Reverse Mortgages Explained
Reverse mortgages explained: Learn about reverse mortgage loans and how they work, who is eligible, and the benefits of this financial tool.
This financial tool allows homeowners 55-years or older to access the equity in their home. Homeowners can borrow against their home value and receive funds as a lump sum, fixed monthly payment, or line-of-credit. Unlike a traditional mortgage, a reverse mortgage doesn’t require the homeowner to make any loan payments until the loan is paid off. In other words, the interest expense is added to the loan and paid when the home is either sold, refinanced or simply paid off.
The Federal Government designed the Home Equity Conversion Mortgage (HECM) to provide financial aid for senior homeowners. It gives access to some of the equity in the home so the owner can enjoy the freedom and comfort of the home for the rest of their lives.
You will never owe more than what your house is worth. Suppose through extreme market conditions the loan balance exceeds the value of the home. In that case, FHA reimburses the lender for the difference of the market value and the amount owed. Therefore, leaving no possible debt to heirs.
Common Misconceptions of a Reverse
There are numerous misconceptions about reverse mortgages, largely because this loan has evolved and improved drastically over the last 40 years. Generally, a reverse mortgage loan functions very similar to other residential mortgages. The key difference is the interest payment accrues.
Below is a summary of these misconceptions, specifically the Home Equity Conversion Mortgage (HECM).
MYTH
The Banks Owns the House
The Heirs Lose their Inheritence
High Set Up Fees
No Way Out, Inflexible
Payment Penalties
Lender Equity Share
High Interest Rates
Legacy Concerns
A Younger Spouse must move out if the older one dies
FACTS
The borrowers remain on title and continue to own and control the home. They retain the right to sell or refinance at any time.
The home may be left to the children, just like any other mortgage. The heirs may then sell the home and retain any remaining equity or pay off the reverse mortgage and keep the house for themselves. No monthly debt obligation is due during the period while the estate is either selling the home or refinancing it.
Interest continues to accrue, but no payment is due if the estate is settled within one year from the death of the last borrower. Heirs may elect to “buy” the house for 95% of the home value or the loan balance, whichever is less, despite the fact that the loan amount may be more than the home value.
HECM fees are similar to all FHA insured mortgages.
The homeowner maintains title and control and can sell or refinance at his/her discretion. There is simply no other financial product with the flexible terms inherent in the HECM. Payments may be deferred until the loan’s end, or voluntary payments may be made, which increase the HECM’s Line of Credit. The lender cannot cancel, freeze, or reduce the HECM’s LOC, a common problem with a traditional HELOC. The homeowner is not subject to recasting of the mortgage to a payment schedule.
FHA forbids prepayment penalties on HECM loans. Although payments are never required while in the home, payments against the loan balance are accepted; in variable-rate HECM loans, payments are applied to reduce the outstanding balance of the Line of Credit.
The lender is not entitled to any repayment beyond the accumulated loan balance on all HECM loans. All remaining equity belongs to the estate.
Interest rates are similar to other FHA loans. Fixed-rate HECM loans are an option as well.
Research demonstrates that coordinating the housing asset to protect other resources may improve overall legacy value.
With new regulations, FHA protects younger spouses from early displacement when the older homeowner dies. If the younger spouse is 62 when the loan starts, they have the same rights as the older homeowner.
1 Plau, Wade, 2018. “Reverse Mortgages: How to use Reverse Mortgages to Secure Your Retirement (The Retirement Researcher’s Guide Series) (Vol. 1)” Retirement Researcher Media. 2nd Edition. Pgs 96-99
Infographic Explainer of a Reverse Mortgage Equity over 5, 10, 15 and 20 years
- With a reverse mortgage, the loan balance will continue to grow each year; however, so may the equity balance. The following example demonstrates that your equity may increase yearly, event with a reverse mortgage. Assuming inflation of 5% (the 10-year historical avg. is 14.6%) and a market interest rate of 5.81% + 0.5% (mortgage insurance) = 6.31% the equity balance continues to grow each year.
- In year one the equity balance is $350,000. In year five the equity balance is $422,210. Finally, in year 20 the equity balance is $704,635. Even with the interest expense accruing, the equity in the home continues to increase every year!
