Reverse mortgage can be a financial tool
Note: This story picks up where our January Housing Options feature, “Tap into a home’s value with refi or loan” ended, with a reference to reverse mortgages.
Over the past several years, reverse mortgages have begun to overcome a somewhat tarnished reputation through product changes and additional requirements for financial assessment that have corrected some potentially detrimental features.
Retirement income researchers have established reverse mortgages as a viable tool, not just for financially strapped retirees but for well-heeled ones, too.
“You may leave more to the kids if you strategically use a reverse mortgage,” said John Salter, a financial planner in Lubbock, Texas, who has studied reverse mortgages.
Contrary to what you may have heard about reverse mortgages, consider these facts:
- You remain the owner of your home and retain title to it.
- Because, in effect, you’re receiving loan advances, not income, the money is tax-free, and it won’t affect Social Security or Medicare benefits.
- The loan comes due when the last surviving borrower dies, sells the home, or leaves it for more than 12 months due to illness.
- After the borrower leaves the home, lenders must allow an eligible nonborrowing spouse or committed partner to stay. A surviving partner can’t take any more money from the reverse mortgage, but must continue maintaining the home and paying taxes and insurance.
- You’ll never owe more than the value of your home when you or your heirs sell it to repay the reverse mortgage. If your home sells for more than you owe, you or your heirs keep any leftover equity. If your heirs want to keep the home, they can refinance the reverse mortgage, or they can pay the outstanding debt or 95% of the home’s appraised value, whichever is less.
Who is eligible?
To be eligible for a reverse mortgage, borrowers must be at least 62 years old, own the property outright or have paid down a considerable amount of the mortgage, and occupy the home as their primary residence.
Lenders will review your income and credit history to ensure you can sustain yourself, keep the home in good condition, and pay for property taxes, hazard insurance and homeowner association fees to avoid defaulting on the loan.
If the lender determines you can’t handle those costs, it will set aside funds from your payout in an escrow account and pay those bills for you.
The maximum payout, or principal limit, that you’ll qualify for depends on your age (or that of a younger co-borrower or a nonborrowing spouse, who must meet certain criteria to be eligible), as well as the current interest rate and the appraised value of your home, up to a maximum of $765,600 for a reverse mortgage insured by the Federal Housing Administration in 2020.
Several lenders make proprietary jumbo reverse mortgages. The higher your age and home value, and the lower your current mortgage balance and the interest rate that you take, the greater your payout will be.
If you have a mortgage, you must pay it off from the loan or other sources. You can withdraw no more than 60% of your principal limit in the first year, though. Up to an additional 10% of the available funds can be tapped to pay off an existing mortgage debt or make repairs required by the lender.
A line of credit from a reverse mortgage typically gives you the most proceeds and flexibility. You’re only charged interest on the portion of the line used, and you can make payments at any time.
Unlike a regular home equity loan (see January article), a reverse mortgage credit line will grow, because the untapped portion of the line compounds at the same rate at which interest and an annual mortgage insurance premium accrue on the balance. With many years and rising interest rates, the line of credit can increase to far more than the original amount.
Borrowers who want guaranteed income can also choose to receive a fixed monthly payment for a set term or for as long as they live in the home.
You’ll get the least payout and flexibility if you take a lump sum. Because you incur interest from day one, it makes no sense to take the money and sit on it.
Get professional advice
Before shopping for a reverse mortgage, ask an adviser who has earned the retirement income certified professional designation from the American College of Financial Services.
For a reverse mortgage calculator or to find lenders by state or company, visit the consumer website of the National Reverse Mortgage Lenders Association. Look for a loan officer who is a certified reverse mortgage professional.
You must get financial counseling to ensure that you can meet your obligations as a borrower. To find a counselor certified by the Department of Housing and Urban Development, visit the department’s website and search by map or Zip code, or call 1-800-569-4287. A session costs $125 to $250 by phone or in person.
At closing, you’ll pay an initial FHA mortgage insurance premium equal to 2% of the home’s appraised value or the maximum limit — $765,600 — whichever is less. You’ll also accrue an annual mortgage premium of 0.5% of the outstanding loan balance, which isn’t payable until the loan comes due.
The insurance guarantees that you will receive your payout and you’ll never owe more than the value of your home.
Lenders can charge an origination fee of up to $6,000, plus fees for third-party services. The fee is equal to the greater of $2,500 or 2% of the home’s value, up to the first $200,000, plus 1% of the amount over $200,000, up to the cap.
You’ll pay a fixed interest rate on a lump sum payout and a variable rate on all other types of payouts. The average fixed rate was 3.26% and the variable rate was 2.91% for loans closed in December (the latest data available), according to HSH.com.
Variable rates are based on an underlying index — such as the 1-Year Treasury Bill or the Libor — to which lenders add a margin of 1 to 3 percentage points. In general, the higher the margin you accept, the lower the origination fee.
It pays to shop around because lenders vary in the margins, origination fees and closing costs that they charge.
Get at least three quotes to compare margins, upfront costs and payouts.
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