What this article is all about:
History of Reverse Mortgages
Prior to the availability of reverse mortgages retirees who wanted to continue living in their home, but also garner income from their home’s equity, would have very limited choices. One of the only options to convert the home’s equity into cash, while not selling the home, was to take out a home equity loan. Home equity loans usually came with a monthly payment.
For retirees that needed more income, this extra expense would eat in to cash received from the loan and deflate the net income received as a result. The limited number of solutions for this problem is one big reason reverse mortgages grew so popular.
During the 1970’s many private banks began offering this style of loan. At the time, these loans were not federally insured and talk in favor of federal insurance began to take hold. It was not until the 1980’s that federal insurance for the reverse mortgage really began to get attention.
In 1987 an insurance bill called the Home Equity Conversion Mortgage Demonstration* was passed by Congress. The following year, President Ronald Reagan signed the bill into law allowing the Federal Housing Administration (FHA) the authorization to federally insure reverse mortgages. Federal insurance helped reduce the interest rates at which these loans could be acquired and expanded eligibility to a broader group of people.
Key Differences between Conventional and Reverse Mortgages
Reverse mortgages are not like the conventional forward mortgages you are used to. Although there are a few similarities, such as the fact that both loan types include interest charges as well as income and credit requirement to qualify, there are also distinct key differences between the two.
Forward mortgages usually require a down payment, commonly ranging from 5-20 percent of the home value, whereas reverse mortgages require no down payment.
Conventional mortgages require scheduled monthly payments, while reverse mortgages do not. In fact, a reverse mortgage could provide you with income every month if you choose the disbursement option.
Unlike conventional mortgages, reverse mortgages are usually paid back using the proceeds from the sale of the home once the loan matures. Repayment of reverse mortgage loan is due in full if the borrower moves out of the home, defaults on the loan according to loan terms, or becomes deceased.
Reverse mortgages have a minimum eligible age requirement of 62, whereas conventional mortgages have no such requirement.
In a conventional mortgage, the homeowner’s home equity (the value of the home beyond any outstanding mortgage balance) increases, while the loan principal (the initial amount borrowed) decreases. With a reverse mortgage, the home equity decreases while loan principal increases.
Benefits & Common Pitfalls
Like any financial product, there are pros and cons to reverse mortgages. For many seniors, they are a great solution to deliver a monthly income while continuing to live in their homes. So why would you consider a reverse mortgage?
Costs can be high when compared to conventional mortgages. This includes the interest rate, mortgage insurance fees, loan origination fees, appraisal fees, title insurance fees, and other closing costs. These costs can usually be rolled into the loan, so that you won’t have to pay out of pocket, but it can reduce the amount of your monthly income or increase the repayment amount when the loan comes due.
It may be difficult for your heirs to keep the home. If keeping the home in the family is an important personal preference, a reverse mortgage might not be the best option. Your home is usually sold to pay back the loan and although your heirs will receive the rest of the proceeds after the loan is paid, the home will be out of their ownership. If your heirs choose to keep the home they must first pay back the loan in full. Also, consider what the market value of your home may be should such a situation arise.
The loan becomes due in full if you leave the home. If, for example, you find that you must move to an assisted living facility for more than a year, the loan would become due. The loan may also become due in full if you default on your loan terms by failing to pay property taxes, homeowner’s insurance, or perform regular home maintenance. When the loan becomes due, you may have to sell your home to repay the balance.
Get tax-free income with no monthly mortgage payment. A popular reason among many retirees to secure reverse mortgages is the benefit of taking the equity available in their home and converting it into tax-free cash, while eliminating monthly mortgage payments. This shift from monthly payment to monthly income can offer exceptional economic relief.
You remain the owner of your home while receiving its equity. Before reverse mortgages, receiving your homes equity either meant you took on a home equity loan with an additional monthly mortgage payment, or you sold your home. With reverse mortgages, you are able to receive your home’s equity while retaining ownership and living there as long as you wish.
Reverse mortgages are insured by the Federal Government and are a non-recourse loan. This means a few things:
The government guarantees you will receive your scheduled payments.
If you choose a line of credit as your disbursement option, your available line of credit will not be withdrawn.
If ever your home’s value dips below your loan balance, you will only owe what the home is valued when sold.
Like any loan, you should do your research to ensure a reverse mortgage is right for you. For senior homeowners who plan to move into a nursing facility or have heirs who want the home, a reverse mortgage may not be helpful. If you would benefit from access to your home equity, plan to age at home, and are comfortable with the property being sold at the maturity of the loan, a reverse mortgage may be the best option for financial security in your retirement years.
Resource Center & Glossary
Key terms – in plain English
Conventional Mortgage – Also referred to as a forward mortgage, this is the standard loan product for purchasing a home. A down payment is usually required to secure the loan, and there are varying income and credit requirements as well. This loan type is characterized by recurring monthly payments amortized over a pre-defined period of time, where each payment reduces the loan principal so that the principal is paid off at the end of the term.
FHA – The Federal Housing Administration is responsible for insuring and guaranteeing many real estate financial products, including reverse mortgages.
Home Equity – This is the value of your home in excess of any debt obligations on that home.
HUD – The Department of Housing and Urban Development administers many programs that facilitate home buying for various socio-economic groups.
Loan Principal – The initial amount borrowed from the lender to secure the home purchase.
Non-recourse – This means that the government provides certain guarantees and securities related to your loan, many of which are detailed above.
Reverse Mortgage – This is a non-stantard loan product for a very specific population that allows for borrowers to turn their home’s equity into liquid assets, among other options. This loan does not require a down payment, but there are various other requirements for securing the loan. This loan is primarily charecterized by the lack of any monthly payments, and commonly a tax-free payment back to the borrower. Unlike with a conventional mortgage, the home’s equity decreases during the term of the loan while the principal increases.