CONSIDERING A REVERSE MORTGAGE?
FREQUENTLY ASKED QUESTIONS
The FHA-insured Home Equity Conversion Mortgage, or HECM, was signed into law on February 5, 1988, by President Ronald Reagan as part of the Housing and Community Development Act of 1987.
WHAT IS A REVERSE MORTGAGE?
A reverse mortgage (also called a Home Equity Conversion Mortgage or HECM) is a mortgage loan secured over a residential property that enables the borrower to access the unencumbered value of the property. These loans are typically suited to older homeowners and typically do not require monthly mortgage payments.
Reverse mortgages allow elders to access the home equity they have built up in their homes now, and defer payment of the loan until they die, sell, or move out of the home. Because there are no required mortgage payments on a reverse mortgage, the interest is added to the loan balance each month. The rising loan balance can eventually grow to exceed the value of the home, particularly in times of declining home values or if the borrower continues to live in the home for many years; However, the borrower (or the borrower's estate) is generally not required to repay any additional loan balance in excess of the value of the home.
In a 2010 survey of elderly Americans, 48% of respondents cited financial difficulties as the primary reason for obtaining a reverse mortgage and 81% stated a desire to remain in their current homes until death.
To qualify for the HECM reverse mortgage in the United States, borrowers generally must be at least 62 years of age and the home must be their primary residence (second homes and investment properties do not qualify). The HECM reverse mortgage follows the standard FHA eligibility requirements for property type, meaning most 1–4 family dwellings, FHA approved condominiums, and PUDs qualify. Manufactured homes also qualify as long as they meet FHA standards.
On April 25th 2014, FHA revised the HECM age eligibility requirements to extend certain protections to spouses younger than age 62. Under the old guidelines, the reverse mortgage could only be written for the spouse who was 62 or older. If the older spouse died, the reverse mortgage balance became due and payable if the younger surviving spouse was left off of the HECM loan. If this younger spouse was unable to pay off or refinance the reverse mortgage balance, he or she was forced either to sell the home or lose it to foreclosure. This often created a significant hardship for spouses of deceased HECM mortgagors, so FHA revised the eligibility requirements in Mortgagee Letter 2014-07. Under the new guidelines, spouses who are younger than age 62 at the time of origination retain the protections offered by the HECM program if the older spouse who got the mortgage dies. This means that the surviving spouse can remain living in the home without having to repay the reverse mortgage balance as long as he or she keeps up with property taxes and homeowner's insurance and maintains the home to a reasonable level.
Before starting the loan process for an FHA/HUD-approved reverse mortgage, applicants must take an approved counseling course. An approved counselor should help explain how reverse mortgages work, the financial and tax implications of taking out a reverse mortgage, payment options, and costs associated with a reverse mortgage.
PROPERTY TAXES, INSURANCE & MAINTENANCE
Though HECM borrowers are not required to make monthly mortgage payments, borrowers are still responsible for property taxes and homeowner's insurance. FHA wants to make sure borrwers have the financial ability and willingness to keep up with property taxes and homeowner's insurance (and any other applicable property charges). Financial assessment involves evaluating two main areas:
Residual Income - Borrowers must have a certain amount of residual income left over after covering monthly expenses.
Satisfactory Credit - All housing and installment debt payments must have been made on time in the last 12 months and there are no more than two 30-day late mortgage or installment payments in the previous 24 months. There is no major derogatory credit on revolving accounts in the last 12 months.
INCOME & CREDIT RESTRICTIONS
If residual income or credit does not meet FHA guidelines, the lender can possibly make up for it by documenting extenuating circumstances that led to the financial hardship. If no extenuating circumstances can be documented, the borrower may not qualify at all or the lender may require a large amount of the principal limit (if available) to be carved out into a Life Expectancy Set Aside (LESA) for the payment of property charges (property taxes, homeowners insurance, etc.).
AMOUNT OF PROCEEDS AVAILABLE
The total pool of money that a borrower can receive from a HECM reverse mortgage is called the principal limit (PL), which is calculated based on the maximum claim amount (MCA), the age of the youngest borrower, the expected interest rate (EIR), and a table to PL factors published by HUD. Similar to loan-to-value (LTV) in the forward mortgage world, the principal limit is essentially the percentage of the value of the home that can be lent under the FHA HECM guidelines. Most PLs are typically in the range of 50% to 60% of the MCA, but they can sometimes be higher or lower.
The money from a reverse mortgage can be distributed in four ways, based on the borrower's financial needs and goals:
Lump sum in cash at settlement
Monthly payment (loan advance) for a set number of years (term) or life (tenure)
Line of credit (similar to a home equity line of credit)
Some combination of the above
*Note that the adjustable-rate HECM offers all of the above payment options, but the fixed-rate HECM only offers lump sum.
The line of credit option accrues growth, meaning that whatever is available and unused on the line of credit will automatically grow larger at a compounding rate. This means that borrowers who opt for a HECM line of credit can potentially gain access to more cash over time than what they initially qualified for at origination. The line of credit growth rate is determined by adding 1.25% to the initial interest rate (IIR), which means the line of credit will grow faster if the interest rate on the loan increases.
On September 3rd 2013 HUD implemented Mortgagee Letter 2013-27, which made significant changes to the amount of proceeds that can be distributed within the first year of the loan. Because many borrowers were taking full draw lump sums (often at the encouragement of lenders) at closing and burning through the money quickly, HUD sought to protect borrowers and the viability of the HECM program by limiting the amount of proceeds that can be accessed within the first 12 months of the loan.
If the total mandatory obligations (which includes existing mortgage balances, all closing costs, delinquent federal debts, and purchase transaction costs) to be paid by the reverse mortgage are less than 60% of the principal limit, then the borrower can draw additional proceeds up to 60% of the principal limit in the first 12 months. Any remaining available proceeds can be accessed after 12 months.
If the total mandatory obligations exceed 60% of the principal limit, then the borrower can draw an additional 10% of the principal limit if available.
ARE REVERSE MORTGAGE PROCEEDS TAXABLE?
The money received from a reverse mortgage is considered a loan advance. It therefore is not taxable and does not directly affect Social Security or Medicare benefits. However, an American Bar Association guide to reverse mortgages explains that if borrowers 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 total liquid assets (cash, generally) is then greater than those programs allow.
WHEN THE LOAN COMES DUE
The HECM reverse mortgage is not due and payable until the last borrower (or non-borrowing spouse) dies, sells the house, or fails to live in the home for a period greater than 12 months. The loan may also become due and payable if the borrower fails to pay property taxes, homeowners insurance, lets the condition of the home significantly deteriorate, or transfers the title of the property to a non-borrower (excluding trusts that meet HUD's requirements).
Once the mortgage comes due, borrowers or heirs of the estate have several options to settle up the loan balance:
Pay off or refinance the existing balance to keep the home.
Sell the home themselves to settle up the loan balance (and keep the remaining equity).
Allow the lender to sell the home (and the remaining equity is distributed to the borrowers or heirs).
The HECM reverse mortgage is a non-recourse loan, which means that the only asset that can be claimed to repay the loan is the home itself. If there's not enough value in the home to settle up the loan balance, the FHA mortgage insurance fund covers the difference.
HECM for PURCHASES
The Housing and Economic Recovery Act of 2008 provided HECM mortgagors with the opportunity to purchase a new principal residence with HECM loan proceeds — the so-called HECM for Purchase program, effective January 2009.
The "HECM for Purchase" applies if "the borrower is able to pay the difference between the HECM and the sales price and closing costs for the property. The program was designed to allow the elderly to purchase a new principal residence and obtain a reverse mortgage within a single transaction by eliminating the need for a second closing.
The following are the most typical closing costs paid at closing to obtain a reverse mortgage:
Counseling fee: The first step to get a reverse mortgage is to go through a counseling session with a HUD-approved counselor. The average cost of the counseling session is usually around $125, but counselors often don't charge at all.
Origination fee: This is charged by the lender to arrange the reverse mortgage. Origination fees can vary widely from lender to lender and can range from nothing to several thousand dollars.
Third-party fees: These fees are for third-party services hired to complete the reverse mortgage, such as appraisal, title insurance, escrow, government recording, tax stamps (where applicable), credit reports, etc.
Initial mortgage insurance premium (IMIP): This is a one-time cost paid at closing to FHA to insure the reverse mortgage and protect both lenders and borrowers. The IMIP protects lenders by making them whole if the home sells at the time of loan repayment for less than what is owed on the reverse mortgage. This protects borrowers as well because it means they will never have to pay out of other assets to settle up the reverse mortgage if they owe more than the home is worth. How the IMIP is calculated was changed in late 2013 with Mortgage Letter 2013-27. The IMIP is now charged as either 0.50% or 2.50% of the max claim amount (which usually equals the appraised value of the home up to a maximum of $625,500), depending on how much of the principal limit is utilized within the first 12 months of the loan. If the utilization is under 60% of the principal limit, the lower rate applies. If it's above that amount, then the higher rate applies.
The vast majority of closing costs typically can be rolled into the new loan amount (except in the case of HECM for purchase, where they're included in the down payment), so they don't need to be paid out of pocket by the borrower. The only exceptions to this rule may be the counseling fee, appraisal, and any repairs that may need to be done to the home to make it fully compliant with the FHA guidelines before completing the reverse mortgage.
Lenders disclose estimated closing costs using several standardized documents, including the Reverse Mortgage Comparison, Loan Amortization, Total Annual Loan Cost (TALC), Closing Cost Worksheet, and the Good Faith Estimate (GFE). These documents can be used to compare loan offers from different lenders.
There are two ongoing costs that may apply to a reverse mortgage: annual mortgage insurance and servicing fees. Like IMIP, annual mortgage insurance is charged by FHA to insure the loan and accrues annually at a rate of 1.25% of the loan balance. Annual mortgage insurance does not need to be paid out of pocket by the borrower; it can be allowed to accrue onto the loan balance over time.
Servicing fees are less common today than in the past, but some lenders may still charge them to cover the cost of servicing the reverse mortgage over time. Servicing fees, if charged, are usually around $30 per month and can be allowed to accrue onto the loan balance (they don't need to be paid out of pocket).
TAXES & INSURANCE
Unlike traditional forward mortgages, there are no escrow accounts in the reverse mortgage world. Property taxes and homeowners insurance are paid by the homeowner on their own, which is a requirement of the HECM program (along with the payment of other property charges such as HOA dues).
LIFE EXPECTANCY SET ASIDE (LESA)
If a reverse mortgage applicant fails to meet the satisfactory credit or residual income standards required under the new financial assessment guidelines implemented by FHA on March 2, 2015, the lender may require a Life Expectancy Set Aside, or LESA. A LESA carves out a portion of the reverse mortgage benefit amount for the payment of property taxes and insurance for the borrower's expected remaining life span. FHA implemented the LESA to reduce defaults based on the nonpayment of property taxes and insurance.
WHAT IS THE INTEREST RATE?
Your interest rate depends on a culmination of a few factors:
Whether you are planning on getting a HECM reverse mortgage or a HECM for Purchase
Your home’s value
Your property zip code
Any existing mortgage balance or liens
Number of expected years in the house
Your life expectancy
The disbursement option chosen
Fixed Interest Rates:
Fixed interest rates are usually decided upon by investors and various government agencies whose job it is to keep these rates stable. Actual rates available to borrowers will vary and are dependent on loan factors.
Variable Interest Rates:
Variable rates are different from fixed rates in that they are composed of two parts: an Index and a Margin.
Index – An index is a standard rate that changes depending on market interest rates. It is not controlled by the lender. The rate charged on your loan can go up or down depending on if the index goes up or down.
The LIBOR Index (London Interbank Offered Rate) is the rate at which banks borrow money from other banks, and this is the index that variable rate loans are based off of.
Currently, all HECM reverse mortgage variable rates are LIBOR based. The 1-month and 1-year LIBOR rates are most commonly used.
Margin - The margin is the interest percentage that is added to the index by the lender. The margin rate is not adjustable, meaning that after loan origination, the margin stays the same throughout the loan term, regardless of what the index may change to.
Fixed Rate Reverse Mortgage Loan
Fixed rates have come to be a favorite in the HECM marketplace since 2009, with about 67% of originated reverse mortgage loans having a fixed rate. They are popular with borrowers because they eliminate the risk that their rate will increase. But, this does not necessarily mean that it is the best loan type for you. There are pros and cons to a fixed rate loan:
Fixed rates are certain to remain the same for the entire loan term, so you are protected if market rates rise.
Borrowers who choose a fixed rate reverse mortgage must take their funds as a lump sum, as opposed to other disbursement options offered at a variable rate.
When taking a lump sum, borrowers are restricted to pull only up to 58% of the principal limit of the loan.
Due to these details, fixed rate reverse mortgages are usually best for borrowers who plan to use their reverse mortgage funds all at once, such as to pay off an existing mortgage or other debt, or to make major home repairs or modifications.
Variable Rate Reverse Mortgages
The less popular, but oftentimes the more flexible option, is the variable rate. Just as the fixed rate is “fixed” for the loan period, a variable rate varies throughout the loan period, and may adjust annually. There are pros and cons to variable rate reverse mortgages:
They come with more disbursement options then a fixed rate loan. Borrowers may choose between a line of credit, monthly payments, a lump sum, or a combination of the three.
Interest is only charged on funds that have been withdrawn. This means that, if you have a line of credit that you rarely use, you will only be charged interest on the amount withdrawn.
Unused lines of credit may also grow with time, allowing the borrower even more flexibility in the amount available for them to borrow.
Greater risk of your interest rate rising quickly and drastically.
In general, variable rates are best for borrowers who plan to use their reverse mortgage funds over time, or in rare instances. In this way, borrowers may use it to add to their existing fixed income every month, to supplement their other retirement accounts, or as a stand by account so money is readily available in the case of an emergency.