Cash Flow from Your Home – Reverse Mortgages

The use of reverse mortgages is climbing as more seniors learn how to use them to raise cash from their home equity. The loans are not for every senior American, but they can be a valuable source of cash for strapped homeowners.

Fewer than 20,000 reverse mortgages were originated in 2003. That’s a tiny part of the mortgage market, but it is about 40% more reverse mortgages than were originated in 2002. A reverse mortgage also is known as a home equity conversion mortgage (HECM).

In a reverse mortgage a lender makes a loan to a homeowner. Neither principal nor interest on the loan needs to be paid until the homeowner dies, moves, or sells the home. The loan and interest are paid from proceeds of the sale of the home. The loan proceeds are tax free and do not affect Social Security or Medicare benefits.

Reverse mortgage proceeds can be received in either a lump sum, fixed monthly payment, or a line of credit to be tapped as needed. Most homeowners choose the line of credit. Under the line of credit, interest accrues only on the amount actually borrowed, not on the entire amount authorized.

Most reverse mortgages are guaranteed by the Federal Housing Administration. That means the lender is guaranteed to receive payment of the principal and interest, even if they exceed the final value of the home. To qualify for the guaranteed loans, one needs only to be at least age 62 and own a home. There is no income limit to be eligible. The maximum loan amount is the lower of the home’s value and an FHA limit that is $160,176 to $290,319, depending on the area. These amounts change annually.

You cannot borrow the entire value of the home. The lender wants to make a profit, and the eventual sale price of the home must cover the loan principal, accrued interest, and perhaps the upfront costs of the loan. So, you will be able to borrow much less than the home’s value.

The amount of the loan depends on current interest rates, the borrower’s age, and the home’s value. Low interest rates increase the potential loan. The older you are, the higher the maximum loan amount.

The major disadvantage of a reverse mortgage is the cost, especially the upfront fees.

There is an origination fee, which for FHA-guaranteed loans can be up to the greater of $2,000 and 2% of the lower of the home’s value and the FHA lending cap. There also is a mortgage insurance premium, which also has a 2% cap. Then there are closing costs, which can be 1% to 2% of the loan amount. The closing costs depend on the lender and prevailing practices in your area. You probably also will be charged an appraisal fee. For a home worth the maximum FHA loan amount of $290,319, these costs can be 6% of the home’s value, or $17,420. For lesser-valued homes, the costs can be a higher percentage of the value. These costs are exclusive of the interest charged on the amount borrowed.

The upfront costs don’t have to be paid in cash. They can become part of the loan.  That will reduce the amount of cash that can be borrowed, and you will be accruing interest on those costs since they become part of the loan.

Most lenders charge a monthly loan servicing fee of about $35. There also can be an annual mortgage insurance premium of up to 0.5% to the interest rate.
Another disadvantage of a reverse mortgage is that most of the home equity eventually could go to the lender and will not be available for loved ones.

Because reverse mortgages can be complicated and expensive, the FHA requires that a homeowner meet with a counselor before a loan can be made, but the counselors are paid by the lenders.

The big advantage of a reverse mortgage is that it can allow someone to “age in place.” Cash is available to pay for major medical expenses, major repairs, and other expenses. The homeowner does not have to move, sell the home, or lose title to the home.

Because of the costs, a potential reverse mortgage borrower should first consider other alternatives. For example:

• Many areas allow senior citizens either reduce real estate taxes or defer payment until the home is sold. Taking advantage of this break can increase cash flow. 

• Consider other loans. Regular home equity loans usually have much lower upfront costs and lower interest rates. The disadvantage is that repayment must begin right after the loan is made. 

• It might be better to sell the current home and move into a lower cost home. The excess proceeds from the sale of the first home can be used to pay bills or it can be invested and the income used to pay for living expenses. 

Some lenders offer reverse mortgages that are not FHA-guaranteed. These loans have no maximum amount, so they are appropriate for those whose homes exceed the FHA lending limits. They also have lower costs, because borrowers aren’t paying for the FHA insurance. Key lenders of these reverse mortgages are Fannie Mae and Financial Freedom of Irvine, Calif.

A reverse mortgage can be an important way to pay for medical bills, home maintenance, or other large expenses. Because they are expensive and can absorb all or most of the home equity, reverse mortgages should be a last resort. There is good reason why the average reverse mortgage borrower is a single woman age 75 or older. If you take a reverse mortgage a relatively young age, the amount you can borrow will be low.

For more information on reverse mortgages, consider these sources:
AARP (800-687-2277 or www.aarp.org/revmort) for its booklet Home Made Money: A Consumer’s Guide to Reverse Mortgages.
National Council on Aging, 202-479-1200 or www.ncoa.org
Fannie Mae (800-732-6643) and its Home Keeper loans.
Financial Freedom Senior Funding (888-738-3773)
National Reverse Mortgage Lenders Association at 866-264-4466 or www.reversemortgage.org
www.ltccounselor.org