Reverse Mortgage is a specific type of home loan that will generate monthly cash payments to the homeowner based on the amount of equity in the home. Homeowners maximize their cash flow and commonly defer payment of the loan until they pass away, sell or move out of the home. Upon the death of homeowners, the home’s heirs choose to either give up ownership to the home, or refinance the home to purchase the title from the reverse mortgage company. Varying by jurisdiction, the laws which regulate reverse mortgages can be different by state. Under the terms of a conventional mortgage, the homeowner will make predetermined monthly payments to the mortgage lender. Following each remitted payment, the homeowner’s equity increases by the amount of principal balance included in that payment. However, with a reverse mortgage, the homeowner is not required to make monthly payments. If payments are not made on a reverse mortgage, interest is added to the loan balance. Over time, the increasing loan balance can eventually become greater than the value of the home in certain circumstances. Although generally in most cases, if the loan balance exceeds the value of the home, the borrower is generally not required to repay any additional balances in excess of the home value. Economists, academics, and financial regulators have provided mixed commentary on the reverse mortgage market. Certain professionals contest that reverse mortgages allow seniors to generate crucial cash flow towards later stages in their earning cycle, smoothing out consumption during retirement and maintaining standard of living. On the other hand, regulatory authorities such as the CFPB have argued that reverse mortgages are often presented in complex ways that may mislead elderly consumers with low quality counseling and advertising scams.
Reverse Mortgage EligibilityThe two basic requirements to be eligible for a reverse mortgage are that the property is a primary place of residence, and the homeowner must be at least 62 years of age. Moreover, any existing mortgages on the property must be small enough so that it can be paid off with the proceeds of the reverse mortgage. Reverse mortgages follow FHA eligibility standards for property types. Before starting the loan process for an FHA/HUD-approved reverse mortgage, applicants must take an approved counseling course. The counseling is meant to protect borrowers, although the quality of counseling has been criticized by groups such as the CFPB. By March 2015, the FHA will implement its financial assessment for reverse mortgages. For borrowers that are assigned a case number by FHA after March 2nd, 2015 will be subject to the new financial assessment. The case number is assigned by FHA for identification purposes. With the new financial assessment, lenders will now be required by FHA to conduct a more comprehensive credit history, income and asset underwriting procedure. During this process, a reverse mortgage lender will look for late payments, unpaid taxes and similar delinquencies to determine the borrowers willingness or ability to repay a loan.
Reverse Mortgage Total Annual CostThe ‘Truth in Lending Act’ requires lenders to disclose the Total Annual Lending Cost (TALC) for reverse mortgages. The Total Annual Lending Cost formula is designed to allow borrowers to more easily compare the costs of the reverse mortgage from different lenders.
Reverse Mortgage Taxes and Insurance
- The IRS does not consider loan advances to be income
- Annuity advances may be partially taxable
- 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.
Reverse Mortgage Loan Due Date?A Reverse Mortgage Loan becomes due when the borrower sells the home, moves out for more than 12 consecutive months, or passes away. The loan may also be declared as due and payment required if the borrower fails to pay the home’s property taxes, or does not maintain hazard insurance on the property. When the reverse mortgage loan becomes due, the borrower or estate owners of the time must decide to keep the home by refinancing a new mortgage, sell the home and cash out any remaining equity after the reverse loan, or simply turn the home over to the lender. If the property is turned over to the lender, the borrower or their heirs will no longer have a claim to the property or any equity in the property. The lender has recourse against the property, but not against the borrower personally and not against the borrower’s heirs. Thus the mortgage is within the category known as non-recourse limit.
Reverse Mortgage Loan AmountThe total amount of money that a borrower can receive under a Reverse Mortgage, or Home Equity Conversion Mortgage (HECM) is called the principal limit. The principal limit is based on the claim amount, the age of the youngest borrower, and the expected average interest rate going forward. The maximum amount that a borrower can claim with a reverse mortgage loan is equal to the accurately appraised value of the property, or the maximum amount insured by HUD. The maximum claim amount is multiplied by a principal limit factor to determine the principal limit. Principal limit factors are determined by HUD and are based on the borrower’s age and the expected average rate of interest. If a current loan exists, the old loan will be paid off with your new reverse mortgage, totally eliminating your current mortgage payments. If there is surplus cash after your existing loan is paid off, the extra cash is yours – tax free. If your home is paid off, it is possible to use a reverse mortgage to turn your existing home equity into cash.
Reverse Mortgage Interest RateInterest rates on reverse mortgages may be fixed or adjustable. Prior to 2007, all major reverse mortgage programs had adjustable interest rates. Adjustable rate reverse mortgages are typically adjusted on a monthly or annual rate up to a maximum rate. The note rate (or accrual) rate is used to calculate the interest added to the loan balance each month. The note rate may be different from the expected average interest rate used to determine the available loan proceeds.
Proceeds from a Reverse Mortgage
Cash from a Reverse MortgageThe money from a reverse mortgage can be distributed in several different ways:
- Cash Settlement or Lump Sum
- Monthly Cash Payment, For life or a fixed term
- As a Line of Credit, similar to HELOC