Reverse mortgages allow an elderly homeowner to borrow on home equity in their home, receiving a lump sum, fixed monthly payment or credit line.
How does a reverse mortgage work?
As the name suggests, reverse mortgages are the opposite of conventional mortgages. Instead of borrowing money from a lender, you borrow money secured by equity that you already have in your home. Anyone aged 62 and over can get a reverse mortgage, and they are often reserved for people who may have retired and are living without a monthly salary. Reverse mortgages can help homeowners pay for a range of costs, including regular living expenses, home accommodations or paying for their children’s college tuition. Reverse mortgages have their advantages and disadvantages, so it’s important to listen to both sides of the story before making a decision.
The process of making a reverse mortgage
There are several different ways to receive payment when making a reverse mortgage:
Lump Sum: Get all the money after all the paperwork for your loan has been signed.
Tenure: Receive equal monthly payments each month until at least one borrower lives in the house, or until the money runs out.
Frequency: Receive equal monthly payments for a predetermined period of time.
Credit Line: Access the credit line so you can borrow money if needed.
Modified tenure: Get equal monthly payments while at least one borrower lives in the house, plus a line of credit to potentially borrow more money.
Modified deadline: Get equal monthly payments for a predetermined period of time, plus a line of credit if you need to borrow more money.
The reverse mortgage is paid either when the recipient of the loan moves out of the house or when he dies. At this time, the money must be returned. This is usually done with the money raised from the sale of the house.
The types of a reverse mortgage
Home Equity Conversion Mortgage (HECM) is the most popular type of reverse mortgage. It is insured by the federal government and is only available through creditors approved by the Federal Housing Administration (FHA).
The FHA limits the amount of money you can borrow on this type of mortgage to the current limit of $970,800 for 2022.
This type of loan has no restrictions on income or medical requirements. It can also be used for any reason, which is part of what makes it popular.
A single-purpose reverse mortgage is a loan from a state, local or non-profit agency. You can only use it for one reason, such as paying property taxes or renovating your home, and the lender must approve the loan designation.
You may be eligible for a private reverse mortgage (aka “jumbo reverse mortgage”) if the value of your home exceeds the lending limit for HECM (currently $970,800 in 2022).
While this type of mortgage allows you to borrow more money, it is not insured by the federal government and you are likely to pay a higher interest rate.
The pros and cons of a reverse mortgage
As with any major financial decision, there are both advantages and disadvantages to getting a reverse mortgage. It is important to weigh both sides before making a final decision.
Pros
That could be one of the only ways you get money if you’re over 62 and struggling financially.
Reverse mortgage payments (especially in the case of HECM) can be used for a variety of purposes.
You can stay in the house you worked so hard to create.
Cons
Reverse mortgages often come with high fees and interest rates. Fees are charged for shipping, maintenance, recording and other closing costs. The average fixed-rate reverse mortgage rate in 2022 was 4.81%, according to the U.S. Department of Housing and Urban Development (HUD).
When you take out a reverse mortgage, you reduce the equity in your home. This could mean you have fewer assets to leave to your heirs and the likelihood that your family will have to sell your home to repay the loan.
if you don’t pay home insurance and property taxes, you risk losing your home. Failure to pay any of these payments may result in foreclosure.
Because older people are often easy targets for fraudsters, there are a number of fraudulent schemes specifically designed for reverse mortgages. We’ll look at them in more detail in the next section.
The rules for a reverse mortgage
Since HECMs are regulated by the FHA, there are rules related to these loans.
The first rule is that you must be at least 62 years old or older. You have to live in this house as your primary residence, and you have to own most or all of it, according to HUD. Lenders may have special requirements for how much equity you need, but you usually have to own at least half.
You should also consult with a HUD-approved counselor before taking out a reverse mortgage so they can discuss the pros and cons of this type of credit.
In addition, you must continue to pay property taxes, homeowner insurance and any homeowner association fees. Failure to comply with these requirements can result in the loss of your home.
Fees and interest rates for reverse mortgages
Because HECM credits are federally regulated and insured, HUD sets the following fees:
Mortgage insurance premiums: Pay 2% of the loan balance at closing and 0.5% of the loan balance each year.
Down payment: Pay whichever is more – $2,500 or 2% of the first $200,000 home value plus 1% of the home value over $200,000. The maximum amount is $6,000.
Third party fees: Additional fees may include valuation, title retrieval, insurance, checks, among others.
Service charges: Lenders provide a range of regular services as long as you have credit, such as sending you payments and statements, and making sure you pay insurance and property tax. The maximum amount of this fee is $30 if the interest rate is fixed or adjusted once a year, or $35 if the rate is adjusted monthly. For single-target reverse mortgages, interest rates and fees tend to be lower than for HECMs.
But with your own reverse mortgage, you’re likely to pay higher interest rates to offset the lack of mortgage insurance.
How to avoid reverse mortgage scams
Unfortunately, there are people looking for ways to trick unsuspecting seniors into depriving them of their hard-earned money and home. These scammers are often strangers, but sometimes close people.
These scammers can take the form of contractors or home goods suppliers urging older people to take out reverse mortgages to pay for redevelopment and repairs they don’t need.
Under another common scenario, a financial adviser can persuade a homeowner to take out a reverse mortgage to pay for shares or insurance products that may not be in their best interests.
Unfortunately, in some scams, children or other loved ones of the elderly convince them to take out a reverse mortgage for their own benefit.
Here are some ways to avoid falling victim to reverse mortgage fraud:
– Seek advice on reverse mortgages before making a purchase.
– Be careful if anyone (including a loved one or financial adviser) asks you to grant them power of attorney.
– Don’t sign anything you don’t understand.
– Do not accept unsolicited offers.
– Never agree to a reverse mortgage that requires you to transfer ownership of your home.
– A good way to avoid fraud could be to use the list of creditors HUD maintains.