A reverse mortgage is a loan for elderly homeowners that uses the home’s equity as collateral. The loan generally does not have to be repaid until the last surviving homeowner permanently moves out of the property or passes away. At that time, the estate has between six months and one year to repay the balance of the reverse mortgage or sell the home to pay off the balance. Any remaining equity is inherited by the estate. The estate is not personally liable if the home sells for less than the balance of the reverse mortgage.
Eligibility for a Reverse Mortgage
The most popular reverse mortgage (representing about 95% of the market) is the Home Equity Conversion Mortgage (HECM). This program is offered by the Department of Housing and Urban Development (HUD) and is insured by the Federal Housing Administration (FHA).
To be eligible for a HECM, FHA requires that all homeowners be at least 62 years old. The home must be owned free and clear, or all existing liens must be satisfied with proceeds from the reverse mortgage. If there is an existing mortgage balance, it can be paid off completely with the proceeds of the reverse mortgage loan at closing. Generally, there are no credit score requirements for a reverse mortgage.
Outliving the Reverse Mortgage
Generally speaking, HECM loans cannot be outlived and will not become due, assuming that at least one homeowner lives in the home as his/her primary residence, continues to pay required property taxes and homeowners insurance, and maintains the home in accordance with FHA requirements.
In the event of death or in the event that the home ceases to be the primary residence of the homeowners for more than 12 months, the homeowner’s estate can choose to repay the reverse mortgage loan or put the home up for sale. If the equity in the home is higher than the balance of the loan when the home is sold to repay the loan, the remaining equity belongs to the estate. If the sale of the home is not enough to pay off the reverse mortgage, the lender must take a loss and request reimbursement from the FHA. No other assets are affected by a reverse mortgage. For example, investments, second homes, cars, and other valuable possessions cannot be taken from the estate to pay off the reverse mortgage.
The amount that is available generally depends on four factors: age (older is better), current interest rate, appraised value of the home and government imposed lending limits.
Distribution of Money from a Reverse Mortgage
There are several ways to receive the proceeds from a reverse mortgage:
- Lump sum – a lump sum of cash at closing.
- Tenure – equal monthly payments as long as the homeowner lives in the home.
- Term – equal monthly payments for a fixed number of years.
- Line of Credit – draw any amount at any time until the line of credit is exhausted.
- Any combination of those listed.
Reverse Mortgage vs. Home Equity Loan
Home equity loans, second mortgages and home equity lines of credit (HELOC) generally have strict requirements for income and creditworthiness. Also, with other traditional loans, the homeowner must make monthly payments to repay the loans. A reverse mortgage generally has no credit score requirements and instead of making monthly mortgage payments, the homeowner receives cash from the lender. With a reverse mortgage, the amount that can be borrowed is determined by an FHA formula that considers age, the current interest rate, and the appraised value of the home. Typically, the more valuable the home, the higher the loan amount will be, subject to lending limits.
To summarize the key differences, with traditional loans the homeowner is still required to make monthly payments, but with a reverse mortgage the loan is typically not due as long as the homeowner lives in the home as their primary residence and continues to meet all loan obligations. With a reverse mortgage no monthly mortgage payments are required; however the homeowner is still responsible for property taxes, insurance, and maintenance.
Is a Reverse Mortgage Right for You?
While reverse mortgages may look like “win-win” situations on the surface, they also have some significant downsides. First, the closing costs for these loans are about double those for conventional mortgages. For example, closing costs on a $110,000 reverse mortgage for a $200,000 home would be more than $10,000. These costs can be financed by the loan itself, but that reduces the money available to you.
Reverse mortgage payments also may affect your eligibility for government benefits, including Medicaid. Generally, these payments will not be counted as income as long as they are spent within the same month that they are received. The unspent balance from a lump-sum reverse mortgage loan could put a borrower over the allowable asset limits for Medicaid or Supplemental Security Income (SSI) eligibility. Even if the loan is taken as monthly payments, the payments could accumulate and push your resources over. In addition, payments from reverse annuity mortgages may be counted as income for purposes of Medicaid and SSI whether or not they are spent within the month they are received. This shouldn’t be treated as income, since it simply involves withdrawing equity from one’s home, but the state may view it differently since the funds come in a regular monthly check. In any case, you should consult with an elder lawyer in your state if you have any concern about how a reverse mortgage will affect your eligibility for federal benefits.
Also, bear in mind that if your major objective is to safeguard an inheritance for your children, a reverse mortgage may not be a good idea. As soon as the elderly person (or the survivor of an elderly couple) dies, it will most likely be necessary to sell the home, and much, if not all, of the sales proceeds will have to be paid to the reverse mortgage lender. But if you have a pressing need for additional income and have no close heirs, or if you do not intend to benefit your children or your children don’t particularly want to inherit the house, a reverse mortgage can be a way to supplement income, perhaps without jeopardizing Medicaid eligibility.
Reverse mortgages are complex products and borrowers are advised to acquaint themselves with the different options available and then carefully compare competing loan offerings.
ByIsaac Yedid, Esq. and Raymond Zeitoune, Esq. How reverse mortgages work. The attorneys in the Real Estate Practice Group at Yedid & Zeitoune have a combined 25 years of real estate experience and are ready to assist you with all your commercial and residential real estate needs.