Chapter 2 Reverse Mortgages for Retirement Income

Grasping the Reverse Mortgage Basics

A reverse mortgage is a loan against your home that you don’t have to repay as long as you live there. In a regular, or so-called forward mortgage (the kind you likely had when you bought your home), your monthly loan repayments make your debt go down over time until you’ve paid it all off. Meanwhile, your equity is rising as you repay your mortgage and as your property value appreciates.

With a reverse mortgage, by contrast, the lender sends you money, and your debt grows larger and larger as you keep getting cash advances (usually monthly), make no repayment, and interest is added to the loan balance (the amount you owe). That’s why reverse mortgages are called rising debt, falling equity loans. As your debt (the amount you owe) grows larger, your equity (that is, your home’s value minus any debt against it) generally gets smaller. However, your equity could still increase if you’re in a strong housing market where home values are rising nicely.

If your financial goal is to preserve the equity in your home, you may be able to conservatively structure your reverse mortgage so you limit the amount of equity you pull out of your property to the estimated increase in home values anticipated over future years. Of course, predicting future real estate appreciation is definitely an inexact science. But real estate values do generally rise over time, and you may find that if you’re modest in the amount of money you receive from the lender, you won’t erode your home equity as much as you thought.

As mentioned in Book 6, Chapter 1, reverse mortgages differ from regular home mortgages in two important respects:

To qualify for most loans, the lender checks your income to see how much you can afford to pay back each month. But with a reverse mortgage, you don’t have to make monthly repayments. Thus, your income generally has nothing to do with getting a reverse mortgage or determining the amount of the loan.
With a regular mortgage, you can lose your home if you fail to make your monthly repayments. With a reverse mortgage, you can’t lose your home by failing to make monthly loan payments — because you don’t have any to make!

A reverse mortgage merits your consideration if it fits your circumstances. Reverse mortgages may allow you to cost-effectively tap your home’s equity and enhance your retirement income. If you have bills to pay, want to buy some new carpeting, need to paint your home, or simply feel like eating out and traveling more, a good reverse mortgage may be your salvation.

This section focuses on the ABCs of reverse mortgages and helps clarify any confusion you may have.

Considering common objections

Most older homeowners contemplating a reverse mortgage have worked hard for many years to eliminate their home’s mortgage so that they own their home free and clear. After what they’ve gone through, the thought of reversing that process and rebuilding the debt owed on their home is troubling. Furthermore, reverse mortgages are a relatively new type of loan that few people understand. And most of today’s reverse mortgage borrowers are low-income, single seniors who have run out of other money for living expenses. Some people think reverse mortgages are only a last resort, but that isn’t true. The following sections answer some of the most common questions about reverse mortgages.

Can you lose your home?

It’s not too surprising that folks who don’t fully understand reverse mortgages often have preconceived notions, mostly negative, about how they work. Seniors with home equity often erroneously think that taking a reverse mortgage may lead to being forced out of their homes or ending up owing more than the house is worth.

Seniors taking out a reverse mortgage won’t be forced out of their home. Nor will they (or their heirs) end up owing more than their house is worth. Federal law defines reverse mortgages to be nonrecourse loans, which simply means that the home’s value is the only asset that can be tapped to pay the reverse mortgage debt balance. In the rare case when a home’s value does drop below the amount owed on the reverse mortgage, the borrower isn’t on the hook for the extra debt. The lender assumes that risk.

As detailed later in this chapter (see the section “When do you pay the money back?”), not keeping current with your property taxes and homeowners insurance can trigger your reverse mortgage going into default and requiring payoff. When a loan is called due and payable, the reverse mortgage borrower or the borrower’s estate needs to repay only the lesser of either the loan balance or 95 percent of the home’s appraised value at that time.

Would a home equity loan or second mortgage work better?

Some people who are intimidated by having to understand reverse mortgages wonder whether it would be simpler to get a home equity loan or a new mortgage that allows them to take some equity out of their home. The problem with this strategy is that you have to begin paying traditional mortgage loans back soon after taking them out.

For example, suppose you own a home worth $200,000, with no mortgage debt. You decide to take out a $100,000, 15-year mortgage at 7 percent interest. Although you’ll receive $100,000, you’ll have to begin making monthly payments of $899. No problem, you may think; you’ll just invest your $100,000 and come out ahead. Wrong!

Most seniors gravitate toward safe bonds, which traditionally may yield in the neighborhood of 5 percent — a mere $416 of monthly income — an amount far short of your monthly mortgage payments. If you invest in stocks and earn the generous average return of 10 percent per year, which is by no means guaranteed, your returns would amount to more — $833 per month — but still not enough to cover your monthly mortgage payment. (Also note that most income from stocks and bonds is taxable at both the federal and state level. By contrast, reverse mortgage payments you receive aren’t taxable.) Advantage: reverse mortgage.

Here’s another big drawback of taking out a traditional mortgage to supplement your retirement income. The longer you live in the house, the more likely you are to run out of money and begin missing loan payments, because you drain your principal to supplement inadequate investment returns and cover your monthly loan payment. If that happens, unlike with a reverse mortgage, the lending institution may foreclose on your loan, and you can lose your home.

Who can get a reverse mortgage?

Of course, reverse mortgages aren’t for everyone. As discussed later in this chapter (see the section “Deciding Whether You Want a Reverse Mortgage”), alternatives may better accomplish your goal. And not everyone qualifies to take out a reverse mortgage. Specifically, to be eligible for a reverse mortgage, the following must be true:

You must own your home. In the early years of reverse mortgages, as a rule, all the owners had to be at least 62 years old. Now, for a couple, you may qualify for a reverse mortgage if one person is at least 62 years of age and the other person is younger than that. However, such a couple will qualify for less reverse mortgage money due to the younger spouse because “life expectancy” is part of the calculation.
Your home generally must be your principal residence — which means you must live in it more than half the year.
For the federally insured Home Equity Conversion Mortgage (HECM), your home must be a single-family property, a two- to four-unit building, or a federally approved condominium or planned-unit development (PUD). Reverse mortgage programs will lend on mobile homes with foundations that meet the U.S. Department of Housing and Urban Development (HUD) guidelines but won’t lend on co-op apartments.
If you have any debt against your home, you must either pay it off before getting a reverse mortgage or, as most borrowers do, use an immediate cash advance from the reverse mortgage to pay it off. If you don’t pay off the debt beforehand or don’t qualify for a large enough immediate cash advance to do so, you can’t get a reverse mortgage.

One final and important point about qualifying for a reverse mortgage: Lenders are now required to perform a financial assessment analyzing the prospective borrower’s financial situation, including credit history and monthly income and expenses. Lenders pay particular attention to whether borrowers have enough cash flow to pay their property tax and home insurance bills. If borrowers have little wiggle room in their monthly budget, lenders may require a “set aside” fund to ensure payment of property taxes and home insurance, and this “set aside” fund reduces how large a reverse mortgage the borrowers can get. The amount of this “set aside” fund may also vary depending on the age of the reverse mortgage borrowers.

How much money can you get and when?

The whole point of taking out a reverse mortgage on your home is to get money from the equity in your home. How much can you tap? That amount depends mostly on your home’s worth, your age, and the interest and other fees a given lender charges. The more your home is worth, the older you are, and the lower the interest rate and other fees your lender charges, the more money you should realize from a reverse mortgage.

For all but the most expensive homes, the federally insured Home Equity Conversion Mortgage (HECM) generally provides the most cash and is available in every state.
In general, the most cash is available for the oldest borrowers living in the homes of greatest value over current debt (net equity) at a time when interest rates are low. On the other hand, the least cash generally goes to the youngest borrowers living in the homes of lowest value (or with high current debt) at a time when interest rates are high.

The total amount of cash you actually end up getting from a reverse mortgage depends on how it’s paid to you plus other factors. You can choose among the following options to receive your reverse mortgage money:

Monthly: Most people need monthly income to live on. Thus, a commonly selected reverse mortgage option is monthly payments. However, not all monthly payment options are created equal. Some reverse mortgage programs commit to a particular monthly payment for a preset number of years. Other programs make payments as long as you continue living in your home or for life. Not surprisingly, if you select a reverse mortgage program that pays you over a longer period of time, you generally receive less monthly — probably a good deal less — than from a program that pays you for a fixed number of years.
Line of credit: Instead of receiving a monthly check, you can simply create a line of credit from which you draw money by writing a check whenever you need income. Because interest doesn’t start accumulating on a loan until you actually borrow money, the advantage of a credit line is that you pay only for the money you need and use. If you have fluctuating and irregular needs for additional money, a line of credit may be for you. This is also the preferred way to access funds if your financial goal is to limit the equity you pull from your home to its increase in value. The size of the line of credit is either set at the time you close on your reverse mortgage loan, or may increase over time. Generally, during the first 12 months, you can receive up to but no more than 60 percent of the maximum loan allowed.
Lump sum: The third, and generally least beneficial, type of reverse mortgage is the lump-sum option. When you close on this type of reverse mortgage, you receive a check for the entire amount that you were approved to borrow. Lump-sum payouts usually make sense only when you have an immediate need for a substantial amount of cash for a specific purpose, such as making a major purchase or paying off an existing or delinquent mortgage debt to keep from losing your home to foreclosure. Ironically, but also a blessing, when your financial troubles are caused by falling behind on your mortgage payments, you can get a reverse mortgage to tap the remaining equity in your home to assist in resolving your immediate pending foreclosure.
Mix and match: Perhaps you need a large chunk of money for some purchases you’ve been putting off, but you also want the security of a regular monthly income. You can usually put together combinations of the preceding three programs. Some reverse mortgage lenders even allow you to alter the payment structure as time goes on. Not all reverse mortgage programs offer all the combinations, so shop around even more if you’re interested in mixing and matching your payment options.

When do you pay the money back?

As mentioned earlier, some reverse mortgage borrowers worry about having to repay their loan balance. Here are the conditions under which you generally have to repay a reverse mortgage:

When the last surviving borrower dies, sells the home, or permanently moves away. Permanently generally means that the borrower hasn’t lived in the home for 12 consecutive months.
Possibly, if you do any of the following:
- Fail to pay your property taxes
- Fail to keep up your homeowners insurance
- Let your home fall into disrepair
If you fail to properly maintain your home and it falls into disrepair, the lender may be able to make extra cash advances to cover these repair expenses. Just remember that reverse mortgage borrowers are still homeowners and therefore are still responsible for taxes, insurance, and upkeep.

What do you owe?

The total amount you will owe at the end of the loan (your loan balance) equals

All the cash advances you’ve received (including any used to pay loan costs)
Plus all the interest on them — up to the loan’s nonrecourse limit (the value of the home)

If you get an adjustable-rate reverse mortgage, the interest rate can vary based on changes in published indexes. The greater a loan’s permissible interest rate adjustment, the lower its interest rate initially. As a result, you get a larger cash advance with this type of loan than you do with loans that have higher initial interest rates.

You can never owe more than the value of the home at the time the loan is repaid. True reverse mortgages are nonrecourse loans, which means that in seeking repayment the lender doesn’t have recourse to anything other than your home — not your income, your other assets, or your heirs’ finances.

Even if you get monthly advances until you’re 115 years old, even if your home declines in value between now and then, and even if the total of monthly advances becomes greater than your home’s value — you can still never owe more than the value of your home. If you or your heirs sell your home to pay off the loan, the debt is limited by the net proceeds from the sale of your home.

How is the loan repaid?

How a reverse mortgage is repaid depends on the circumstances under which the loan ends:

If you sell and move, you’d most likely pay back the loan from the money you get from selling your home. But you could pay it back from other funds if you had them.
If the loan ends due to the death of the last surviving borrower, the loan must be repaid before the home’s title can be transferred to the borrower’s heirs. The heirs may repay the loan by selling the home, using other funds from the borrower’s estate, using their own funds, or by taking out a new forward mortgage against the home.

As lenders have learned, not all reverse mortgage borrowers end up living in their homes for the rest of their lives. Some folks who originally planned to live in a particular house forever subsequently change their minds. Others develop health problems that force them to move. So it makes sense to plan for the possibility that you may sell and move some day. How much equity would be left if you did?

If, at the end of the loan, your loan balance is less than the value of your home (or your net sale proceeds if you sell), then you or your heirs get to keep the difference. The lender doesn’t get the house. The lender gets paid the amount you owe on the reverse mortgage, and you or your heirs keep the rest of the house’s proceeds of sale.

If you take the loan as a credit line account, be sure to withdraw all your remaining available credit before the loan ends. You have access to the money sooner that way, and the amount could be more than otherwise may be left. For example, a growing credit line could become greater than the leftover equity if the home’s value decreases.

What’s the out-of-pocket cost of getting a reverse mortgage?

The out-of-pocket cash cost to you with a reverse mortgage is usually limited to just two modest items. First is an application fee that covers a property appraisal (to see how much your home is worth). Second is a minimal credit check (to see whether you’re delinquent on any federally insured loans).

Other costs, including the loan origination fee, can be financed with the loan. This means you can use reverse mortgage funds advanced to you at closing to pay the costs due at that time and later advances to pay any ongoing costs, such as monthly servicing fees. The advances are added to your loan balance and become part of what you owe — and pay interest on.

What are the other reverse mortgage costs?

The specific-cost items vary from one program to another. Many of them are of the same type found on forward mortgages: interest charges, origination fees, and whatever third-party closing costs (title search and insurance, surveys, inspections, document and recording fees, and property taxes) are required in your area.

Two other costs unique to some reverse mortgages are the monthly servicing fee, which can cost up to $35 per month, and a reverse mortgage insurance premium, which can cost up to 2.5 percent of the home’s value at closing (this premium is just 0.5 percent if you take no more than 60 percent of the approved funds).

In addition to the upfront insurance charge paid at closing, there is also an annual mortgage insurance premium of 1.25 percent of your reverse mortgage balance. This ongoing premium accumulates and is owed and paid once your loan ends and is paid back.

Within the federally insured Home Equity Conversion Mortgage (HECM) program, the costs that may be different from one lender to another are the origination fee, the servicing fee, third-party closing costs, and the interest rate. To get the best deal, compare these specific costs.

With HECM loans, there is a maximum origination fee of 2 percent of the first $200,000 of the home’s value and 1 percent of the amount above $200,000 to a maximum fee allowed of $6,000. Note: Individual lenders may charge lower origination fees at their discretion.

It’s difficult to evaluate or compare the true, total cost of reverse mortgages because that amount ultimately depends on the following:

How long you end up keeping the loan
The cash advances you receive during the loan
The interest rate charged on the loan
Your home’s value when the loan is over

You can, however, compare the costs of different reverse mortgages by evaluating each loan’s total annual average loan cost, also known as the total annual rate. The following section talks more about that.

What’s the total annual rate?

The total annual rate on a reverse mortgage includes all the loan’s costs. On any given loan, total annual rates depend on two major factors: time and appreciation.

Total annual average rates are generally greatest in the early years of the loan and decrease over time, for two reasons:

The initial fees and costs become a smaller part of the total amount owed as years go by.
The likelihood increases that the rising loan balance will catch up to — and then be limited by — the nonrecourse limit the longer you have the loan.

Total annual rates also depend on changes in a home’s value over time. The less appreciation, the greater the likelihood that a rising loan balance will catch up to — and then be limited by — the home’s value. On the other hand, when a home appreciates at a robust rate, the loan balance may never catch up to (and be limited by) it.

If you end up living in your home well past your projected life expectancy or your home appreciates at a lower rate than anticipated, you may get a true bargain. But if you die, sell, or move within just a few years, the true cost could be quite high.

When deciding to go with a reverse mortgage, you simply can’t avoid the fundamental risk that the true cost can end up being quite high. You just have to understand the risk in general, assess the potential range of total rates on a specific loan, and decide whether the risk is worth the benefits you expect to get from the loan.

Just remember, total annual rates aren’t really comparable to the interest rates quoted on forward mortgages because

Total annual rates include all the costs.
Reverse mortgages require no monthly repayments.
Reverse mortgages can provide an open-ended monthly income guarantee or a guaranteed credit line (which may grow larger).
You can never owe more than your home’s worth, even if its net value is less than what your loan balance would otherwise have been.

How do reverse mortgages affect your government-sponsored benefits?

Social Security and Medicare benefits aren’t affected by reverse mortgages. But Supplemental Security Income (SSI) and Medicaid are different. Reverse mortgages will affect these and other public benefit programs under certain circumstances:

Because they don’t count as income, loan advances on a reverse mortgage generally don’t affect your benefits if you spend them during the calendar month in which you get them. But if you keep an advance past the end of the calendar month (in a checking or savings account, for example), it counts as a liquid asset. If your total liquid assets at the end of any month are greater than $2,000 for a single person or $3,000 for a couple, you could lose your eligibility.
If anyone in the business of selling annuities has tried to sell you on the idea of using proceeds from a reverse mortgage to purchase an annuity, you need to know that annuity advances reduce SSI benefits dollar for dollar and can make you ineligible for Medicaid. So if you’re considering an annuity and if you’re now receiving — or expect that some day you may qualify for — SSI or Medicaid, check with the SSI, Medicaid, and other program offices in your community. Get specific details on how annuity income affects these benefits.

Reverse Mortgages for Retirement Income