by Nick Gromicko and Rob London
Reverse mortgages are a means to convert part of the equity in a home into cash without having to sell the
home or take on additional monthly bills, as required by home equity loans and second mortgages. Reverse mortgages are
among the fastest-growing financial products today, as many older Americans who own their homes outright are learning to use
these particular loans for a variety of purposes, from financing home improvement projects or paying off a current
mortgage, to healthcare expenses or supplemental income.
In fact, the National Reverse Mortgage Lenders Association estimated in 2008 that
there would be well over 200,000 such loans that year, up from just 157 in 1990. The reason for this increase is partly due
to the enormous reservoir of potential funds in the form of equity ($4 trillion among seniors, in 2008), balanced against
rising medical costs and daily living expenses.
What is a reverse mortgage?
A reverse mortgage is
essentially what it sounds like: instead of borrowing money from the bank to purchase a home, a homeowner borrows money
against the equity of their current home. The amount available to the homeowner depends upon their age, how much their home
is worth, and current interest rates. Reverse mortgages can pay out in one or more of the following three ways:
- a single, lump sum of cash;
- a regular, periodic payout; or
- a credit line to be accessed whenever it is needed.
Also,
reverse mortgages are offered in the following three forms:
- Home Equity Conversion Mortgages (HECMs), which are insured by the U. S. Department of Housing and
Urban Development (HUD). These generally provide larger loan advances at a lower total cost compared with other reverse mortgages.
Approximately 90% of reverse mortgages are HECMs;
- single-purpose reverse mortgages, which are offered
by some state and local governmental agencies and nonprofit organizations. These are generally inexpensive, but they are not available
in all areas, and they can be used only for one purpose specified by the lender; and
- proprietary reverse mortgages,
which are private loans that are backed by the companies that develop them.
What's the difference
between a reverse mortgage and a home equity loan?
While reverse mortgages and home equity loans, also known as second
mortgages, are both based on home equity, reverse mortgages are distinct in the following critical ways:
- There are no income or credit requirements. These
proofs that the borrower can repay the loan are unnecessary when requesting a reverse mortgage, as the proof is solely the
tangible equity of the house itself. Thus, reverse mortgages are popular for senior citizens who are house-rich but income-
or credit-poor.
- There are no required monthly payments. Only when the borrower dies, sells the
home or moves away does the money become due. Of course, borrowers are still required to pay real estate taxes,
utilities and other expenses.
- A reverse mortgage provides home security. The lender cannot
remove the homeowners from their properties, as is done in foreclosures, as long as they stay current with
their property taxes, insurance and home maintenance fees.
- The homeowner cannot outlive
their equity. The accrued principal and interest come due when the borrower moves out of his or her home for longer
than 12 months, sells it, or dies.
- The reverse mortgage provides a "nursing home clause"
that guarantees that if the borrower has to move into a nursing home or other medical facility, he or she has up
to 12 months before the loan becomes due.
- HECMs, which account for the majority of reverse mortgages, require
applicants to meet with an independent counselor who will explain the loan’s costs, financial implications and alternatives.
This requirement improves the chances that the borrower will make an informed decision.
However, reverse
mortgages have the following inherent risks:
- There are substantial upfront fees, such as closing costs (appraisal, title and escrow), origination fee
and a servicing fee. These charges can be paid years later when the loan is due, however, resulting in no immediate burden
to the borrower.
- Eligibility for state and federal government assistance programs, such as Medicare,
may be jeopardized because the money received from the reverse mortgage counts as income.
- Once equity
is withdrawn from the home, there will be less money to pass on to heirs once the home is sold and the loan is repaid.
- The interest rate for reverse mortgage may be tied to a volatile financial index, as are FHA loans and traditional
mortgages.
Eligibility
To be eligible for a reverse
mortgage, you must:
- be a homeowner
62 years of age or older;
- own your home outright, or have a low mortgage balance that can be paid off at
closing using proceeds from the reverse loan; and
- live in the home. To receive an HECM, the
homeowner must live in a one- to four-unit home with one unit occupied by the borrower.
Eligibility for
HECM and other reverse mortgages might require that your home be in structurally good condition and free of major problems,
such as termite damage and roof leaks. An InterNACHI inspector should be hired to check for these and other defects.
A
word about misinformation…
Cash-strapped and uniformed seniors should be wary of brokers and advertisements that claim that reverse
mortgages as tax-free. Make no mistake -- reverse mortgages are loans that must eventually be repaid, with interest, which
is essentially a lender-imposed “tax.” Recipients of FHA loans, for instance, are also free from government taxes
on their loan, but they are “taxed” by the broker who lent them the money.
Reverse
mortgages offer a particular set of cash-strapped seniors an alternative, but they are not right for everyone. Seniors should
educate themselves about reverse mortgages and other loan products so they can avoid manipulation by predatory lenders. While
counseling on the pros and cons of a reverse mortgage is a requirement for federally insured loans — which account for
the majority of loans today — this is not always adequate, and the help of a trusted friend or relative may be needed.
Always be sure to read and understand every clause before you enter into a contract.
In summary, senior citizens who require extra income should consider reverse mortgages,
as well as their alternatives.
