Reverse mortgage

A reverse mortgage is a form of equity release (or lifetime mortgage). It is a loan available to home owners or home buyers, enabling them to access a portion of the subject home's equity. The home owners can draw the mortgage principal in a lump sum, by receiving monthly payments over a specified term or over their (joint) lifetimes, as a revolving line of credit, or some combination thereof.

In a conventional mortgage the homeowner makes a monthly amortized payment to the lender; after each payment 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 home owner is under no obligation to make payments, but is free to do so with no pre-payment penalties. The line of credit portion operates like a revolving credit line, so a payment in reduction of a line of credit increases the available credit by the same amount. Interest that accrues is added to the mortgage balance.

Title to the property remains in the name of the homeowners, to be disposed of as they wish, encumbered only by the amount owing under the mortgage.

If a property has increased in value after a reverse mortgage is taken out, it is possible to acquire a second (or third) reverse mortgage over the increased equity in the home in some areas. However most lenders do not like to take a second or third lien position behind a reverse mortgage because its balance increases with time. It is rare to find reverse mortgages with subordinate liens behind them as a result. 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.

A reverse mortgage lien is often recorded at a higher dollar amount than the amount of money actually disbursed at the loan closing. This recorded lien is at times misunderstood by some borrowers as being the payoff amount of the mortgage. The recorded lien works in similar fashion to a home equity line of credit where the lien represents the maximum lending limit, but the payoff is calculated based on actual disbursements plus interest owing.

Reverse mortgages in Australia

Eligibility

Reverse mortgages are available in Australia. However, there is little regulation: the Financial Services Reform Act does not regulate the loans, and although potential borrowers should seek financial advice before applying for a reverse mortgage, there is no legislation that requires the advisor to be licensed.

Eligibility requirements vary by lender. To qualify for a reverse mortgage in Australia,

• the borrower must be over a certain age, usually 60 or 65 years of age; if the mortgage has more than one borrower, the youngest borrower must meet the age requirement
• the borrower must own the property, or the existing mortgage balance must be low enough that it will be paid off with the reverse mortgage proceeds

Loan size and cost

Reverse mortgages in Australia can be as high as 50% of the property's value. The exact amount of money available (loan size) is determined by several factors:

• the borrower's age, with a higher amount available at a higher age
• current interest rates
• property value
• the property's location
• program minimum and maximum; for example, the loan might be constrained to a minimum of $10,000 and a maximum of 425,000

The cost of getting a reverse mortgage depends on the particular reverse mortgage program the borrower acquires. These costs are frequently rolled into the loan itself and therefore compound with the principal. Typical costs for the reverse mortgage include:

• an application fee (establishment fee) = $950
• stamp duty, mortgage registration fees, and other government charges = vary with location

The interest rate on the reverse mortgage varies. Some programs offer fixed rate loans, while others offer variable rate loans.

In addition, there are costs during the life of the reverse mortgage. A monthly service charge may be applied to the balance of the loan (for example, $12 per month), which then compounds with the principal.

Proceeds from a reverse mortgage

The money from a reverse mortgage can be distributed in several different ways:

• as a lump sum, in cash, at settlement
• as an annuity, with a cash payment at regular intervals
• as a line of credit, similar to a home equity line of credit
• as a combination of these.

Taxes and insurance

The borrower remains entirely responsible for the property. This includes physical maintenance. In addition, some programs require that the property is periodically revalued.

Income from a reverse mortgage set up as an annuity or as a line of credit should not affect Government Income Support entitlements. However, income from a reverse mortgage set up as a lump sum could be considered a financial investment and thus deemed under the Income Test; this category includes all sums over $40,000 and sums under $40,000 that are not spent within 90 days.

When the loan comes due

The reverse mortgage comes due – the loan plus interest must be repaid – when the borrower dies, sells the property, moves out of the house, or breaches the contract in some way.

Prepayment of the loan – when the borrower pays the loan back before it reaches term – may incur penalties, depending on the program. An additional fee could also be imposed in the event of a redraw.

"Some providers offer a ‘no negative equity guarantee’. This means that if the balance of the loan exceeds the proceeds of sale of the property, no claim for this excess will be made against the estate or other beneficiaries of the borrower."

Reverse mortgages in Canada

Eligibility

Reverse mortgages are available through private corporations in Canada, although none of the programs is insured by the government. Examples include:

• the Canadian Home Income Plan (CHIP) provided by HomEquity Bank, a plan that started in 1986 and is the largest program in Canada
• the Fixed Term Reverse Annuity Mortgage through Royal Bank of Canada (RBC Royal Bank)
• Home Income Plan (Canadian Reverse Mortgage) from Origin Mortgages DLC

Eligibility requirements vary some by lender. To qualify for a reverse mortgage in Canada,

• the borrower (or both borrowers if married) must be over a certain age, usually at least 55 or 62 years of age
• the borrower must own the property "entirely or nearly"; in addition, "any outstanding loans secured by your home must be retired with the proceeds" of the reverse mortgage
• there is no qualification requirement for minimum income level.

Loan size and cost

Reverse mortgages in Canada are usually a maximum of 25 to 50% of the property's value. The exact amount of money available (loan size) is determined by several factors:

• the borrower's age, with higher payments for higher age
• current interest rates
• property value, including location and a factor for future appreciation
• program minimum and maximum; for example, the loan might be constrained to a minimum $20,000 and a maximum of $750,000

The interest rate on the reverse mortgage varies by program. The length of loan also varies, with some programs offering no fixed term and some offering fixed terms ranging from 6 months to 5 years.

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. Exact costs depend on the particular reverse mortgage program the borrower acquires. Depending on the program, there may be the following types of costs:

• Real estate appraisal = $175–$400
• Legal advice = $400–$600
• Other legal, closing, and administrative costs = $1,495

Proceeds from a reverse mortgage

The money from a reverse mortgage can be distributed in several different ways:

• as a lump sum, in cash, at settlement
• as an annuity, with a monthly cash payment
• as a line of credit, similar to a home equity line of credit
• as a combination, with a smaller lump some at settlement and then a smaller annuity.

Once the reverse mortgage is established, there are no restrictions on how the funds are used. "The money from the reverse mortgage can be used for any purpose: to repair a home, to pay for in-home care, to deal with an emergency, or simply to cover day-to-day expenses."

The borrower retains title to the property, including unused equity, and will never be forced to vacate the house.

Taxes and insurance

The borrower remains entirely responsible for the property. This includes physical maintenance and payment of all taxes, fire insurance and condominium or maintenance fees.

Money received in a reverse mortgage is an advance and is not taxable income. It therefore does not affect government benefits from Old Age Security (OAS) or Guaranteed Income Supplement (GIS). In addition, if reverse mortgage advances are used to purchase non-registered investments – such as Guaranteed Investment Certificates (GICs) and mutual funds – then interest charges for the reverse mortgage may be deductible from investment income earned.

When the loan comes due

The reverse mortgage comes due – the loan plus interest must be repaid – when the borrower dies, sells the property, or moves out of the house. Depending on the program, the reverse mortgage may be transferable to a different property if the owner moves. Prepayment of the loan – when the borrower pays the loan back before it reaches term – may incur penalties, depending on the program. In addition, if interest rates have dropped since the reverse mortgage was signed, the mortgage terms may include an "'interest-rate differential' penalty."

If the borrower lived long enough that the principal and interest together exceed the fair market value when the mortgage is due, the borrower or heirs do not have to pay more than the house's value at the time.

Reverse mortgages in the United States

Eligibility

To qualify for a reverse mortgage in the United States, the borrower must be at least 62 years of age and must occupy the property as their principal residence. In addition, any mortgage on the property must be low enough that it will be paid off with the reverse mortgage proceeds. There are no minimum income or credit requirements because no payments are required on the mortgage. The proceeds from the loan may be used at the discretion of the borrower and are not subject to income tax payment. While credit is not part of the qualification process a current or pending bankruptcy will require court approval prior to closing. 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.

Before starting the loan process for an FHA/HUD reverse mortgage, applicants must take an approved counseling course. This counseling is available at no or low cost. The counseling is meant to serve as a safeguard for the borrowers, to ensure they completely understand the reverse mortgage. The counselor will explain the legal and financial obligations of a reverse mortgage. The borrower will receive a certificate of completion that is required before the loan application can be processed.

Loan size

The maximum lending limit varies by county, but may not exceed $625,500.00. Reverse mortgages for homes valued over the maximum limit 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.

The amount of money available (the loan size) is determined by the borrower's age, the lesser of the value of the home or county lending limit, and the interest rate of the program the senior selects. The primary factors are:

• The appraised value of the property; this includes any health or safety repairs that need to be made, plus the value of any existing liens on the house.
• The interest rate, as determined by the U.S. Treasury 1 year T-Bill, the LIBOR index or 1 Year CMT.
• The age of the senior; the older the owner is, the more money will be received
• Whether the payment is taken as a line of credit, lump sum, or monthly payments; see below more more discussion of the options.

All these 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.

Costs and interest rates

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. Exact costs depend on the particular reverse mortgage program the borrower acquires. For the most popular type of reverse mortgage in the U.S., the FHA-insured Home Equity Conversion Mortgage (HECM), there will be the following types of costs:

• Mortgage Insurance Premium (MIP) = 2% of the appraised value
• Origination fee, depending on the home's appraised value
  • appraised 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

In all of these cases, except the real estate appraisal, the costs of a reverse mortgage can be financed with the proceeds of the loan itself.

In addition, there are costs during the life of the reverse mortgage. A monthly service charge (between $25 and $35) is usually added monthly to the balance of the loan. An annual Mortgage Insurance Premium is levied every year, equal to 1.25% of the mortgage balance – note that this is in addition to the MIP paid at settlement.

Interest rates on reverse mortgages are determined on a program-by-program basis. Because the loans are secured by the home itself, and backed by HUD, the interest rate should always be below any other available interest rate in the standard mortgage marketplace for an FHA reverse mortgage.^{[citation needed]} Prior to 2007, all major reverse mortgage programs had adjustable interest rates. Such adjustable rate reverse mortgages are still being offered, in programs that are adjusted on a monthly, semi-annual, or annual rate up to a maximum rate. Several lenders now offer FHA HECM reverse mortgages that have fixed interest rates. Some fixed rate reverse mortgages limit the cash proceeds to half of that offered by adjustable rate reverse mortgages. The borrower(s) will be required to take out the entire amount offered at closing.

Some state and local governments offer low-cost reverse mortgages to seniors. These "public sector" loans generally must be used for specific purposes, such as paying for home repairs or property taxes, but most of them often have more favorable interest rates and fewer or no fees associated with them. 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.

Proceeds from a reverse mortgage

Cash from a reverse mortgage

The most common reverse mortgage is one in which the owner receives cash or a credit line from an existing home. The money from a reverse mortgage can be distributed in several different ways:

• in a lump sum, in cash, at settlement; this provides the cash immediately, but the interest fees are the highest
• as a cash payment (cash advance) every month, applied for a fixed term or for the owner's life; monthly payments may be set up by HUD
• as a line of credit, similar to a home equity line of credit; this maximizes the money available, which can be withdrawn only as needed
• some combination of the above, as selected by the borrower.

Once the reverse mortgage is established, there are no restrictions on how the funds are used. The borrower can move money into investments or spend it as they wish. If a borrower wishes interest-bearing instruments, the money can be kept with the lender (in which case the account grows by the same percentage as the interest rate of the loan), the funds can be moved to a directed account with a financial specialist (an option that is risky unless the borrower directs the specialist's investment options), or the money can be invested and managed by the borrower.^{[citation needed]}

Purchase of a new residence with "HECM for Purchase"

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 seniors to purchase a new principal residence and obtain a reverse mortgage within a single transaction by eliminating the need for a second closing. The program was also designed to enable senior homeowners to relocate to other geographical areas to be closer to family members or downsize to homes that meet their physical needs (i.e., handrails, one-level properties, ramps, wider doorways, etc.). Texas is the only state that does not allow for reverse mortgages for purchase.

Taxes and insurance

It is important to note that the homeowner must ensure that taxes and insurance are kept current at all times. Unlike common practice in a standard mortgage, 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.

The American Bar Association guide advises that generally,

• The Internal Revenue Service does not consider loan advances to be income
• Annuity advances may be partially taxable
• Interest charged is not deductible until it is actually paid, that is, at the end of the loan.
• The mortgage insurance premium is deductible on the 1040 long form.

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 loan comes due when the borrower dies, sells the house, fails to keep the taxes or insurance current, or moves out of the house for more than 12 consecutive months. Once the mortgage comes due, the borrower or heirs of the estate have an option to refinance the home and keep it, sell the home and cash out any remaining equity, or turn the home over to the lender. Once a reverse mortgage is called due and payable, the borrower (or their heirs) can possibly be granted time extensions by the lender to give them up to one year to make this decision.

If the property is turned over to the lender, the borrower or the heirs have no more claim to the property or equity in the property.

The lender has recourse against the property, but not against the borrower personally and not against the borrower's heirs. Thus the mortgage is within the category known as "non-recourse limit".

Volume of loans

Home Equity Conversion Mortgages account for 90% of all reverse mortgages originated in the U.S. As of May 2010, there were 493,815 active HECM loans. As of 2006, the number of HECM mortgages that HUD is authorized to insure under the reverse mortgage law was capped at 275,000. However, through the annual appropriations acts, Congress has temporarily extended HUD's authority to insure HECM's notwithstanding the statutory limits.

Program growth in recent years has been very rapid. In fiscal year 2001, 7,781 HECM loans were originated. By the fiscal year ending in September 2008, the annual volume of HECM loans topped 112,000 representing a 1,300% increase in six years. For the fiscal year ending September 2011, loan volume had contracted in the wake of the financial crisis, but remained at over 73,000 loans that were originated and insured through the HECM program.

Loan volume is expected to grow further 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.

Other options

A drawback to reverse mortgages is the high upfront costs. Upfront cost, however, is tempered by the lower interest rate as time goes by, but some seniors choose other options to draw on their home equity, particularly if they don't plan to remain at the property more than five years.

Other options which 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" intended to assist homeowners wishing to remain in their homes and/or neighborhoods. Studies conducted by various agencies and organizations, including AARP, show that over 80% of elderly homeowners do not want to move.

No-cost and low-cost mortgages are available for those homeowners who anticipate moving from the home in the near future. For example, they may select a home equity line of credit, commonly called a "HELOC", requiring interest-only payments for 10 years. These loans typically have very low (or zero) upfront costs, but the interest rates are usually slightly higher than those of a reverse mortgage. Since monthly payments are required on a HELOC, borrowers need to qualify based on their incomes and credit scores. Oftentimes, seniors who may be on a limited fixed income can't get approved for a HELOC for this reason. Reverse mortgages do not require monthly payments and, as a result, income and credit score are not considered as part of the approval process.

Criticism

Reverse mortgages have been criticized for several major shortcomings:

• High up-front costs make reverse mortgages expensive. In the U.S., entering into a reverse mortgage can cost $8,000 or more, as compared with other types of loans which often cost less than $5,000.
• The interest rate on a reverse mortgage may be higher than on a conventional "forward mortgage" even though the collateral – the real property – is the same.
• Interest compounds over the life of a reverse mortgage, which means that "the mortgage can quickly balloon". Since no monthly payments are made by the borrower on a reverse mortgage, the interest that accrues is treated as a loan advance. Each month, interest is calculated not only on the principal amount received by the borrower but on the interest previously assessed to the loan. Because of this compound interest, the longer a senior has a reverse mortgage, the more likely it is that most or all of the home equity is depleted when the loan becomes due. That translates to "less cash for your estate or to pay your bills." That said, with the FHA-insured HECM reverse mortgage, the borrower can never owe more than the value of the property and cannot pass on any debt from the reverse mortgage to any heirs. The sole remedy the lender has is the collateral, not assets in the estate, if applicable.
• Reverse mortgages are confusing. Many seniors entering into reverse mortgages don't fully understand the terms and conditions associated with the loans, and it has been suggested that some lenders have sought to take advantage of this. But in a 2006 survey of borrowers by AARP, 93 percent said their reverse mortgage had a mostly positive effect on their lives, compared with 3 percent who said the effect was mostly negative. Some 93 percent of borrowers reported that they were satisfied with their experiences with lenders, and 95 percent reported that they were satisfied with the counselors that they were required to see.

See also

• Compare reverse mortgage with home equity loan and home equity line of credit.
• Negative amortization
• Bankruptcy

External links

Reverse mortgages at the Open Directory Project