First, I want to make it clear that by including a section on Reverse Mortgages, I am not necessarily recommending them
nor advocating that they be a part of a well-balanced investment portfolio. My purpose is to present them in an accurate
and unbiased manner, explaining how they work and their advantages and pitfalls.
I’ll leave the decision to you
as to whether a reverse mortgage has a place within your retirement financial plan. However, one point that I will make
is that like any loan, a reverse mortgage has significant associated costs and should only be considered when it is absolutely
required to enable you to meet your financial obligations. It will reduce the overall value of your estate and consequently
the assets that can be passed on to your heirs.
Despite these concerns (and others mentioned later), the volume of reverse
mortgages being sold is significant (over 70,000 per year), and it is expected to grow as the U.S. population ages. The
U.S. senior population is expected to increase from 35 million in 2000 to 64 million in 2025, and seniors are expected to
make up a larger share of the population.
Reverse Mortgage Defined
A reverse mortgage is a product that allows you to convert part of the equity in your home into cash without having to
sell your home.
Like a regular mortgage, a reverse mortgage offsets some of the equity assets of your home with a liability
obligation. This liability manifests itself as a lien against your property. The major difference between the
two mortgages is that in a regular mortgage, you make monthly payments to the lender; whereas, in a reverse mortgage, the
lender makes payments to you.
After each payment in a conventional mortgage, the equity increases by the amount of the
principal included in the payment, and when the mortgage has been paid in full, the property is released from the mortgage.
In a reverse mortgage, the mortgage balance increases as money is paid out and interest is charged. The lender
gets the money to pay you from your home’s equity – your equity will continue to decrease as the reverse mortgage’s
Types of Reverse Mortgages
There are three types of reverse mortgages:
- Single-purpose, offered
by some state and local government agencies and nonprofit organizations;
- Federally-insured, known as Home Equity
Conversion Mortgages (HECMs) and backed by the U. S. Department of Housing and Urban Development (HUD)
private loans that are backed by the companies that develop them.
Single-purpose reverse mortgages are the least expensive option. They are not available everywhere and can be used
for only one purpose, which is specified by the government or nonprofit lender. For example, the lender might stipulate
that the loan is to be used only to pay for home repairs, improvements, or property taxes. Most homeowners with low
or moderate income can qualify for these loans.
HECMs and proprietary reverse mortgages are generally more expensive
than traditional home loans, and the upfront costs can be high. However, HECMs alone account for 90% of all reverse
mortgages originated in the U.S. HECM loans are widely available, have no income or medical requirements, and can be
used for any purpose.
Obtaining a Reverse Mortgage (Eligibility)
To obtain a reverse mortgage, you must:
Be at least 62 years of age,
Live in and own
your home (it must be your principal residence),
Have sufficient equity in the home to pay off any existing
mortgage with the reverse mortgage,
Obtain court approval for the reverse mortgage prior to closing if
you have a current or pending bankruptcy, and
For an HECM (and some proprietary reverse mortgages), receive
a certificate of completion from an approved counseling course.
Qualification is based on the youngest borrower on title. Principal residence means that you must reside at the property
for six months and one day per year.
The counseling is meant to serve as a safeguard to ensure that you completely understand
the reverse mortgage. The counselor is required to explain the loan’s costs and financial implications, and possible
alternatives to an HECM. The counseling fee (around $125) can be paid from the loan proceeds, but you cannot be turned
away if you can’t afford the fee.
There are no minimum income or credit requirements because no payments are required
on the mortgage. A credit report will only be used to check any federal tax liens or other items that may affect qualification.
If you have a mortgage already, a reverse mortgage will first pay off your existing mortgage and then give you the remaining
proceeds. In fact, many borrowers use a reverse mortgage for that purpose – to eliminate monthly payments on their
If a property has increased in value after a reverse mortgage is taken out, it is possible in
some areas to acquire a second reverse mortgage for the increased equity in the home. Also, a reverse mortgage may be
refinanced if enough equity is present in the home, and in some cases may qualify for a streamline refinance if the interest
rate is reduced.
Reverse mortgages follow FHA standards for property types, meaning most 1–2 family dwellings,
FHA approved condominiums and PUD's will qualify. Manufactured housing qualifies based on standard FHA guidelines.
How much you can borrow with a HECM or proprietary reverse mortgage depends on several factors, including:
age of the youngest borrower on the title (the older the owner, the more money that will be received);
- The type of
reverse mortgage you select (whether the payment is taken as a line of credit, lump sum, or monthly payments);
appraised value of your home (this includes any health or safety repairs that need to be made, plus the value of any existing
liens on the house);
- The principal amount of any existing mortgage(s) on the home;
- The maximum lending limit
(which varies by county, but may not exceed $625,500); and
- Current interest rates (as determined by the U.S. Treasury
1 year T-Bill, the LIBOR index or 1 Year CMT).
LIBOR is the London Interbank Offered Rate. It's similar to the fed funds rate, in that it represents the rate at
which banks are willing to loan each other reserves. It's an international standard for interest rates, often used as
an index for resetting the rates of adjustable rate loans.
The CMT (Constant Maturity Treasury) index is an average
yield on U.S. Treasury securities adjusted to a constant maturity of 1 year, as made available by the Federal Reserve Board.
All of the above factors contribute to the Total
Annual Lending Cost (TALC) – the single rate, including all the loan costs, as defined by the US Federal Government
in Regulation Z. The specific formulas to calculate the impact of the factors listed above can be found in Appendix
22 of the HUD Handbook 4235.1.
Reverse mortgages for homes valued over the maximum limit ($625,500) are called "Jumbo"
reverse mortgages and are generally offered as proprietary reverse mortgages. For owners of higher-valued homes, a Jumbo
loan can provide a larger loan amount; however, these loans are currently uninsured by the FHA, and their fees are often higher.
Costs & Interest Rates
. Exact loan origination costs depend on the particular reverse mortgage program the borrower
acquires. The HECM will have the following costs:
- Mortgage Insurance Premium (MIP)
= 2% of the appraised value;
- Origination fee, depending on the home's appraised value
value under $125,000 = $2,500
- Appraised value over $125,000 = 2% of the first $200,000 plus 1% of the value over $200,000,
with a $6,000 cap
- Title insurance = varies by location
- Title, attorney, and county recording fees
= varies by location
- Real estate appraisal = $300–$500
- Survey (may be required) = $300–$500
Except for the real estate appraisal, the origination costs of a reverse mortgage can be financed with the proceeds of the
loan itself. The cost of getting a reverse mortgage from a private sector lender may exceed the costs of other types
of mortgage or equity conversion loans.
Ongoing Costs. In addition, there are costs during the life of the reverse mortgage:
charges (between $25 and $35), which are usually added monthly to the balance of the loan;
- Annual Mortgage Insurance
Premium, which is levied every year, equal to 1.25% of the mortgage balance (note that this is in addition to the MIP paid
at settlement); and
- Monthly interest charges, that are based on the particular reverse mortgage program.
Prior to 2007, all major reverse mortgage programs had adjustable interest rates. Adjustable rate reverse mortgages
are still being offered in programs that are adjusted on a monthly, semi-annual, or annual basis up to a maximum rate. Several
lenders now offer FHA HECM reverse mortgages that have fixed interest rates, but these typically limit the amount of the loan.
Because you retain title to your home, you are responsible for property taxes, insurance, utilities, fuel, basic home maintenance,
and other expenses during the loan period. Unlike common practice in standard mortgages, funds for taxes and insurance
are not paid out of an escrow fund; they are paid directly by the homeowner. A lapse in either taxes or insurance could
result in a default on the reverse mortgage.