A. The Difference between Reverse and Forward Mortgages
A reverse mortgage is a loan secured by your home. It is a source of funds for homeowners who are 62 or older and who meet certain conditions. Under the terms of a typical reverse mortgage, a borrower’s debt increases and equity decreases. If the appraised value of the home rises rapidly, the equity may increase, but one cannot rely on this occurring.
Unlike a reverse mortgage, which is used for living costs, borrowers use a forward mortgage to purchase real estate. Over time, usually thirty years, borrowers make monthly payments that are applied to principal and interest. During the life of a typical forward mortgage, debt decreases and equity increases until the loan is repaid.
B. Home Equity Conversion Mortgage
Many lenders offer reverse mortgages. The federal government insures only Home Equity Conversion Mortgages (HECMs). The Federal Housing Authority (FHA), which is part of the U.S. Department of Housing and Urban Development (HUD), insures and regulates HECMs. The HUD maintains a list of approved reverse mortgage lenders.
Before the recession in 2008, there were many privately insured reverse mortgages that were not insured by the federal government. Since the recession began, they have largely disappeared from the marketplace.
C. Prudent and Imprudent Uses of Proceeds
While a borrower lives in the home, the reverse mortgage does not have to be repaid. While borrowers do not have to make a monthly payment, interest accrues on borrowed funds. It is dangerous to frivolously spend or speculate with the proceeds of a reverse mortgage. They are useful for seniors to pay basic needs like health care costs, property taxes, and repairs. Because a reverse mortgage must be a first mortgage, if a forward mortgage exists, the reverse mortgage is used to pay it off.
D. Eligibility
To qualify for a reverse mortgage a borrower must:
– be 62 or older; if there are multiple owners of the property, the youngest borrower must be 62
– own the house
– remain the owner and live in the house; if there are multiple borrowers, the loan becomes payable when the last one no longer lives in the house
– pay property taxes and assessments
– not be delinquent on federal debts
– discuss the program with a HUD-approved counselor.
The property must:
– meet minimum property standards; if repairs are required, one can use the reverse mortgage to make them
– be the borrower’s primary residence
– be a single-family residence
– be a 1 to 4 family dwelling, part of a planned unit development, or a HUD-approved condo or co-op.
The borrower does not need:
– an income
– to make monthly payments.
E. Form of Proceeds
Borrowers can receive the reverse mortgage proceeds:
– in a lump sum
– as a monthly cash advance
– as a line of credit that can be drawn against periodically
– some combination of these methods.
Interest accrues against borrowed money, so taking out more money up front increases the cost of the loan. Of these options, the lump sum is the most expensive because interest accrues against the entire amount of the loan from the earliest moment.
Reverse mortgages have a variety of administrative fees that can be paid for from the loan proceeds. Paying fees in this manner is known as “financing the loan costs.” Because interest is paid on those fees for the life of the loan, it increases the cost.
F. Borrowing Limitations
One’s total mortgage debt will be equal to the loan advances plus the accrued interest. One’s borrowing limit depends on one’s age and the value of the real estate. All things being equal, a borrower can borrow more as one grows older and the real estate increases in value.
The government sets HECM lending limits as a percentage of the house’s appraised value. As of the date of the publication of this column, the maximum borrowing limit set by the government is $625,000, even if the house appraises for much more.
To determine how much you can borrow, consult an online calculator and enter the applicable information including:
– your age (or that of the youngest borrower)
– the appraised value of your home
– expected interest rate.
G. Fees and Costs
Fees and costs differ among lenders. The Truth in Lending Act requires lenders to disclose a Total Annual Loan Cost (TALC) so borrowers can to compare loans. The fees and costs include the:
– Origination fee – It is the amount that a lender charges to prepare paperwork.
– Closing costs – They include the cost of a credit check, title search, real estate appraisal, inspection, insurance, mortgage recording fees, and mortgage taxes.
– Mortgage insurance premium – All HECM loans require this insurance. It guarantees that the borrower will receive loan advances and that the borrower or borrower’s estate (after death) will not owe more than the value of the home when the loan becomes due. HECMs are non-recourse loan. At the time of repayment, the lender cannot seek more then the home’s value. Thus, if a borrower lives longer than actuarial tables predict he will, or the value of the home declines before the loan becomes due, the borrower does not have to make up the balance. For example, if the balance due is $400,000, and the house sells for $350,000, the estate and heirs do not have to pay the difference.
– Servicing fee – It covers the administrative cost of the lender’s work and responsibilities after closing.
H. Interest Rates
Borrowed funds accrue at a rate of interest. Borrowers can choose to borrow at a fixed rate or adjustable rate. Adjustments usually occur monthly and are based on an index (e.g., LIBOR).
I. Choosing a Lender
There are many options in the marketplace. Investigate the list of lenders maintained by HUD. Compare fees and costs. Lenders may reduce or waive certain fees and costs. Some lenders may only reduce fees on fixed rate products, but some will reduce fees on adjustable rate products as well.
J. Repaying the Loan
A reverse mortgage becomes due and payable when the last surviving borrower dies, sells the home, or doesn’t live there for more than 12 months. The lender may accelerate the mortgage if the borrower defaults by failing to pay property taxes, maintain the house, or insure the property. The lender could pay certain costs from unborrowed funds. Also, the loan becomes payable if a lender declares bankruptcy, rents out the house, adds someone to the title, or borrows new debt.
Commonly, the loan is repaid when the borrower dies and estate’s fiduciary sells the house. If any equity remains, it becomes part of the estate. Otherwise, the insurance pays the loan balance, and the estate has no further liability to the lender.
K. Conclusion
A reverse mortgage can help a senior citizen stay in his or her home. Do not rush. Investigate your options and the costs. Use the money frugally. If you need assistance with your loan and closing, I can help.
About the Author: Bryan L. Berson, Esq. is an attorney and mediator at The Berson Firm, P.C., a commercial and civil law firm that handles estate administration and planning, real estate, commercial transactions, mediation, and commercial litigation. His e-mail is bberson@bersonfirm.com. His phone number is (631) 517-1055. Connect with The Berson Firm on Facebook and Bryan L. Berson on LinkedIn. The firm’s website is www.bersonfirm.com.
Disclaimer: Constructive Knowledge is published by The Berson Firm, P.C. (the “Firm”). The information contained in this column is provided for informational purposes only. It is not tax or legal advice on any subject matter. No readers, clients or otherwise, should act or refrain from acting on the basis of any content without seeking appropriate legal or other professional advice with respect to one’s particular circumstances. This column reflects a general discussion of the law in New York. It may not accurately reflect the law of other states. The content is general information and may not reflect current legal developments, verdicts, or settlements. The Firm expressly disclaims all liability with respect to acts taken or not taken based on any or all content of this column. This column is Attorney Advertising. IRS Circular 230 Legend: Nothing in this column is intended to be used and cannot be used to avoid U.S. federal, state, or local taxes. It was not written to promote, market, or recommend any tax planning strategy or action. Copyright: All rights reserved. No part of this publication may be reproduced without prior written consent. Readers may share this column through, but not limited to, social networks.
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[…] A reverse mortgage is a loan used by homeowners, who are 62 years old or older, to provide cash flow for their living needs. This program discusses federally insured loans, eligibility, options to receive proceeds, borrowing limitations, fees and costs, interest rates, and repayment. Click here to read more about reverse mortgages. […]