By Harvey S. Jacobs March 16, 2012
As the country’s home-owning population ages and baby boomers hit their mid 60s, it is time to take another look at the once-popular mortgage product known as the reverse mortgage.
In a reverse mortgage, the bank loans you cash in a lump sum, in monthly installments, a line of credit or some combination of all three. Unlike a typical mortgage, the bank pays you and so long as you are alive and continue to live in your home, you do not have to repay the bank. The bank gets repaid solely from the sale or refinancing of your home when you sell your home, move out or die.
In years past, reverse mortgages got a bad reputation, primarily for their relatively high upfront fees, the negative amortization and the many misconceptions about how they work. Nearly all reverse mortgages these days are insured by the Department of Housing and Urban Development’s Federal Housing Administration – meaning that if the reverse lender does not get repaid in full, FHA insurance will cover their losses.
Still, before pursuing this option, you need to investigate the ramifications of the program on your finances. Your ability to qualify for certain need-based programs such as Supplemental Security Income or Medicaid could be hurt by the additional funds received from a reverse mortgage. Also, this is not a good idea for people who are seriously ill or who plan to move in a year or two, because the cost of the loan would be high.
As long as you don’t fit into those categories, the benefits are numerous.
In extending the protection to the lender, the FHA charges the borrower an upfront mortgage insurance premium equal to 2 percent of the initial loan amount, plus an annual premium equal to 1.25 percent on the then-outstanding loan balance. To avoid the upfront fee sticker shock, reverse lenders have, for the most part, eliminated origination fees and points. Even the upfront insurance premium can be avoided these days by using the Saver Program, which will reduce your upfront costs and the amount you can borrow.
Negative amortization is when the amount that has to be paid back increases over the life of the loan. By its very nature, a reverse mortgage has negative amortization since you make no payments ever. In fact, you can receive monthly payments from the lender. Your loan balance will increase each month by the amount of those payments, plus interest and the annual mortgage insurance premium. This ever-increasing loan balance scares many borrowers until they realize neither they nor their heirs will ever have to pay that loan back personally. Reverse mortgages are non-recourse loans. That means the borrower is not personally liable to repay the loan. The reverse lender looks solely to your home’s value or the FHA insurance for repayment.
Reverse lenders will lend you a certain percentage of your home’s appraised value. The appraised value is called the maximum claim amount and is capped at $625,500. The percentage they will lend depends on your age and life expectancy.
According to Steve Strauss, reverse mortgage consultant for MetLife Home Loans, these loan-to-value ratios will range from approximately 50 percent to as much 80 percent. The older you are, the higher the percentage they will lend. If you have one or more existing mortgages, they will need to be paid off since the reverse lender must be in first lien position.
Once those liens are paid off, any additional available loan proceeds can go directly in your pocket for any purpose, tax-free. The amount loaned will accrue interest at the negotiated interest rate. Reverse mortgages can be obtained at fixed or variable interest rates. If you opt for a fixed rate, you can take your proceeds only in one lump sum.
If you are willing to assume the interest rate risk, you can obtain a variable rate reverse mortgage and receive monthly payments over a fixed time frame or even for your lifetime. In the variable rate scenario, the interest rate may change each month and will accrue, but need not be paid. As with regular adjustable rate mortgages, the interest rate is based on an index, in this case the monthly LIBOR rate, currently at 0.25 percent. Added to the index is the margin, currently set at 3 percent. Thus, current reverse mortgages are being originated at 3.25 percent. Interest rates are capped at 10 percentage points over the initial origination rate.
Common misconceptions about reverse mortgages are numerous. Reverse lenders cannot kick you or your surviving spouse out of your home so long as you continue to pay your property taxes and insurance. The reverse mortgage continues until the last surviving borrower sells, moves or dies. Another myth is that your heirs will be stuck paying off your reverse mortgage. Not true. Neither you nor your heirs will ever have to pay off a reverse mortgage out of pocket. If, at the time the reverse mortgage becomes due, your home still has equity, your heirs can sell your home, pay off the reverse mortgage and keep the excess. If your home does not have any equity at that time, your heirs can just walk away with no personal liability.
Since reverse lenders base their lending decision solely on your home’s appraised value and your age, your credit score is not a factor. There is no need to provide any financial statements or tax returns. Applying is relatively easy. You will need to provide copies of your deed, photographic proof of identity, Social Security number and age, proof of homeowners insurance and a HUD-approved certificate attesting that you have completed a mandatory reverse mortgage educational and counseling class. Often the only cash required is a $300 appraisal deposit.
For homeowners who have retained some home equity, who are at least 62 years old and who plan to remain in their homes for the foreseeable future, a reverse mortgage may provide an ideal way to tap into that equity for today’s needs.
Harvey S. Jacobs is a real estate lawyer with Jacobs & Associates Attorneys at Law in Rockville. He is an active real estate investor, developer, landlord, settlement attorney, lender and Realtor. This column is not legal advice and should not be acted upon without obtaining your own legal counsel. Contact Jacobs at (301) 417-4144, jacobs@jacobs-associates.com or ask@thehouselawyer.com.