Buying a Home with a Reverse Mortgage
You can’t blame senior adults who are wary about buying a new home. After years of work, they might not want to be tied down to a long-term mortgage. Or they might be hesitant to take on a new monthly payment that could strain an already tight budget.
However, there is a lesser-known way to buy a home as a senior adult that addresses some of these concerns. You can actually use a reverse mortgage to buy a new home — and you won’t have to worry about making payments each month.
What is a reverse mortgage?
In simple terms, a reverse mortgage is a loan based on the amount of equity you have in your home. Unlike traditional loans, you don’t have to make monthly mortgage payments. Instead, you receive the loan money as a lump sum, in monthly payments, or through a line of credit. The lender gets paid back when you no longer live in the home you’re borrowing against, usually through selling the home.
The most common type of reverse mortgage is known as a home equity conversion mortgage, or HECM, and is guaranteed by the Federal Housing Administration. To qualify for this loan, you must be 62 years old or older and have substantial equity in your home or own it outright. There’s no specified minimum credit score to qualify, but lenders will look at your overall financial picture.
How much money you’re able to receive is based on your age, your equity and the current interest rates on reverse mortgages. That being said, a HECM loan can never be more than $726,525, per federal limits.
Like traditional mortgages, a HECM can have a fixed or adjustable interest rate. Interest accumulates over time, increasing your loan balance. The amount due is paid at the time you move out, sell the home or pass away.
However, a HECM is a non-recourse loan, meaning you or your heirs won’t have to pay the difference if you end up owing more than your house is worth.
Reverse mortgages can be a good way to increase your income in retirement, providing money for medical expenses, property taxes, travel or unexpected bills. They’re also a way that many seniors can afford to stay in their homes — while keeping ownership of their property.
“The No. 1 misconception that I hear is that the bank owns the property or the bank takes the property, and that’s absolutely not the case,” says Steve Irwin, executive vice president of the National Reverse Mortgage Lenders Association. “It is a loan against the property, and it is a loan that will have to be paid back eventually, but the bank doesn’t take title to the property. The borrower still owns it.”
How a reverse mortgage can help you buy a home
Although most senior adults take out a reverse mortgage on their existing homes, you also can use one to buy a new home. Called the “HECM for Purchase” program, this reverse mortgage works similar to a traditional one, but with a few twists.
Instead of buying a new home and then taking out a reverse mortgage on it, the HECM for Purchase program combines the two transactions. Your down payment on the new home typically comes from the proceeds of the sale of your previous home. The remainder of the purchase price comes from the HECM loan.
The down payment, your equity, and the value of the new home is used to calculate the reverse mortgage loan amount. Like a regular reverse mortgage, you then will receive monies through regular payments or in a lump sum. The loan will have to be repaid when you leave the home or pass away.
- Who qualifies: Like a regular HECM, borrowers must be age 62 or older.
- What types of property qualify: Single-family homes; townhouses; FHA-approved condominiums; two-to-four unit homes wherein the borrower lives in one unit; and manufactured homes that meet HUD guidelines. Also, the property must be the borrower’s primary residence.
- What credit score is needed: No minimum requirement.
- Down payment: Unlike a traditional mortgage or HECM, the down payment on a HECM for Purchase is substantially higher. The required down payment ranges between 45% and 62% of the property’s purchase price. This figure depends on the borrower’s age.
- How much can you borrow: While a regular HECM is limited to $726,525, when buying a home through the HECM for Purchase program, the loan amount will be based on the home’s sale price.
The large down payment may seem like a hindrance, but many borrowers can use the proceeds from the sale of their current residence to buy the new home.
While there is no required credit score to qualify for a HECM for Purchase, that does not mean lenders won’t be looking at your credit history.
Essentially, Irwin says, the underwriters want to make sure the reverse mortgage is a viable solution for the borrower, one that enables them to age in place, as well as provide enough residual income for them to pay their regular living expenses.
As part of the application process, you will have to participate in an informational reverse mortgage counseling session with the U.S. Department of Housing and Urban Development, or HUD. “The applicant will have to meet with an FHA-approved housing counselor to review all of the product features of the reverse mortgage and to possibly explore other benefits that may be available to that applicant in their locality,” Irwin says.
Of course, it’s important to note that a HECM for Purchase also includes many of the same fees that accompany a traditional or reverse mortgage. Most of these costs can be paid using the proceeds of the loan so you don’t pay out of pocket, although that will reduce how much you will receive. These fees include:
- Mortgage insurance premium (MIP): As a FHA-guaranteed loan, a HECM requires FHA mortgage insurance. At the time of closing, an initial MIP fee of 2% will be charged. Then, for the life of the loan, you will be charged an annual MIP equaling 0.5% of the mortgage balance.
- Origination fee: This fee covers the cost of processing your loan. It is the greater amount between $2,500 or 2% of the first $200,000 of the home value plus 1% of the amount more than $200,000. The maximum allowed fee is $6,000.
- Third-party fees: These include the usual fees associated with any mortgage: appraisal, title search, survey, inspection, recording fees, credit checks and so on.
- Servicing fee: This is an ongoing fee for the life of the loan, and covers disbursing loan proceeds, sending account statements, and verifying payments for property taxes and homeowners insurance. Lenders can charge no more than $30 per month for loans with a fixed interest rate or an adjustable rate that changes each year. For loans with adjustable rates that change each month, lenders can charge a maximum of $35 per month.
Given how hefty these fees are and the fact that many must be paid upfront, it’s important to consider how long you will be in the home. If you plan to relocate in the near future, want to downsize in a few years or face the possibility of moving into assisted living or a nursing home, these fees may be cost-prohibitive to the overall benefits of the HECM.
It’s also important to consider that, because there is no escrow account, you will be responsible for paying your annual property taxes and homeowners insurance. Borrowers can make arrangements with their lenders to set up an escrow account to pay the property taxes and homeowners insurance using funds from the HECM.
You also will have to keep the home well-maintained through the life of the loan. Failure to do so could adversely affect your HECM loan status.
Pros and cons of buying a home with a reverse mortgage
Before applying for a HECM for Purchase, it’s important to examine all the pros and cons of a reverse mortgage to ensure it makes sense for your personal finances.
- You don’t have to make regular payments.
- You won’t have to tap into your retirement savings.
- You’ll never owe more than the value of your home.
- The supplemental income received from a HECM is tax-free.
- You get to stay in the home and retain the property title.
- You’ll have to make a much larger down payment than a traditional mortgage.
- The costs can be very high and can erase your home equity at a fast pace.
- Many HECMs have adjustable rates, so it’s likely the interest rate will increase during the life of the loan, which also will reduce your home equity.
- You could lose all of your home equity to the loan.
- The home likely will need to be sold upon your death to pay back the loan. Heirs have the option to repay the loan from their own savings.
The bottom line
Buying a new home using a HECM for Purchase loan could be an ideal choice for many senior adults. However, before doing so, it’s important to examine your entire financial situation to make sure this product is the right fit for your needs. If so, you could be on your way to a new home.
The information in this article is accurate as of the date of publishing.