Friday, 02 July 2010
Reverse Mortgages – Part 2: The Basics
Because there are many small details to know about reverse mortgages and enough individual questions to fill a book, I am going to start broadly and drill down in subsequent posts so that we can absorb the needed information in bites (bytes?) we can easily digest.
Let's start today with a definition.
At least once in their lives, the majority of U.S. grownups go through the process of getting a traditional mortgage to pay for the purchase of a home. We pretty much understand what it is: a bank lends the money to pay for the property; the borrower repays the loan at an agreed-upon interest rate over a set period of years.
It is not much more complicated than that.
Although there are different requirements and more caveats associated with a reverse mortgage, at its most basic level, it is just that – the reverse of a traditional (“forward”) mortgage: a bank loan, secured by your home, that gives you regular payments or a lump sum based on the value of your home at the time the reverse mortgage is made.
Interest is charged on the outstanding balance which continues to grow, due to continuing interest, even when you do not take out additional funds. But you owe nothing, make no payments until the loan is due when you permanently move out of the home through a sale or death.
You (or the youngest borrower, if more than one) must be at least 62 years old.
You must have sufficient equity in your home to pay off any traditional mortgage with the proceeds of the reverse mortgage, a requirement to obtaining the reverse mortgage.
That's it. Income, health, credit rating or score are not considered.
You are required to keep homeowners insurance and property taxes paid and to keep the property in good repair. Failure to do so can result in the loan being called due.
Remember, you continue to hold the title to your home and no matter what rumors you've heard or what others have told you, as long as you keep up those three obligations, you cannot be thrown out of your home. Also, you pay nothing until you sell or move out and you will never owe more than the value of your home.
Types of Reverse Mortgages
Reverse mortgages come with various interest rates and differing up-front costs. Some fees may he high, but the interest low and vice versa. One kind, called proprietary, is designed for people with extremely high-value homes offered by a few banks and other lending institutions. If you are rich enough to qualify for one of these, you're on your own. In this series, I am concerned only with HECMs because that is the type I am considering.
About 95 percent of all reverse mortgages are HECMs (pronounced HECK um by those in the business), the acronym for Home Equity Conversion Mortgages – administered by the Department of Housing and Urban Development (HUD) and insured by the FHA.
The FHA insurance protects the lender if the sale price of a home (when you move out) does not cover balance of the loan. It also protects you, the borrower, so that if the lending institution that holds your reverse mortgage files for bankruptcy or otherwise stops servicing your loan, your reverse mortgage will not be affected.
HECMs are as safe and secure as traditional mortgages and you should not be afraid of them. There was a time, early in the program, when large lenders with many kinds of financial products could give you a reverse mortgage with one hand and lock you into an inappropriate annuity, for example, with the other. But that is no longer allowed.
Problems today are not with the mortgage lenders, but with how people use the proceeds from the reverse mortgages. We'll talk about this in a future installment.
Benefits of a Reverse Mortgage
These are the five most common reasons people give for taking out reverse mortgages:
- To pay for ongoing medical treatments, prescription drugs or a large, one-time medical bill
- To make home improvements, modify a home for aging needs or pay off a traditional mortgage
- To pay off large, high-interest debts
- To take a long-awaited, lavish, dream vacation
- To supplement Social Security and/or other monthly income
Number four seems a frivolous reason to take on large, expensive debt, but who is to say what is important to each of us.
Number five is my reason. As I explained in Part 1, the financial collapse of 2008 took a huge chunk of my savings and I don't have the stomach now to reinvest what remains, so my income is uncomfortably reduced.
For me, a reverse mortgage will provide a cushion to pay for future medical or other unforeseen needs and therefore return some of the peace of mind I lost in the 2008 crash. It also will give me some breathing room around normal expenses and, maybe, allow for some modest travel now and then which I can't otherwise afford. I don't have expensive needs so mostly, it's that peace of mind I'm going for.
Disadvantages of a Reverse Mortgage
There are good reasons to think very carefully before taking out a reverse mortgage.
If you were planning on leaving your home to the kids or grandchildren, they may not be able to afford to pay off the HECM after you die.
If you live alone and need to stay in a rehab, assisted living or nursing home for more than a year, you are required to pay off the mortgage.
Costs are high. They include all the fees you paid when you purchasedd your home (title search and insurance, FHA appraisal, document preparation, flood certification, credit report, etc.) plus an origination fee to the lender based on the appraisal of your home. The least it can be is $2,500 and there is an upper cap of $6,000. And there is the MIP - mortgage insurance premium - for the FHA mortgage insurance which is two percent of the amount of the reverse mortgage up front and, annually thereafter, one-half of one percent of the loan amount.
Usually, closing costs and fees are tacked onto the mortgage, but keep in mind that you pay interest on that money throughout the life of the loan in addition to the lender's ongoing service fe which is $30 or $35 per month.
Recently, lenders have been offering reverse mortgages with low or no origination fees and lower service fees. I'll look into this and let you know details as this series proceeds.
This is a general overview, the basic information needed to think clearly and rationally about a reverse mortgage. More next week. If I have been unclear, please leave questions in the comments. You can leave other questions too that you would like answered in future installments.
Reverse Mortgage Series
Part 1: One Reason For a Reverse Mortgage
Part 3: Finding a Lender
Part 4: Do Not Fear HECMs
Part 5: The Mandatory Counseling Session
Part 6: The Home Appraisal
Part 7: Lender Conditions
At The Elder Storytelling Place today, D. Sugar: Circa 1980