What is a reverse mortgage?

While all of these ads make a reverse mortgage sound great there can be dangers and pitfalls that you should be aware of before signing on the dotted line.

There are plenty of ads on TV touting the benefits of a reverse mortgage, you can access the equity in your home while still living in it, allowing you to have a more financially exciting life. The ads claim the money can be used for travel, upgrades to your home or to simply supplement your retirement income.

While all of these ads make a reverse mortgage sound great there can be dangers and pitfalls that you should be aware of before signing on the dotted line.

Keep reading to learn all you need to know about reverse mortgages.

What is a reverse mortgage?

Reverse mortgages are loans that are available to homeowners who are at least 62 years old. They allow a homeowner to convert some of the equity in their home into cash that they can use now.

Reverse mortgages were created to meet the needs of homeowners with limited incomes. It allowed them to use the equity in their homes to cover basic living expenses as well as health care costs but there are no restrictions as to how the money can be used so many reverse mortgage holders used the proceeds for other purposes.

The term reverse mortgage simply means that the lender makes monthly payments to the borrower instead of the other way around. A reverse mortgage can be taken as a monthly income, a lump sum or as a line of credit. Basically it is a loan that uses your paid off home as security.

A reverse mortgage does not require the borrower to make any loan repayments until the house is sold or they move out. As long as the homeowner is living in the home they are not required to make any payments against the loan balance and interest.

Loan terms require that the homeowner keep all property taxes and HOA dues current. They are also required to keep a homeowners insurance policy in force on the property.

Over time, the loan balance will grow (and home equity will decline) as the homeowner receives payments and interest accrues on the reverse mortgage loan.

The loan is paid in full when the homeowner passes away and the home is sold or they move out and sell the house. It is also possible for a homeowner to repay the loan at any time they choose.

Reverse mortgages are designed so that the loan amount cannot exceed the value of the house which means that if your reverse mortgage balance is $200,000 and the house only sells for $175,000, the homeowner is not required to pay the $25,000 difference.

However, if the house sells for more than the loan amount, the homeowner or their estate receives the extra money.

Reverse Mortgage Requirements

Reverse mortgages do not have super restrictive requirements so it is often fairly easy to qualify for one. Here is a brief overview of the requirements:

• Age: You must be at least 62 years old. All borrowers on the title of the house must be over 62 years of age.
• Home: The house you are taking out a reverse mortgage on must be your primary residence. You cannot do a reverse mortgage on a vacation home.
• House Type: It must be a single family, multi-family or an approved condo or manufactured home.
• Own the Home: Your must own the home outright or have a very small amount left on your mortgage that will be paid off with the reverse mortgage. The reverse mortgage must be the primary lien on the home.
• Counseling: In order to qualify for a reverse mortgage you must meet with a HUD approved counselor to determine that a reverse mortgage makes sense for you and meets your financial needs. They will also advise you on other products that may meet your needs.
• Assessment: A financial assessment is also required to ensure that you can cover the costs of ongoing expenses such as property taxes, basic maintenance on the home, HOA fees as well as homeowners insurance.

Fees

As with all loans, there are fees involved. Here is a quick overview of common fees.

• Origination Fees: These fees are paid to the lender at the beginning of the loan and are regulated by the government. They can range from a minimum of $2,500 all the way up to $6,000 depending on the value of your home. The formula for the fees is 2% of the first $200,000 in property value and 1% of the amount above $200,000.
• Other Fees: There are numerous fees involved when dealing with a reverse mortgage loan and they can add up to a significant amount of money. You will need to cover the cost of an appraisal, inspection, title search as well as other third party fees.
• MIP Fee: This is an upfront mortgage insurance premium that must be paid to the FHA. It is 2% of your properties value so it can be pricey. This helps cover the cost of the protections that the FHA gives to all reverse mortgage loans. One such protection is if the house sells for less than the loan balance, the FHA covers the balance of the loan. Borrowers are charged a 0.5 percent annual MIP fee on the loan balance.

The Downside of Reverse Mortgages

While a reverse mortgage can be great for some homeowners there are downsides you should be aware of before signing up for one:

Impossible to Renegotiate: It is very important that you understand all terms related to the loan as they are very difficult if not impossible to renegotiate once you have committed to the loan. If interest rates go down, you cannot renegotiate the terms of the loan and in many cases adjustable rate loans have seen interest rates head up quickly.

High Costs: When compared to a traditional home loan, a reverse mortgage comes with some pretty heavy fees, especially upfront. In addition, interest rates are often higher. While a higher interest rate may not seem like a big deal as you are not making monthly mortgage payments, the interest will eat into your equity.

Issue for your Heirs: If you plan on leaving your home to your children or other heirs, a reverse mortgage is not a great choice. The balance of the loan is due immediately upon your death and if your heirs cannot afford to cover the balance, the house must be sold to satisfy the loan. This can leave your heirs with a difficult decision shortly after your death.

Foreclosure is Possible: The older a person is, the more money they can borrow which has led some homeowners to only put the name of the older spouse on the loan. Unfortunately, they failed to understand that if the older spouse dies before the younger one, the surviving spouse could end up being foreclosed on and kicked out of the home. Always verify this is not a possibility before agreeing to a reverse mortgage.