A reverse mortgage is a type of mortgage that works in “reverse” from your typical, regular mortgage.
With a regular forward type mortgage, you borrow the money, and pay it down with mandatory monthly or periodic payments of principal, interest and related mortgage insurance premiums. Eventually, you may pay it all off.
With a reverse mortgage, you take money out of the equity in your home, the mortgage will increase in size as you draw more proceeds (if you did not previously take it all out as a single lump sum) and add interest and mortgage insurance that you decide not to pay down (you can opt to pay it down). The reverse mortgage outstanding unpaid balance may sometimes grow in excess of the value of your home.
The most common and feature rich reverse mortgage is a Federal Housing Authority (“FHA”) insured Home Equity Conversion Mortgage (“HECM”).
You do not sell your house. You own your home and any equity in your home. And should you sell your home you will never owe any more than the current value of the home. If you or your estate sell it for more than what is owed on the HECM mortgage, that equity belongs to you or the estate. If the home sells for less than the HECM mortgage balance outstanding, no one can ask you or your estate to make up the deficit. You owe no more than the value of the home.
The HECM has some very attractive features……
- With a HECM you may live in your home as long as you want or can. You can never be thrown out of your home provided you pay the property taxes, maintenance, and insurance.
- Neither you nor your estate can ever be held liable should the home not be worth enough money to pay off the HECM fully.
- If the lender goes out of business and is unable to fund any remaining monies due you under the HECM, the FHA guarantees your access to those funds. (i.e. it’s not like a bank that could cut you off on something like a HELOC!)
- Neither the lender or the government own your home. It’s always your home. Always in your name.
- If any equity remaining in your home after your estate or you pay off the HECM, you can leave it to your heirs.
- Your heirs can buy the home for the lesser of either 95% of its then current market value, or the HECM payoff.
- If your spouse qualifies and is on title, both of you are protected until the last surviving one of you either passes away or leaves the home permanently.
- If your spouse is not on title (a qualified Non-Borrowing Spouse) he/she is protected from eviction upon your death, and may stay in the home until they die or leave the home.
- If you did not use the available line of credit (if you took this product option), the unused line of credit actually increases every year by the mortgage rate of interest and the annual rate of mortgage insurance premiums normally charged on the outstanding balance.
- The available credit can exceed the homes original or current market value and no one can stop you drawing against that line of credit, provided you are current on your property charges.
- If you fail to pay the property taxes and insurance, the FHA requires the lender to advance funds to meet these obligations and give you time (up to 24 months) to repay those advances before authorizing foreclosure proceedings.
- At any time, if you permanently leave the home, and there is no equity in the property, you can simply hand it back to the lender and walk away from any deficits.
- If you make repayments on a Variable Rate HECM (including interest payments), you may redraw those amounts. It’s an open ended loan, but unlike a HELOC which permits only a redraw on repayments of actual draws, HECMs permit redraw on repayments of interest, draws, and mortgage insurance premiums.
- The HECM may be repaid at any time, either partially or in full. There are no prepayment penalties.
- There are no restrictions on how you use a HECM. You can refinance an existing traditional forward mortgage, pay off a HELOC, purchase a new home, refinance an existing HECM, take the available cash out monthly or leave it in place as a line of credit or obtain an annuity type monthly payment, or spend available proceeds on basically anything you want.
That’s the mechanics. So how do you qualify for a HECM?
- Well, you have to be both at least 62 years of age to gain access to the full protections of the HECM. If one of you is not 62, you cannot be on the home title or on the HECM mortgage note. But this Non-Borrowing Spouse is protected from eviction should the borrower on title pass away before the Non-Borrowing Spouse.
- It has to be a loan on your primary residence. You could use the money from a HECM to buy a 2nd home. But the mortgage must be on your primary residence.
- You have to be able to demonstrate you can maintain the property repairs, property tax and all property insurance, and if you fail to pay, you may lose your home in foreclosure. It’s no different than a normal forward mortgage, but you need to be very confident that you can pay.
- You need to meet certain minimum Residual Income requirements after you have paid your annual or monthly property charges and other installment debt repayments. You don’t need higher monthly or annual income levels to be eligible for the HECM as you would with a home equity or regular forward mortgage. But FHA must be satisfied you can maintain the property and afford to look after you and your family.
- Most single family, 2-4 units, manufactured homes, and HUD-approved condominiums and PUDs are eligible property. Co-ops, investment properties, vacation/2nd homes, bed & breakfasts and new construction that does not yet have a Certificate of Occupancy, are not acceptable collateral for a HECM.
- You have to be counseled by an independent financial counselor about the risks and benefits of taking a HECM before any lender can accept your final application and incur possible closing costs on the loan.
- If you have an existing mortgage, the amount advanced to you (what we call the Principal Limit) must be large enough (based on age of youngest borrower and value of property – not to exceed Federal limit of currently $679,650) to pay off the existing mortgages and possibly other delinquent Federal debt.
- A few other things to remember…
- The loan is Due and Payable when the last borrower (or a remaining qualified Non-Borrowing Spouse) permanently leaves the home or dies, or the property charges remain unpaid for a period of time.
- All borrowers must be on the deed (some exceptions for Life Estates and Trusts).
- Borrowers must be a citizen or a legal resident.
How Much Money Can I get?
How much money you get depends on (a) the home appraisal (limited for purposes of calculating how much money you can get to $679,650), (b) the age of the youngest borrower or qualified Non-Borrowing Spouse, and (c) a qualifying or Expected Interest Rate of interest that all together calculate how much of the appraised value of the home must be set aside to reserve for the future accruing interest and mortgage insurance premiums on the HECM. The calculation assumes the borrower drew all the money immediately and made no payments at all during the life of the HECM loan. Initial credit availability (before paying off existing obligations) fall within a range (depending on the Expected Interest Rate and age of youngest borrower) of 40% to 70% of the property appraised value. The lower the Expected Interest Rate or the older the youngest co-borrower the higher the percentage of your home value can be lent to you. Any money you obtain from a HECM is net of upfront closing costs and paying off existing liens on your home.
There is a limit in the 1st 12 months on how much cash you can get after closing. The rule is you can obtain the greater of 60% of the Principal Limit (or initial gross loan amount) or the sum of Mandatory Obligations (which include all existing liens paid off on home and mortgage closing costs) plus 10% of the Principal Limit.
Because of the HECM loan complexities, FHA requires that before an application is processed, all borrowers are counseled by an approved counselor. Depending on the state, counseling is available over the phone or face-to-face. Costs vary from free to around $200. Certain agencies want payment at the time of counseling. Others can bill the cost to the closing of the HECM loan. After the counseling is completed, a HECM Counseling Certificate is issued. It is good for six months. When applying for a HECM, the Certificate is given to the lender as proof the required counseling is completed.
The upfront costs to get a HECM loan include a 2% of home value (limited to $679,650) Upfront Mortgage Insurance Premium paid at closing. Other closing costs are similar to traditional mortgages, including the payment of an appraisal cost at time of application. These costs are paid out of your loan proceeds. If you owe other liens on your home, those must also be paid off at time of obtaining a HECM.
On monies borrowed and not paid back, ongoing HECM note interest and annual mortgage insurance premium is charged on the outstanding balance. The annual mortgage insurance premium is a constant .50% annually and may not be canceled. One can expect that the HECM note rate will be 0.25%-0.50% higher than traditional mortgages due to the negative amortization risk aspect of the loan (because regular monthly payments are not assured to investors, and the cash flow from the payoff could be deferred until loan is called due). The mortgage insurance premium on a HECM at .50% annual rate is lower than an FHA traditional forward mortgage which usually has annual rates closer to 0.80%-1.05%.
There is no minimum credit score requirement.
And the income requirements are much less than a traditional forward mortgage loan or a HELOC. You only need to have certain specified monthly or annual income left over after paying property charges (like tax and insurance).
The very first thing the application process requires is an evaluation of your willingness to repay your debts. If a credit report indicates significant issues, the HECM may not proceed. However, a good loan officer can help you find practical solutions.
The application process requires valuing the home with an appraisal. The appraiser must be FHA certified and is hired independent of the sales person and borrower involved. The appraiser will also conduct a safety inspection. Assuming the appraisal is sufficient, and there are no significant issues that can’t be solved on the credit report, the underwriter will review the appraisal and determine if your willingness and capacity to repay contractual debts and pay the lifetime property charges on the home meets the necessary minimum Residual Income requirements.
After a HECM loan refinance is closed, a borrower has three business days to rescind. If the borrower rescinds, the transaction is canceled, and the borrower is not charged any penalty or costs. If the closing goes forward, the legal documents are recorded with the city or town clerk. Any funds requested for the closing are disbursed to the borrower. In the case of a HECM used to purchase a home, there is no rescission or 3-day delay in paying funds to the home seller.
This is a highly personal choice and depends on your circumstances. You best approach here is to define your needs and discuss with a professional loan officer.
Types of HECMs Disbursement
- Tenure– equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.
- Term– equal monthly payments for a fixed period of months selected.
- Line of Credit– unscheduled payments or installments, at times and in amounts of your choosing until the line of credit or Net Principal Limit is exhausted.
- Modified Tenure– a combination of line of credit with monthly payments for as long as you remain in the home.
- Modified Term – a combination of line of credit plus monthly payments for a fixed period of months selected by the borrower.
The line of credit option is the most popular among seniors. Borrowers can use the bulk of the line of credit immediately to cover home repairs, repay debts or for other reasons. The balance of the money can be kept in reserve or used to create a monthly payment.
For other borrowers, the monthly payment plan makes more sense from a budgetary standpoint.
Seniors can also change their payment options for a small fee.
Defaults and Due and Payable
If during a HECM loan period, the borrower does not pay the required taxes or insurance, the lender will advance funds on behalf of the borrower to pay these amounts. Depending on the size of these advances, borrowers will have 24 months to repay the lender (FHA requires the lender to do their very best to help borrower find ways to meet the monthly/annual tax and insurance burden). But should it become evident that the borrower is unable to meet the tax and insurance requirements, and amounts are delinquent, the lender may ask FHA to grant permission to call the loan Due and Payable and start a process of foreclosure.
The loan comes Due and Payable (i.e. the HECM must be repaid) if the home is (a) sold, (b) the borrower changes principal residence, (c) the last borrower in the home dies, (d) the last borrower leaves the home longer than a 12-month period (say, for a nursing facility or to live with relatives), (d) mandated repairs are not made, or (e) taxes and insurance advances paid by the lender on behalf of the borrower remain unpaid despite a concerted effort to help the borrower meet this obligation.
The HECM loan is a Non-Recourse loan.
Only the current value of the home need be made available to repay the mortgage. Even if the loan is greater than the value of the home, it doesn’t matter. Neither the borrower or the estate will owe any deficit that might arise when the home is sold to payoff the HECM. Even better, the estate or heirs can buy the home at 95% of its current market value (as stated above) and is still not liable for any deficit on the payoff of HECM loan. If the HECM balance is less than the value of the home, that equity belongs to the borrowers or their estate.
Your Estate or Heirs can buy the Home
In the event of the death of the last borrower in the home, the estate has an initial period of six months, with the possibility of two 90-day extensions to sell the house, to repay the HECM and take any remaining equity. The estate or the heirs can decide if they wish to retain the house and may own it for the lesser of (a) 95% of the current market value, or (b) the amount due on the HECM loan. There are no payments to the bank required of the heirs during the time they are trying to sell. However, the estate or heirs are responsible for maintenance, paying the property taxes and keeping the home adequately insured. During this period, interest and MIP will continue to accrue on the HECM, until payoff.
Important HECM Terms
Maximum Claim Amount: This refers to the appraised value of the collateral, as limited to Federal limit of $679,650. i.e. no matter if property worth $1 million, the program restricts the amount to $679,650. JUMBO Reverse Mortgage products are not government insured, have no Federal limits and this concept is dependent on those program’s separate rules.
Principal Limit: Refers to the initial estimated available borrowing capacity the borrower has. It’s based on the borrower’s age or a co-borrowers youngest age, the Expected Interest Rate and the value of the property (as limited by the Federal limit, if a HECM loan)
Principal Limit Factor or “PLF”: Refers to the percentage of Maximum Claim Amount that creates your Principal Limit. E.g. a PLF factor of 50% on a Maximum Claim Amount of $200,000 means you have a Principal Limit of $100,000
Net Principal Limit: This is the net amount of Principal Limit available to the borrower after payment of Mandatory Obligations. After the initial draw, the Net Principal Limit can (i) decline as more draws are made, (ii) it can increase if repayments are made on the HECM, or (iii) the unused Net Principal Limit can grow at the HECM rate of interest plus the annual MIP. The HECM has that unique feature that unused lines of credit (which is essentially what the Net Principal Limit is) grow over time if not drawn down against.
Expected Interest Rate: This is the interest rate used by FHA to estimate how much interest might accrue on the HECM over the expected life of the youngest borrower. The minimum Expected Interest Rate required by FHA is, for a Fixed Rate loan, the actual interest rate on the mortgage. For a variable rate loan, the Expected Interest Rate is the monthly or annual margin over LIBOR selected and added to the 10 year estimated LIBOR rate.The lower the Expected Interest Rate, the higher the Principal Limit.
Mandatory Obligations: These are the financial obligations a borrower must payoff (normally out of the HECM proceeds). They include existing mortgages, delinquent Federal debts (like your income taxes) not subject to a repayment plan, and costs associated with closing the HECM.
Would you like to learn more?
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- If you would like to know how much you potentially qualify for, and whether you possibly have adequate monthly cash flow, go to the HECM WIZARD and input your information.
- If you would like to reach out and talk with me, fill out the information on Contact Me or email at st.john.bannon@JMCapGroup.com