What You Should Know About Reverse Mortgages
Unlike all other mortgages, in which borrowers pay their lenders, reverse mortgages flip the money flow: They pay the borrower, either in the form of a credit line, monthly payments or a combination of the two.
The loan debt gets paid off with the proceeds of the sale of the home -- either when a borrower moves out or passes away.
"You're leveraging the remaining equity in your home," said Jeff Corbett, a former mortgage broker and current consultant in the mortgage and real estate technology industries. He said the most "practical, prudent" reverse mortgage is probably one that pays you in monthly payments, rather than in a lump sum.
Different Loan Options
Home Equity Conversion Mortgages, which are insured by the Federal Housing Administration, are the most common form of reverse mortgages. To be eligible for an HECM, which may have a fixed or variable interest rate, you must be 62, own your home outright (or, in some cases, have a low primary mortgage balance) and live in your home full-time. A borrower with an HECM must pay property taxes, utilities and hazard and flood insurance premiums over the course of the loan, or otherwise face the possibility of foreclosure. HECMs may not exceed $625,500.
There are also single-purpose reverse mortgages, which are offered by state, local and non-profit organizations. These mortgages may only be used for one purpose, such as home renovations or property taxes. Usually, only low- or moderate-income borrowers qualify for them.
Proprietary reverse mortgages are a last option, which may have higher interest rates and upfront costs but have no income or medical requirements. These mortgages have all but vanished in the wake of the housing crisis.
The maximum loan amount a borrower may receive from a reverse mortgage is determined by the length of the loan, the loan's interest rate and the anticipated appreciation of the home's value over the course of the loan. This is in order to maximize the chances that the home's eventual sale will be enough to pay the accumulated debt.
For a home worth $400,000 that has no existing mortgage, that maximum amount -- known as the "net principal limit" -- could be around $193,000, according to Jack Guttentag, who gives mortgage advice on his website, The Mortgage Professor. Origination fees, mortgage insurance, closing costs and anticipated servicing fees are all tacked onto the balance of a reverse mortgage when it is originated, accounting for why your net principal limit may be smaller than you'd expect.
Know the Disadvantages of Reverse Mortgages
While a reverse mortgage may seem like a great deal at first, the loan can carry steeper upfront costs than a forward mortgage.
This is sometimes true in the case of HECMs because an HECM has a relatively high insurance premium.
And if you plan on leaving a significant inheritance to your family members, you may want to think twice before taking out a reverse mortgage. In the event that the borrower dies and the home is sold, a lender collects whatever it is owed from the proceeds of the sale. Only what's left over after the debt is satisfied goes to the borrower's heirs, Guttentag said.
If borrowers do run into trouble with reverse mortgages, it's usually when they choose to accept the loan in a lump sum. "They'll do something frivolous with it," Corbett said, "like paying off all their debt or giving it to their children. They tend to blow their entire nest egg ... all in one big shebang, and now they're left with nothing."
The New York Times reported that this is increasingly becoming a problem for retiring baby boomers. Many more homeowners have been taking out reverse mortgages in lump sums than in the past, with an alarming percentage of them risking foreclosure by failing to pay their taxes and insurance.
CORRECTION: An earlier version of this story cited data, originally reported by CNNMoney, that overstated loan origination fees on reverse mortgages. Those fees are currently capped at $6,000. In addition, a source quoted in the story suggested that the lender takes possession of the home at the end of a reverse mortgage. While the borrower or estate must pay back the outstanding loan balance, the bank never possesses title to the home.