A reverse mortgage is a loan available to homeowners 62 years or older (although some private-label reverse mortgages go down to age 55) that allows them to convert part of the equity in their homes into cash.
The product was conceived to help retirees with limited income to use the accumulated wealth in their homes to cover basic monthly living expenses and pay for health care. There is no restriction on how reverse mortgage proceeds can be used. As a result, an increasing number of homeowners are using reverse mortgages as part of a comprehensive retirement plan to enhance their financial security.
The loan is called a reverse mortgage because instead of making monthly payments to a lender, as with a traditional mortgage, the lender makes payments to the borrower.
The borrower is not required to pay back the loan until the home is sold or otherwise vacated. As long as the borrower lives in the home, they are not required to make any monthly payments towards the loan balance. However, the borrower must remain current on property taxes, homeowners insurance, and homeowners association dues (if applicable).
Features of Reverse Mortgages
With a reverse mortgage, the borrower always retains title or ownership of the home. The lender never, at any point, owns the home even after the last surviving spouse permanently vacates the property.
The amount of funds that a borrower is eligible for depends on the person’s age (or age of the youngest spouse in the cast of couples), home value, interest rates and upfront costs. The older someone is, the more proceeds he or she may receive.
Types of Reverse Mortgages:
Home Equity Conversion Mortgage
HECM (pronounced HEKUM) is the commonly used acronym for a Home Equity Conversion Mortgage, a reverse mortgage created by and regulated by the U.S. Department of Housing and Urban Development.
A HECM is not a government loan. It is a loan issued by a mortgage lender, but insured by the Federal Housing Administration, which is part of HUD.
FHA collects a Mortgage Insurance Premium (MIP) at closing that equals two (2) percent of the home’s appraised value or FHA lending limit ($1,209,750), whichever number is less. FHA also collects an annual premium equal to 0.5 percent of the outstanding loan balance. Your loan balance thus increases by the amount of this fee. The insurance purchased by this fee protects the borrower (1) if and when the lender is not able to make a payment; and (2) if the value of the home upon selling is not enough to cover the loan balance. In the latter case, the government insurance fund pays off the remaining balance.
Currently, HECMs make up most reverse mortgages offered in America. HECMs come with rules and regulations that include a requirement that the borrower receive third-party counseling.
Private-Label Reverse Mortgage
Private-label reverse mortgages are privately insured by the mortgage companies that offer them. They are not subject to all the same regulations as HECMs, but as a standard best practice, most companies that offer private-label reverse mortgages emulate the same consumer protections that are found in the HECM program, including mandatory counseling.
Private-label reverse mortgages can meet the needs of older homeowners whose properties are ineligible for FHA financing — such as units in non-FHA approved condominiums or some planned unit developments (PUDs) — or if their home values exceed $1 million.
These loans are sometimes referred to as “jumbo” reverse mortgages because the borrowers may be eligible for more proceeds than they would be with an FHA-insured HECM.
HECM for Purchase
A Home Equity Conversion Mortgage (HECM) for Purchase is a reverse mortgage that allows seniors, age 62 or older, to purchase a new principal residence using loan proceeds from the reverse mortgage.
What’s different about HECM for Purchase versus a traditional mortgage?
Borrower age:
HECM for Purchase: Exclusively for home buyers age 62+
Traditional mortgage: No age restriction (except being legal age to enter a contract)
Repayment requirements
HECM for Purchase: Flexible repayment feature — The borrower can choose to repay as much or as little as they like each month, or make no monthly principal and interest payments. The flexible repayment feature makes it easier for a buyer to afford the home they really want, preserve more savings and retirement assets, and improve cash flow. As with any mortgage, the borrower must keep current with property-related taxes, insurance and maintenance as part of their ongoing loan obligations. Repayment is generally required once they sell the home, pass away, move out or fail to meet their loan obligations.
Traditional mortgage: Monthly principal and interest payment required. Builds equity as the loan is paid down.
Down payment amount
HECM for Purchase: Required down payment between approximately 40% and 60% of the purchase price, depending on buyer’s age or Eligible Non-Borrowing Spouse’s age, if applicable. (This range assumes closing costs will be financed.) The rest of the funds for purchase come from the HECM loan. This allows the buyers to keep more assets to use as they wish, as compared to paying all cash, while still having the flexibility of no required monthly mortgage payments.
Traditional mortgage: Typically requires a smaller down payment.
Eligible Properties
HECM for Purchase: Single-family homes; FHA-approved condominiums; townhouses or Planned Unit Developments (PUDs); 2-to-4 unit homes that are owner-occupied; and manufactured homes meeting HUD guidelines.
Traditional mortgage: Single-family homes; condominiums; townhouses or Planned Unit Developments (PUDs); 2-to-4 unit homes that are owner-occupied; manufactured housing; second homes; vacation homes; and investment properties.
Protection Against Owing More Than Home Is Worth
HECM for Purchase: A Federal Housing Administration (FHA)-insured* program, HECM for Purchase has a non-recourse feature, which means the borrower can never owe more than the home is worth when the loan is repaid. The home is the only source of repayment regardless of the loan balance at maturity.
Traditional mortgage: Most do not have a non-recourse feature. Since home values can decline, the borrower could owe more than the home is worth.
