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Mortgage Basics

Is a Reverse Mortgage Right for You?

A reverse mortgage works by allowing homeowners to use their home as collateral to get a loan. Reverse mortgages are designed for people who own their home outright or have considerable equity in it and want to tap into that equity while staying in the home.

There are, however, some requirements you'll need to meet to qualify for a reverse mortgage, and it's important to know both the benefits and drawbacks before you apply.

What Is a Reverse Mortgage?

A reverse mortgage is self-explanatory in that it does the opposite of a traditional mortgage loan: Instead of borrowing money to buy a house, you can use the equity in your home to secure a loan. In other words, a reverse mortgage can be viewed as one or more advance payments on your home equity.

There are three types of reverse mortgages:

  • Single-purpose reverse mortgage: Offered by some state and local government agencies, as well as some nonprofit organizations, these loans are designed for one purpose only—such as paying for property taxes or home improvements—which is specified by the lender. It is possible to qualify for a single-purpose reverse mortgage with low or moderate income.
  • Proprietary reverse mortgage: Backed by the private lenders that offer them, proprietary reverse mortgages don't have the same limits as government-backed loans, so they may be better for homeowners who have a high property value and are looking for a bigger loan advance. These loans can typically be used for any purpose.
  • Home Equity Conversion Mortgage (HECM): The most common type of reverse mortgage, the HECM is insured by the Federal Housing Administration and can be used for any purpose. However, as of 2019, they are limited to $726,525 and have other requirements that may exclude some homeowners.

A reverse mortgage is primarily designed for retirement-age people who are looking to access funds to cover living expenses but don't want to sell their home to get it.

The money you receive is generally considered tax-free, and you don't have to pay any of it back as long as you remain in the home and pay property taxes, homeowners insurance and overall maintenance of the home.

When you ultimately sell the home, move out or you (and in some circumstances your spouse) die, the loan must be repaid, either by you, your spouse or your estate. If the loan comes due at you or your spouse's death, your heirs may need to sell the home to pay off what your estate owes.

Reverse mortgages typically come with several costs, including a mortgage insurance premium, origination fee, servicing fee and third-party fees. Also, interest will accrue over the life of the loan.

With HECMs, for instance, the initial mortgage premium is 2% of the loan amount, and you'll pay an ongoing 0.5% annually. The origination fee will be the greater of $2,500 or 2% of the first $200,000 of your home's value, plus 1% of the amount over $200,000—there's a maximum of $6,000 total.

How a Reverse Mortgage Is Determined

Your loan amount on a mortgage is determined by a number of factors. Depending on the type of reverse mortgage, some criteria may vary by lender, government agency or nonprofit organization.

For HECMs, those factors include:

  • The age of the youngest borrower or non-borrowing eligible spouse
  • The current market interest rate
  • The value of the home
  • The current HECM FHA mortgage limit

With an HECM, you can receive your loan money in several ways, including:

  • A lump-sum disbursement (the only option if you want a fixed interest rate)
  • Fixed monthly payments for a set period
  • Fixed monthly payments for as long as you live in the home
  • A line of credit you can draw upon at any time until you've used it up
  • A combination of monthly payments and a credit line

Choosing the right payment option for your situation can be tough. For example, the lump-sum disbursement gives you more upfront but less overall than the other options. Also, you'll likely receive more money getting payments for a set period over the lifetime option because the latter is riskier for the lender.

In some cases, however, you may be able to switch your method of payment after the fact for a fee. If you're worried about making the wrong choice, check with your lender to find out your options.

Who Can Qualify for a Reverse Mortgage?

Eligibility criteria for single-purpose and proprietary reverse mortgages vary by lender, but if you're looking for an HECM, the requirements are clear:

  • All borrowers must be 62 or older
  • You must own the property outright or have a considerable amount of equity in it
  • The home must be your primary residence
  • You can't be delinquent on any federal debt
  • You have the financial resources to pay ongoing property taxes, homeowners insurance, HOA fees and other necessary expenses
  • You must visit with an HECM counselor approved by the U.S. Department of Housing and Urban Development (HUD)
  • You must be creditworthy and meet other financial requirements
  • The property meets all FHA standards and flood requirements

Also, the property must be a single-family home, a two- to four-unit home with one unit occupied by you, an HUD-approved condominium project, or a manufactured home that meets FHA requirements.

If one spouse is not yet 62 years old, they can't be included as a borrower on the loan. However, they may still be eligible to stay in the home after the borrowing spouse dies without further payments. Also, there is an option to refinance a reverse mortgage after the non-borrowing spouse turns 62 to ensure ongoing payments after the older spouse dies.

When a Reverse Mortgage Is a Good Option

For homeowners who qualify, there are a few situations where a reverse mortgage might be worth considering.

  • It can help solve financial problems. Even if you don't have a mortgage payment, retirement can be expensive. Average health care expenses alone for a retired couple amount to $285,000, according to Fidelity Investments, and that's not including long-term care. Through a lump-sum payment or ongoing monthly payments, a reverse mortgage can provide retired homeowners with some extra cash flow to help stay afloat financially.
  • You can't afford a monthly payment. Another way to gain access to your home's equity is through a home equity loan or line of credit. If you need cash but can't afford a monthly payment, however, those may not be good options.

On the flip side, a reverse mortgage won't require you to make monthly payments on the debt you've incurred. You will, however, still be required to pay your property taxes, your homeowners insurance premiums and any other ongoing expense the lender requires.

  • You're not looking to maximize the value of your estate. If you and your spouse—if they're also a borrower or an eligible non-borrowing spouse—die, payment on the loan will come due, and your estate will need to settle the amount owed. This often means that your loved ones will need to sell the home to pay off the loan, leaving them without that amount as part of their inheritance. If that's something you want to avoid, a reverse mortgage may not be for you. But if providing a large inheritance isn't in your game plan, a reverse mortgage is worth considering.

When It Might Not Be a Good Idea

While there are some clear situations where it's worth thinking about a reverse mortgage, in some circumstances it won't make sense at all.

  • You're planning to move relatively soon. If you're not planning to stay in your home for the long term, it may not make sense to get a reverse mortgage because the loan will come due as soon as you move out. Depending on how you've used the money you've received so far, it could be difficult to pay it back. As such, reverse mortgages are best for homeowners who plan to stay in the house for a long time.
  • You can't afford upfront and ongoing costs. If you're struggling to get by financially, paying high closing costs and the ongoing expenses of maintaining the property and paying taxes and insurance may be too much. If the lender notices that you're falling behind, it could require you to pay back the loan immediately.
  • You want to leave the home to your children. If you want your heirs to take over your home after you die, either to live there or to sell it and take the profit, a reverse mortgage will make that difficult to manage. That's especially the case if your estate doesn't have enough assets from other sources to pay back the loan and your children are forced to sell it to pay the debt.

How Credit History Affects a Reverse Mortgage

There is no minimum credit score requirement for a reverse mortgage, primarily because the main thing lenders want to know is whether you can handle the ongoing expenses required to maintain the house.

Lenders will, however, look to see if you're delinquent on any federal debt. Also, if your credit history shows that you have a habit of not making payments or defaulting on debt, you may be required to set up what's called a Life Expectancy Set Aside (LESA).

A LESA is essentially an account where you set aside a certain amount to cover property taxes and insurance costs, which the lender can use if you stop paying them. How much you'll need to deposit into a LESA is based on your credit and income, monthly property tax and insurance costs, and the life expectancy of the youngest borrower.

Before you start the application process for a reverse mortgage, get a copy of your credit report and score and look for anything that might make it difficult to get approved without a LESA. Address those issues, if possible. If you can't, look at your assets to determine whether you can afford a LESA or if you're better off looking into other alternatives.

Avoid Making a Rash Decision About Your Home

Your house may be one of the most valuable assets you own. So while there are many appealing features of a reverse mortgage, it's crucial that you take a considerable amount of time to determine whether it's the best option for you.

Because your heirs will be affected, it may also be worth talking with them about it, keeping in mind that you'll ultimately make the final decision on the matter.

And whether or not you're planning to get an HECM, consider working with an HECM counselor to make sure you understand all of the effects a reverse mortgage can have on you based on your situation.

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