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A reverse mortgage (known as lifetime mortgage in the UK) is a type of loan available to seniors (62 and over in the US), used as a way of converting their home equity (the value of the home, minus the amount of any existing mortgages) into one or more cash payments while retaining ownership of the property (continuing to live there) and avoiding monthly payments. Repayment of the loan is deferred until the borrower is no longer living in the home.
In a typical mortgage, a home owner pays a monthly amortized amount; after each payment, the owner has more equity in the house. After a certain amount of time (typically 30 years), the mortgage will be paid in full and the property released from the debt. In a reverse mortgage, the home owner pays nothing each month and all interest on the debt is added to the lien on the property. If the owner receives monthly payments, then the debt on the house increases each month.
If a house gains significantly in value after a reverse mortgage is taken on it, it is possible to get a second and even third reverse mortgage to borrow against the increased equity that the owner now has in the more valuable house. But, in the United States a reverse mortgage must be the first and only mortgage on the property (if there is an existing mortgage, it will be paid off with some of the proceeds from the reverse mortage). In the United States, if the property increases in value (and as the mortgagee ages and qualifies for more money), the reverse mortgage may be refinanced to borrow more against the increased equity.
Reverse mortgages in the United States
Requirements
To qualify for a reverse mortgage in the United States, the borrower must be at least 62. The borrower must pay off any existing mortgage(s) with the proceeds from the reverse mortgage and, if needed, additional personal funds. There are no minimum income or credit requirements, and for most reverse mortgages, the money can be used for any purpose. A pending bankruptcy that has not been finalized may, however, slow the process. Some types of dwellings, such as lower-value mobile homes, do not qualify. Before borrowing, applicants must seek HUD approved counseling. The counseling is a free safeguard for the borrower and his/her family, to make sure they completely understand what a Reverse Mortgage is, and what the process of obtaining one is.
Reverse mortgages are offered by some state and local governments. These "public sector" loans generally must be used for specific purposes, such as paying for home repairs or property taxes.. The majority of reverse mortgages are FHA insured.
Payment(s) (loan advances)
The amount of money that an individual homeowner can receive from a reverse mortgage depends on their age, the Federal Housing Administration (FHA) or Fannie Mae (FNMA) appraised value of the home, and the starting interest rate (effective upon closing/finalization of the loan). The location of the home may also have an impact. There is also a type of reverse mortgage for homes valued over the maximum Fannie Mae limit. These are called "cash" accounts, and are proprietary loan products.
In a reverse mortgage in the U.S., a borrower can be paid in a lump sum, monthly (payment of advances), through an increasing line of credit, or a combination of all three. The money received (loan advances) are not taxable and do not affect Social Security or Medicare benefits.
An American Bar Association guide explains that if you receive Medicaid, SSI, or other public benefits, loan advances will be counted as "liquid assets" if the money is kept in an account (savings, checking, etc.) past the end of the calendar month in which it is received. The borrower could then lose eligibility for such public programs if their total liquid assets (cash, generally) is then greater than those programs allow. .
Costs and Interest Rates
The cost of getting a reverse mortgage from a private sector lender tends to exceed the costs of other types of mortgage or equity conversion loans. Exact costs however are dependant on the particular reverse mortgage program that the borrower acquires. For the most common type of United States reverse mortgage, the HECM (Home Equity Conversion Mortgage), there is an insurance premium of 2 percent of the loan and a 2 percent origination fee in addition to normal closing costs, which are typically some thousands of dollars, but vary depending on the third-party costs (appraisal fees, title searches, etc.) that must be undertaken. Thus a $200,000 loan would have $8,000 in costs beyond the normal closing costs added onto the loan at the outset. Other programs tend to skip the insurance premium, but still require the origination fees and closing costs, though some programs will waive the initial costs if the borrower is willing to borrow the maximum or close to the maximum amount that they are eligable to receive. In addition, there is a monthly service charge of between $25 and $35 that is usually added to the total amount of the loan.
In all of these cases, the costs of a reverse mortgage can typically be financed through the loan itself, with the costs and fees being rolled directly into the principal balance of the loan, rather than paid by the borrower in cash. While this does permit borrowers with little or no available cash to get a reverse mortgage, it does mean that the initial loan principal will be increased, and consequently, that the fees will begin accruing interest.
Interest rates on reverse mortgages are determined on a program-by-program basis, but are typically similar to interest rates offered by Adjustible Rate Mortgages (ARMs), or at time of this writing, approximately 7-8%. All major reverse mortgage programs have adjustable interest rates that are adjusted on an annual, semi-annual, or monthly basis. Due to the fact that reverse mortgages have no fixed duration, there are no reverse mortgages with fixed interest rates.
Some state and local governments offer low-cost reverse mortgages to seniors, which tend to have more favorable interest rates and fewer or no fees associated with them. However, as mentioned above, these programs are typically very restrictive in terms of qualification and location, and many regions, states, and areas do not have such programs at all.
When the loan ends
The loan ends when the homeowner dies, sells the house, or moves out of the house for 12 consecutive months or more (for example, to go into an assisted living home). At that point, the reverse mortgage can be paid off by the proceeds of the sale of the house, or refinanced by the heirs of the homeowner's estate. If the proceeds exceed the loan amount, the owner of the house (if moving out or selling) receives the difference; if the owner has died, the heirs receive the difference. For cases where the proceeds are not sufficient to pay off the loan, then the bank (or insurance that the bank has, on the loan) makes up the difference.
The technical term for this cap on debt is "non-recourse limit." It means that the lender does not have legal recourse to anything other than the value of the home when the loan is to be paid off. .
Volume of loans
The most popular type of reverse mortgage in the U.S. is the FHA-insured Home Equity Conversion Mortgage (HECM) which accounts for 90% of all reverse mortgages originated in the U.S. As of December 31, 2005 a total of 195,418 HECM loans had been issued since the program's inception in 1989. However, program growth in recent years has been very rapid. The National Reverse Mortgage Lenders Association (NRMLA) reports that 55,659 HECM loans were endorsed thru the first nine months of fiscal year 2006, an 83 percent increase over the 30,404 loans endorsed during the same period in the prior fiscal year.
Section 255 of the National Housing Act, which governs the HECM program, limits the aggregate number of outstanding HECMs to 250,000. Conceivably, the cap could be reached in the next 12-24 months. Efforts are currently underway to remove or expand the cap on the number of HECM loans that can be issued.
Drawbacks of a Reverse Mortgage
A reverse mortgage borrower may encounter many financial hazards in taking out a reverse mortgage. First, reverse mortgages are very expensive while promising an uncertain amount of benefits. For example, a typical reverse mortgage may provide to the consumer a $300 per month payment with a monthly compounded interest rate of 1%. Over the course of ten years, the borrower will receive $36,000, but by that time she will owe almost $70,000-almost twice as much as she has received.
In addition, reverse mortgages have complex contract terms that are confusing and can greatly impact the overall cost of a reverse mortgage to the borrower. This report examines the effect of some of these terms on some California reverse mortgage borrowers and looks at the danger to borrowers when lenders or third parties involved in arranging reverse mortgages do not fully disclose a loan's terms and fees. One example involves a lawsuit filed by the San Mateo County Public Guardian which, on behalf of Berta Grey, an 83-year old woman, alleged that Transamerica Corporation unfairly and unconscionably charged her what was in effect a shared appreciation fee. This fee gave Transamerica an automatic 50% interest in the difference between the base value of the home when the loan was signed and the appreciated value of the home when the loan terminated, even though the fee bore no relation to the amount she actually borrowed. Additionally, the cost of Berta Grey's reverse mortgage soared when she was required to purchase an annuity in conjunction with her reverse mortgage. An annuity is an insurance product financed out of the home's equity to provide monthly payments to the borrower immediately or after a certain number of years. The San Mateo County Public Guardian alleged that Transamerica charged Berta Gray the cost of the annuity immediately and that interest began compounding on that fee even though she was not due to receive any payment on the annuity until six years after the loan began, at age 89. Under this arrangement, if Ms. Gray died before the six-year period ended, her estate would see no benefit from the annuity purchase, although she had paid in full for it.
Numerous other front-end and back-end fees can quickly drive up the cost of a reverse mortgage and are discussed in more detail in this report. These fees include origination fees, points, mortgage insurance premiums, closing costs, servicing fees, shared equity or "maturity" fees, and shared appreciation fees. The case of the San Mateo County Public Guardian v. Commonwealth Life Insurance illustrates how some of these fees generated allegations by a class of 1,505 borrowers that they were charged tens of thousands of dollars in artificially inflated loan fees. This suit was settled in 1999.
Reverse mortgage counseling, which is the main consumer safeguard against financial fraud and abuse against seniors, is required for some but not all loans. This means that the current system of reverse mortgage counseling is not enough to protect potential borrowers. Some of the major flaws cited in this report include situations where reverse mortgage counselors are not neutral parties because they are affiliated with the lender. Unfortunately, this practice is encouraged by the fact that Fannie Mae will purchase reverse mortgage loans from loan originators who themselves provide "counseling" to prospective reverse mortgage borrowers.
Other Options
The biggest drawback with reverse mortgages are the high upfront costs. Some seniors may want to consider other options to tap their home equity, particularly if they do not think they will remain in the home for at least five years.
For example, a home equity line of credit (HELOC) requiring interest-only payments for 10 years can be used. These loans typically have very low (or zero) upfront costs. The drawback is that, unlike a reverse mortgage, the borrower must make a monthly (interest-only) payment to the lender. These payments can be made for several years by drawing on the line of credit itself. Of course, the balance needs to be paid off when the house is sold or the owner dies - just as with a reverse mortgage.
Other options that can free up home equity but avoid the high upfront costs of a reverse mortgage include: 1) intra-family loan or sale-leaseback and, 2) selling and moving to a less expensive dwelling or location. However, when selling the homeowner incurs high closing costs including, typically, a 6% commission, moving costs, and purchase costs on the new dwelling. Currently, there is a coordinated government program called "Aging in Place" that strives to assist the homeowner in staying in their home and neighborhood, if that is their desire. Various studies, including AARP, show that over 80% of elderly homeowners do not want to move.
Taxes Related to the Reverse Mortgage
What about taxes?
An American Bar Association guide to reverse mortgages advises that generally,
- the IRS does not consider loan advances to be income,
- annuity advances may be partially taxable, and
- interest charged is not deductible until it is actually paid, that is, at the end of the loan.
("Reverse Mortgages: A Lawyer's Guide," American Bar Association 1997.)
Warning & Cautions
Statutory Requirement - To be eligible for a federally-insured Home Equity Conversion Mortgage (HECM), a homeowner must receive counseling from a HUD-approved counseling agency. Here is the federal law that spells out this counseling requirement.
"The Secretary shall provide or cause to be provided by entities other than the lender the information required in subsection (d)(2)(B) of this section. Such information shall be discussed with the mortgagor and shall include
1. 1) options other than a home equity conversion
mortgage that are available to the homeowner,
including other housing, social service, health,
and financial options;
2) other home equity conversion options that are
or may become available to the homeowner, such
as sale-leaseback financing, deferred payment
loans, and property tax deferral;
3) the financial implications of entering into a
home equity conversion mortgage;
4) a disclosure that a home equity conversion
mortgage may have tax consequences, affect
eligibility for assistance under Federal and State
programs, and have an impact on the estate
and heirs of the homeowner; and
5) any other information that the Secretary may
require."
Reference
- ^ reverse mortgages Information From AARP
- Reverse Mortgage Fees and Reverse Mortgage Rates Detailed article on the costs of a Reverse Mortgage
See also
External links
- U.S. Department of Housing and Urban Development - Top Ten Things to Know about Reverse Mortgages
- Australian Security & Investment Commission - Consumer Protection (FIDO): Reverse Equity Products / Reverse Mortgages
- Reverse Mortgage articles