What Is a Reverse Mortgage?
According to the U.S. Census Bureau, there are over 54 million Americans over the age of 65. This is a huge chunk of the population, amounting to about 16%.
As science and technology have advanced, medical care and awareness of one’s health have improved too, causing seniors to live longer and healthier lives. This has resulted in the need to stretch funds further in retirement and possibly afford pricey medical accommodations that in decades past would have seemed like science fiction.
Pensions have become less common, and the interest in retirement accounts is struggling to keep up with inflation. According to TheFool.com, the average interest rate is currently around 5-8% (if invested wisely).
Cost of living has gone up 6.2% in just the past year, which is the most rapid increase since 1990. This has created a strong demand for solutions. While variations of the reverse mortgage existed as far back as the 1960s, it wasn’t until 1988 that President Reagan signed it into law.
Now, seniors have the option to access the funds from (without even selling) their biggest investment: their home.
What Type of Reverse Mortgage Can You Get?
Most people’s largest asset is their home, and it is a goal for many to buy a nice house and gradually pay it off. Assuming the market stays stable, values continue to increase, and the payments are made on time, the amortization of the mortgage should gradually result in increasing equity.
There are several options for accessing the equity without selling, and the reverse mortgage is a common one for senior citizens specifically.
There are three main types of reverse mortgages that you may see on a title report.
Single Purpose Reverse Mortgage
A single purpose reverse mortgage is typically acquired through local governments and nonprofits, but the downside is that it can only be used for one purpose. If you need to access funds for repairs or to pay back taxes, this one could be a good fit. These tend to have a lower cost but can be hard to find.
Proprietary Reverse Mortgage
A proprietary reverse mortgage is offered from private companies, and the money can be used for any purpose. These reverse mortgages are not backed by the government and as such do not have the severe limits.
Home Equity Conversion Mortgage
A home equity conversion mortgage is the most common type of reverse mortgage, and it is the one you will most likely see on your title reports. It is federally insured by the Department of Housing and Urban Development. The funds you receive from it can be used for any purposes, but it comes at a higher cost.
A senior citizen can qualify for a home equity conversion mortgage based on several factors:
- All borrowers must be 62 years of age or older.
- The home must be the primary residence.
- The home must be owned, or the balance left on the original mortgage must be minimal.
- The home must have at least 50% equity.
- The borrower must not owe any federal debt.
- The borrower must attend a consumer information session with a HECM counselor.
The requirements that are specific to taxes, mortgages, and repairs can be discussed with the HECM counselor. In some cases, the money from the reverse mortgage can be applied to clear these things up.
Reverse Mortgage Payment Options
To receive the distributions from a reverse mortgage, there are three main options.
One Lump Payment
The borrower can receive one lump payment. In many cases, the borrower can receive 60% of their equity and then, if they choose a variable interest rate, the remaining 40% 12 months later.
In some cases, if you choose a fixed rate mortgage, then you forfeit the access to the remaining 40%. This can depend on what you are going to use the lump sum for, and it varies depending on circumstance.
The contingencies of the lump payment option should be thoroughly discussed with the HECM counselor. The lump payment amount is ideal for those who either have a specific plan in mind for their equity or who are very good at managing their money.
Monthly payments can be distributed to the borrower based on term, tenure, or a combination of both. You could choose a higher payment for a specific term (such as five years), or you could choose to receive a lower monthly payment every month for the rest of your time living in the home.
Combinations of these options or modifications to these options can be made and should be discussed with your HECM counselor. The monthly payments are ideal for those who need to rely on a monthly income for their day-to-day expenses.
Line of Credit
With a line of credit, the borrower can withdraw funds as needed and pay interest on only what they access. The unused portion can increase due to interest growing at an annual rate that equals the interest rate the lender charges on the withdrawn amount. This is a very cost-effective way to take your distributions and is especially ideal for those who don’t necessarily need money to live on but expect to have medical needs and expenses down the line.
There are ways to combine the distribution methods or modify them to your needs, so all options should be thoughtfully considered with your HECM counselor. Regardless of what you choose, there are no monthly payments for you to worry about and the loan is paid back when the home is sold, or it is repaid out of the estate when the borrower has passed away.
Consider Every Factor Before Choosing a Reverse Mortgage
It is important to note that banks do not offer reverse mortgages out of the kindness of their hearts. There are significant costs associated with this decision, and it should be considered alongside other options for seniors and their families.
Origination fees can be either 2,500 or 2% of the first $200,000 of the home’s value. HECM loan origination fees are capped at $6,000. The borrower will also have to pay an appraisal fee, which could be over $500. There are charges for various insurances, document preparation, and the fee for the HECM consumer counseling session.
The interest can often be on the high side depending on what type of reverse mortgage you get and how you receive your payments. According to Investopedia.com, in August of 2021 the fixed rate APR was 3.38% and the adjustable-rate APR was 2.33%. Compound interest is especially relevant as no payments are being made from the borrower.
When you make monthly payments on your traditional mortgage, you pay down your balance every month and your amount owed will get smaller as time goes on. The interest charged on your traditional mortgage is on a smaller and smaller amount. With a reverse mortgage, the amount owed will increase, interest will accumulate, and interest will be charged on the larger amount, snowballing the balance.
The borrower will not necessarily be faced with the high costs, as they won’t have a payment; however, their heirs may not have much left from the estate when all is said and done. The borrower does not get to access 100% of their equity, as a large portion is reserved for the interest and fees.
How much equity you receive will depend on many factors, including your age, the payment option you choose, and the type of reverse mortgage you take out. In most cases, you cannot access more than 60% of your home’s equity.
Another concern is that if the senior citizen was not clearly informed about their tax obligations, it can result in unfortunate foreclosure situations. We are all used to making monthly payments that include our mortgage payment, insurance, and property taxes.
Now, suddenly there is no monthly payment at all. It is even stated multiple times in the reverse mortgage literature that there are “no monthly payments.” Many consumers who have taken out reverse mortgages overlook paying their property taxes.
Time goes on, taxes accumulate, and by the time the owner is fully aware of what has happened, the taxes are too high to ever be paid back all at once on a limited income.
The taxes must be paid on the property — otherwise, the lender can foreclose. The property could also end up as a tax deed sale for the delinquent taxes. Either way, many of the properties that are for sale at county auctions are a direct result of this breakdown in communication.
Reverse Mortgages at Foreclosure and Tax Deed Auctions
When a foreclosure does occur, the property is listed for auction and will be visible on PropertyOnion.com. A title search will always be necessary to make sure the potential bidder is fully aware of all liens and encumbrances attached to any property.
When you receive your title report, you may notice that the reverse mortgage appears twice. Similar information is written in both the Mortgage 1 and Mortgage 2 fields. This is because (in most cases) the reverse mortgage is a home equity conversion mortgage and is federally backed.
You will notice that Mortgage 2 is listed as Department of Housing and Urban Development. This is because reverse mortgages are recorded with two deeds of trust and a first and second note. If for some reason the lender was unable to make the payments to the borrower, the HUD would step in and the borrower would still receive their funds.
Many investors who have ordered title reports want to know if Mortgage 2 will be wiped out in the foreclosure auction. The answer is that if Mortgage 1 is cleared, Mortgage 2 will be as well.
What Can Happen to a Reverse Mortgage?
Many consumers mistakenly believe that reverse mortgage means signing over the title of their home to the bank, but this is simply not the case. The homeowner’s name remains on the title, and they continue to be in full ownership of their home. The homeowner would only lose their home if they failed to pay taxes and insurance and maintain the property.
If the homeowner chooses to sell their home, the full amount of the reverse mortgage is due. This is no different from a traditional mortgage that may have a due on sale clause. The reverse mortgage would be paid back out of the amount from the sale of the property.
If the homeowner passes away, the heirs inherit the home; however, they would then be tasked with making several decisions.
The Heirs Can Let the Lender Acquire the Property
The heirs either sign the property over to the lender or allow the bank to foreclose. It is important for not only the borrower but also the heirs of the borrower to be well informed about the reverse mortgage.
There have been many well-meaning parents who wrongly believed that the reverse mortgage ensured the home would go directly to the bank upon their death. This resulted in many unfortunate scenarios of mourning families being tasked with receiving foreclosure notices and having to inform themselves about the terms of the reverse mortgage in the middle of grieving the loss of their parents.
The Heirs Can Keep the Home
The heirs have every right to keep the home. They just need to pay back 95% of the appraised value, and the FHA will cover the remainder of the loan. The heirs have 60 days to acquire an appraisal and make the payment.
The Heirs Can Sell the Home
Upon sale of the property, the heirs would repay the loan out of the proceeds of the sale. The remaining amount from the sale would belong to the heirs.
When a property that has a reverse mortgage is auctioned by the county, it is important to identify if it is a foreclosure sale or a tax deed sale. If it is a foreclosure sale and it is the reverse mortgage that is the foreclosing party, then the reverse mortgage will be satisfied during the auction process.
If there are additional liens and encumbrances on the property, they will have to be considered in each circumstance, but the reverse mortgage itself will be gone. If it is a foreclosure sale and it is not the reverse mortgage that is foreclosing but rather a homeowner’s association or a different lien, the reverse mortgage would still need to be addressed.
If the auction is a tax deed sale, after winning the property the buyer would pay the taxes for four consecutive years and then consult with an attorney to apply for a quiet title action. While in a tax deed sale, private mortgages would not encumber the property after the taxes were due, the reverse mortgage would still attach with no satisfaction, and it would be difficult to sell the property with a warranty deed.
Reverse mortgages are one of many possible liens that may show up on your title report. It is always a good idea to go over your title report with a real estate attorney if you have any questions.
With Florida being a favorite location for senior citizens, it is likely that you will come across a reverse mortgage on a title report at some point when doing your research. Like many other types of encumbrances, once you have learned more, there is no reason why a reverse mortgage should dissuade you from considering a potential investment.