by Jean Freeman and Susan Brown
Everyone knows a family member, friend or old neighbor who is transitioning from a consistent income to a less “lucrative” income due to divorce, death of a loved one or fixed income due to retirement. Most often, most of their next egg is locked up in equity in their home. While each situation is unique, a reverse mortgage, when properly used can help aging seniors turn the equity in their homes into income that will last the rest of their lives. With the baby boomers entering this phase of their financial lives, there have been improvements made to insure that reverse mortgages don’t make life more difficult for the people they were designed to benefit.
What is a Reverse Mortgage
A reverse mortgage is a Federally Insured Program that provides alternatives to individuals age 62 and older who can no longer afford to stay in their home. In basic terms, a reverse mortgage lender will loan you a lump sum on a portion of the equity in your home. The loan grows at a specified interest rate and you are not required to make any payments. When you either leave the home or pass away, the home is sold and the reverse mortgage lender recoups their loan with interest. Any remaining proceeds from the sale passes to your heirs. When there are no proceeds the government guarantees the loss and the heirs do not “owe” on the home. The “old” reverse mortgages did not have this provision. With this change it now makes good sense in some situations to use the reverse mortgage.
Example: You own a home worth $120,000 with no mortgage. A reverse lender may loan you $60,000 at 6.5% interest plus closing costs. You are not required to make any payments on the loan. Let’s assume you pass away 15 years later. Your home is sold and the Reverse Mortgage Lender recoups its $60,000 loan plus interest for a total of $158,652. The remaining proceeds go to your heirs.
Who Qualifies for a Reverse Mortgage?
- Be 62 years of age or older
- Own the property outright or paid-down a considerable amount
- Occupy the property as your principal residence
- Not be delinquent on any federal debt
- Have financial resources to continue to make timely payment of ongoing property charges such as property taxes, insurance and Homeowner Association fees, etc.
- Participate in a consumer information session given by a HUD- approved HECM counselor
How much of a Loan can I get? (For the purpose of this article we will refer to Fixed Rate Loans)
For the purpose of this article we will refer to Fixed Rate Loans. The amount you may borrower will depend on:
- Age of the youngest borrower or non-borrowing spouse
- Current interest rate
- The appraised value of your home Current mortgage balance
- Initial Mortgage Insurance Premium
- The amount of loan is generally limited to a maximum of 50% to 60% of equity
Costs for a Reverse Mortgage
- Mortgage Insurance Premiums (MIP) Upfront fees and Annual Fees
- 3rd Party Charges
- Origination Fees
- Interest and Servicing Fees – Current Fixed Interest Rates are around 5.0%ARMs are also available
Mortgage Loan $106,000
MIP Upfront 900
Origination Fees 3,600
Other Closing Costs 2,185
Total Costs Upfront 6,685
Interest Rate 5.06%
Annual MIP 1.25%
Total Interest 6.31%
Mortgage Insurance Premiums
Reverse Mortgages are federally insured by FHA. If the reverse mortgage loan is more than the proceeds of the sale of the home, FHA will cover the difference.
Case Scenarios for a Reverse Mortgage
Scenario 1 – Eve is a 70 year old widow, living on her husband’s social security benefit of $3000 per. Her home is worth $150,000. She is finding it more and more difficult to make ends meet and fears she will have to sell her home. Like many widows, she is cash poor and home rich.
Option 1 – Sell the home and rent Home sale proceeds after closing costs and commissions generates $138,000 at 4% = $460 per month Rent is $900 per month, a net loss of $440 per month. After rent, her income available for other expenses is $2,560
Option 2 – Take a reverse mortgage for 50% or $75,000 that generates $250 month net gain. Now Eve still lives in her home and has an extra $250 month or $3250 a month.
The difference is $690 per additional funds available per month. ($3250 – 2,560) = $690. For Eve, it’s the difference between living in an apartment or her home of 45 years.
Scenario 2 – Bob and Patricia are about to retire at 67. Their combined social security is $4,200 per month. Like many individuals, they are cash poor and home rich. They still owe $100,000 on their $200,000 home with mortgage payments of $760 per month for another 15 years. They can take out a reverse mortgage for $100,000 to pay off the mortgage and free up an additional $760 per month.
Scenario 3 – Karen is 62 and recently divorced. Her and her ex-husband sold their home net for $180,000 and she received $90,000. She is disabled on collecting $2200 in social security disability. The only other assets she has is $12,000 in a bank savings account.
Option 1 – Rent for $1000 month leaving her with $1200 for all other expenses
Option 2 – Based on Karen’s income it is unlikely she would qualify for a mortgage. Karen can put the $80,000 down on a $160,000 home and use the reverse mortgage to cover the rest. With no mortgage payment, she has the full $2,200 at her disposal for other expenses.
Drawbacks of a reverse mortgage
- You receive the equity in your home instead of your heirs, who will potentially receive a reduced inheritance
- If you want to sell your home before passing away, your proceeds will be less the loan amount
- Interest rates for reverse mortgages are higher than conventional mortgage rates
- Closing costs are considerable, consistent with new mortgages or refinancing of a mortgage
- A Reverse mortgage may disqualify the recipient for other low income programs
As mentioned earlier, each individual’s situation is unique. There are many other considerations that must be evaluated to enable this to be a good choice. The key is to have a professional evaluate the situation and prepare your options.
** Calculations based on estimates from www.reversemortgage.org
To learn more about this topic with Brown & Freeman, Listen to Financial Security for Women with Brown and Freeman: Reverse Mortgages on Plaid Radio.