgage programs that have fixed interest rates.^[5] Since there are no payments made during the course of the loan the interest accrued on the principal is then added to the principal of the loan.

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^[4], but most of them are insured by the Federal Housing Administration (FHA) and 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.^[6]

Related taxes

The American Bar Association guide^[3] 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.

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). At that point, the reverse mortgage can be paid off with the proceeds of the sale of the house, or be refinanced by the heirs of the homeowner's estate. If the proceeds exceed the loan amount, 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 that the bank has on the loan) absorbs the difference.

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 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).

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.^[4]

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)^[7] 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. 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. 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.

Other options that 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.^{[citation needed]}

References

See also

• Mortgage loan
• Equity release

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