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What is a reverse mortgage?
A reverse mortgage is a special type of home loan that allows you to convert part of the equity in your home into cash without having to sell your home or pay additional monthly bills.
Reverse mortgages may be a good option for seniors:
- When selling your home may not be profitable due to capital gains taxes; or
- When you are seeking to improve your standard of living by increasing your income.
Proceeds from a reverse mortgage can be used:
- For living expenses;
- For medical expenses;
- To pay off the remaining first mortgage; or
- Any other purpose.
Reverse mortgage loans do not have to be paid back until the owners die or move out. Owners may use proceeds of the sale of the home to pay off the loan. If the owners die, heirs may sell the home to repay the loan. If the heirs cannot repay the loan, the lender gains possession of the property.
Reverse mortgages also come in a wide variety of options, shapes and sizes. A reverse mortgage that worked for your neighbor may be the worst thing for you. The only reverse mortgage insured by the U.S. Federal Government is called a Home Equity Conversion Mortgage or HECM, and is only available through an FHA approved lender. The U.S. Department of Housing and Urban Development insures HECM loans. Governments and private corporations also offer reverse mortgage products. Usually, HECM loans are the least expensive reverse mortgages.
- Be 62 years of age or older,
- Own the property outright or paid-down a considerable amount,
- Occupy the property as your principal residence,
- Not be delinquent on any federal debt, and
- Participate in a consumer information session given by a HUD- approved HECM counselor.
The following eligible property types must meet all FHA property standards and flood requirements:
- Single family home or 2-4 unit home with one unit occupied by the borrower
- HUD-approved condominium project
- Manufactured home that meets FHA requirements
- Income, assets, monthly living expenses, and credit history may be verified.
- Timely payment of real estate taxes, hazard and flood insurance premiums may be verified
Read the Law: 12 United States Code 1715z-20
Maryland's Reverse Mortgage Loans Act, passed in 2010, requires that a lender, on receiving an application for a reverse mortgage loan, shall provide a prospective borrower with a written checklist, written in 12 point type or larger, advising the borrower to discuss the following issues with a counseling agency counselor:
- How unexpected medical or other events that cause the borrower to move out of the borrower's home earlier than anticipated will impact the total annual cost of the reverse mortgage loan;
- The extent to which the borrower's financial needs would be better met by options other than a reverse mortgage loan, including less costly home equity lines of credit, property tax deferral programs, or governmental aid programs;
- Whether the borrower intends to use the proceeds of the reverse mortgage loan to purchase an annuity or other financial or insurance product and the consequences of doing so;
- The effect of repayment of the reverse mortgage loan on other residents of the home securing the reverse mortgage loan after all borrowers have died or permanently left the home;
- The borrower's ability to finance routine or catastrophic home repairs, especially if maintenance is a factor that may determine when the reverse mortgage loan becomes payable;
- The impact that the reverse mortgage loan may have on the borrower's tax obligations and eligibility for government assistance programs, and the effect that losing equity in the home securing the reverse mortgage loan will have on the borrower's estate and heirs; and
- The ability of the borrower to finance alternative living accommodations, such as assisted living or long-term care, after the borrower's equity is depleted. Read the Law: Md. Code, Commercial Law § 12-1207
How a reverse mortgage works
The HECM lets you choose among several payment options. You can select a:
- Term option – fixed monthly cash advances for a specific time.
- Tenure option – fixed monthly cash advances for as long as you live in your home.
- Line of credit that lets you draw down the loan proceeds at any time in amounts you choose until you have used up the line of credit.
- Combination of monthly payments and a line of credit.
If your circumstances change, you can change your payment option for a fee of $20.
Other characteristics of reverse mortgages:
- Borrowers remain the owners of the home;
- Borrowers are still responsible for all applicable taxes, insurance, maintenance, and repair; and
- Borrowers can never owe lenders more than the value of their home at the time the loan is repaid.
The amount that a person may take out depends upon:
- The age of the youngest homeowner;
- The current interest rate;
- The appraised value of the home; and
- Government imposed lending limits.
The Department of Housing and Urban Development sets a mortgage limit for HECM reverse mortgage loans. Even if a person has equity in a home above the mortgage limit, the borrower will only be able to borrow up until the mortgage limit ($765,600 in 2020).
Pitfalls - Use Caution
Most financial counselors advise seniors to be careful when considering a reverse mortgage. While a reverse mortgage can be a great opportunity for an older person to draw on the equity of his or her home to obtain a better lifestyle, this type of loan is not for everybody. It can be costly, and an elderly homeowner may only see 30% to 80% of the value of their home through a reverse mortgage. There are also a number of fees. Typically, taking out an HECM loan includes:
- An origination fee (capped at $6,000);
- Closing costs;
- A mortgage insurance premium;
- Interest; and
- A servicing fee of $35 per month.
Some carry fixed interest rates and some are adjustable. Also, because of the disparity in the amount of home equity that younger borrowers can get versus what older borrowers can get, it may be wise to hold off. In general, the older you are, the more equity you have in your home, and the less you owe on it, the more money you can get.