5 Things to Consider Before Taking Out a Reverse Mortgage
During the 2013 fiscal year, homeowners established 60,091 Home Equity Conversion Mortgages (HECMs). Backed by the U.S. Department of Housing and Urban Development (HUD), HECMs are the most common form of reverse mortgage in the U.S. today. Unlike a traditional mortgage that requires a homeowner to make monthly payments to a lender, the reverse mortgage makes it so the lender pays the homeowner — either in installment payments, as a lump sum or line of credit, or as some combination of a lump sum and installment payments. The amount you receive depends on a factors including your age (the youngest homeowner’s age), the value of your home, and interest rates.
Ken Terrill of Reverse Mortgage Experts has been in the business of reverse mortgage lending for over twenty years. Terrill says reverse mortgage candidates are sometimes “widows and divorcees who can’t afford to pay their house payments. … Some people want to help their kids, help their grandkids with college, there are infinite uses.” Homeowners “over 62 who need an increase in income (and have a) qualifying property” are generally eligible, he says.
The process of obtaining a reverse mortgage comes at little or no out-of-pocket costs as closing costs and other fees can be deducted from the loan. The homeowner, or homeowners, must attend government-approved counseling to ensure they understand the reverse mortgage. “Counseling is about an hour long and the counselor talks about different options, risks, and uses,” Terrill says.
A brief overview of the reverse mortgage process and the benefits that come along with this type of loan make it sound like an ideal option for anyone who qualifies. Although the program is beneficial to many people, there are some pitfalls to the reverse mortgage. Here is some information you may want to consider when determining whether or not a reverse mortgage is the right path for you.
Your home, its condition, and the costs of your insurance and property taxes are all relevant factors to consider when weighing the pros and cons of a reverse mortgage. Homes that qualify for reverse mortgage should “meet FHA standards (and should not) have any tax liens,” explains Terrill. The appraiser may determine your home needs a certain amount of repairs. You would then have to allocate or “set aside” a certain amount of funds to complete these repairs. You will also have, detailed within your loan agreement, a set time period during which these fixes must be completed.
Although you do not have to make a mortgage payment with a reverse mortgage, you will continue to have other payments related to your home. Fees, such as homeowners insurance, taxes, and any condominium fees must remain current. There is the possibility of “default due to an inability to pay insurance,” says Terrill.
Your current and future family situation is also applicable. Is one of the members of your household the primary earner? Are you still working, or do you have stable retirement income? You may hear horror stories about people losing their homes after a reverse mortgage. According to Terrill, this sometimes happens when a younger spouse has little or no income and the couple borrows in the older spouse’s name. “Borrowing in the older spouse’s name is not advisable unless there is no other option,” he says. Sometimes, “people borrow in the older spouses name to get more money and when the older spouse dies, the other spouse has to either pay off the loan or refinance the loan. … The payoff then may be more than the value of the home,” he says.
“When used wisely, the reverse mortgage is a useful program,” Terrill adds. Many families do benefit from reverse mortgages and in some cases, people use the program “to get taken out of foreclosure,” he says. These families use the proceeds of the reverse mortgage to pay off the existing mortgage.
Before deciding to go the reverse mortgage path, it’s wise to have a plan pertaining to how you are going to budget the funds. Decide in advance on how you can make the money last as long as you need it to. Using the funds on something you may not be able to recover like a gift or to make an uninformed investment decision may prove financially detrimental, particularly for lower income homeowners.
HUD made recent changes to the HECM program. One change says you “are not allowed to take out the full amount during the first year unless you are using it to pay an existing mortgage,” says Terrill. Terrill is referring to the initial draw limitation, which says you generally cannot take more than 60 percent of initial principal amount at closing. If you have an existing mortgage to pay off, you can take the sum of the amount you need to pay your mortgage, plus an additional 10 percent. This forces you to hold onto some of the equity in your home.
As of 2014, HUD also requires that lenders evaluate your complete financial health, prior to approving you for a reverse mortgages. Lenders will examine measures of financial stability, such as income, credit worthiness, and budget. If a financial assessment says you may be at risk for running into trouble paying property taxes or insurance, HUD says a lender may set up “set asides.” These are allotted monthly amounts to pay these necessities. They are set aside for as long as your life expectancy.
You can only obtain a reverse mortgage on your home of residence — investment properties or vacant homes are not eligible. Considering “a house is most people’s primary source of equity,” says Terrill. “The major downside is that you are spending your kid’s inheritance.”