If you have ever watched TV or listened to the radio, you may have seen or heard commercials advertising reverse mortgages. While I was watching March Madness several weeks ago, I came across this commercial and thought that this would be a good topic for our next blog post. A large percentage of people have negative opinions about reverse mortgages, with many of those thinking that it’s a scam. Just like in any industry, there are some lenders who are out to take advantage of people, but the concept of a reverse mortgage is not a scam in and of itself. That being said, a reverse mortgage can be difficult to understand and is not the best option for everyone. Hopefully, this post will shed some light on reverse mortgages and help you or a family member determine if it is right for your situation.
What is a reverse mortgage?
For starters, most everyone understands that with a “regular” mortgage you receive a loan from a lender to purchase a home (after meeting certain criteria) and then make monthly payments to the lender for the life of the loan. With a reverse mortgage, you receive money from a lender without having to pay it back until you no longer live in that home. This is done by converting some of the equity in your home into cash which is available for you to use at your discretion (depending on the program). In order to qualify for a reverse mortgage, you must be at least 62 years old. The loan is then repaid when your home is no longer your primary residence, you sell your home, or after you pass away.
Types of Reverse Mortgages
Home Equity Conversion Mortgages (HECMs)
Also known as federally-insured reverse mortgages, these loans are backed by the U.S. Department of Housing and Urban Development (HUD). Upfront costs for these mortgages can be high, so make sure that you factor that in to any decision you make, especially if you only plan on staying in the home for a short amount of time or are borrowing a very small amount. Before applying for a HECM, the borrower must meet with an approved counselor who will explain the ins and outs of a reverse mortgage and explore the costs of the different types. If you are approved for a HECM, you can choose to receive your money in either monthly allotments, through a line of credit that you can pull from at any time, or a combination of monthly payments and the line of credit. HECMS can be used for any purpose, at any time. How much you can borrow depends on several factors and will be discussed below.
Proprietary Reverse Mortgages
These loans are very similar to HECMS, except they are backed by private companies. The borrowed amount may be higher than you can find with HECMs, but this may also be accompanied by higher costs and fees.
Single-Purpose Reverse Mortgage
This type of mortgage can only be used for one specific purpose, which is specified by the lender. Examples of these purposes can include making upgrades to your home, paying for deferred maintenance or other home repairs, or to pay off property taxes. Single-purpose reverse mortgages are normally the least expensive of the three types, requiring smaller upfront fees.
How much can you borrow?
The amount of money that you can borrow under a HECM reverse mortgage is based on a number of factors. The main factor to consider is the Maximum Claim Amount (MCA), which is the lesser value of the appraised value of your house or the maximum amount that the U.S. Department of Housing and Urban Development will insure ($625,500 as of April 2015). Other factors include the type of reverse mortgage you choose, the interest rate, and the age of the youngest borrower. In essence, the maximum claim amount is multiplied by a percentage known as the principle limit factor, and this amount is what is known as the principal limit. The principal limit factor will vary depending on the borrower, so this number can range anywhere from 0.20 to 0.70.
Some of these numbers can be confusing, so below is an example that could be typical for a Ventura County resident. The numbers were calculated using the reverse mortgage calculator that can be found here.
Gloria is considering taking out a reverse mortgage on her home. She was born on July 7, 1943 and is the sole borrower on her current mortgage. Gloria currently owes $100,000 on her mortgage and her home was recently appraised at $500,000. After talking with an approved counselor, it was determined that the principle limit she could borrow is $295,500. Gloria decides to use $100,000 of the principal limit to pay off her existing mortgage and then decides to take out the remaining amount in monthly payments. After taking into account fees and costs in excess of $11,000 Gloria is left receiving monthly payments of over $1100.
This was a fairly simple example to illustrate how some of the calculations would work. Of course there are other factors that would need to be taken into consideration in real life, such as what you or your family plan on doing with the house in the future. Especially if you have heirs that you would like to leave the home to, you need to realize what the financial implications of a reverse mortgage would be. If you have a high amount of equity in your home, it could be possible for them to sell the home and completely pay off the reverse mortgage and still be left with money in their pockets. But on the flip side, if they are unable to pay off the reverse mortgage, the lender has the right to take possession of the home. Again, every situation is different and these are things that should be discussed with a counselor or financial advisor.
Hopefully, this brief discussion shed a little bit of light into how reverse mortgages work. It is highly recommended that anyone considering a reverse mortgage fully understand the implications of doing so, not only on yourself, but also any family members who may be left with the house in the future. While reverse mortgages can play a part in your financial strategy, there are companies out there that will try and prey on those who may not be knowledgeable on how they work. For more information on reverse mortgages, you can check out the National Reverse Mortgage Lenders Association’s website. If you are looking for lenders in Ventura County to talk about reverse mortgages or any other financial questions, you can call us at 805-250-8335 for information about our preferred lenders in the area.