What Are the Rules for a Reverse Mortgage?
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If you’re a senior struggling to deal with rising costs on a limited income, a reverse mortgage offers a potential financial solution. In short, reverse mortgages allow senior homeowners to convert some of their equity they’ve built up in their to cash.
This article will provide an overview of reverse mortgage rules to help you determine if this is a good option for you.
What is a reverse mortgage?
A reverse mortgage is a type of home loan that lets homeowners borrow a portion of their equity without needing to pay it back until they pass away or leave the home.
With a traditional mortgage, you make a payment each month, that goes toward paying down the principal and interest. Over time, you pay off the loan. However, with a reverse mortgage, the opposite occurs. The homeowner does not make mortgage payments. Instead, the interest accumulates over time and is added to the balance. This balance continues to grow until the loan is paid off, typically either when the homeowner vacates the house or dies.
While the idea of not having to make mortgage payments might sound great, a reverse mortgage is not for everyone. In fact, there are strict rules governing who can apply for one. Reverse mortgages are designed for seniors who are ages 62 and older.
For someone who is living on limited retirement funds, a reverse mortgage provides a way to bring in additional income. “The majority of my clients are primarily living off of Social Security [and] maybe a small pension and some savings,” says Eric Rittmeyer, a certified reverse mortgage professional and founder of Fidelis Mortgage in Baltimore.
“This loan basically gives them access to some of the equity.”
The most common type of reverse mortgage is known as a Home Equity Conversion Mortgage, or HECM. It’s insured by the Federal Housing Authority and can only be offered by an FHA-approved lender. Strict rules dictate who qualifies and how much money a borrower can receive.
Some private lenders offer proprietary reverse mortgage products. If you’re considering getting a non-FHA-backed reverse mortgage with a private lender, that lender may have its own guidelines.
Rules for qualifying for a reverse mortgage
Since reverse mortgages were designed primarily to help seniors, one of the main HECM rules is that the borrower must be 62 years old or older. However, there are other criteria that must be met.
Your home must be your primary residence
You can’t take out a reverse mortgage on a second home or rental property.
You must have a substantial amount of equity in your house
Lenders typically require that you have at least 50% equity in your house because the reverse mortgage must pay off your existing home loan first.
You must have enough money to maintain the house
While you don’t have to make a mortgage payment, you’re still responsible for paying taxes on the house as well as paying for home insurance. You’re also expected to pay for regular upkeep and repairs to the home as needed. If your house is in bad shape when you apply for a reverse mortgage, you may be required to make repairs before the loan is approved.
You must attend a counseling session
The FHA requires all seniors who are applying for a reverse mortgage to meet with a HUD-approved HECM counselor. They want to make sure that you understand how reverse mortgages work and don’t fall prey to some unscrupulous lender who may try to get you to do something you don’t want to do.
The FHA also wants to make sure you understand that there are fees associated with taking out a reverse mortgage. Just like you’d pay lender’s fees and closing costs when taking out a traditional mortgage loan, you’ll be charged lender’s fees and closing costs when taking out a reverse mortgage, as well. Some people choose to roll such fees into the loan, though it costs more to do that than to pay the fees upfront. A counselor makes sure you understand all of this, and you can find one from this list of HUD-approved counseling agencies.
Rules for how much you can borrow on a reverse mortgage
Since the balance of your reverse mortgage loan grows over time, if you took out all of your equity you’d end up owing more than the house is worth. Lenders don’t want that to happen, so they set caps on how much you can borrow.
When you’re approved for a reverse mortgage, there are a few factors that determine how much you can ultimately borrow.
The age of the borrower
A reverse mortgage is designed to allow you to stay in your house for the rest of your life, so lenders want to make sure there is enough equity to let you do that as the loan balance grows each month. As a result, the older you are when you take out the reverse mortgage the more you’re able to borrow.
Someone who is 62 years old might be able to get access to 50% of the value of their property, Rittmeyer says. Someone 10 or 20 years older may qualify for more.
In addition to looking at the age of the borrower, lenders may also take into consideration the age of a younger spouse even if that spouse is not one of the borrowers on the loan. That’s because a non-borrowing spouse can continue to live in a house that has HECM financing even after the borrower dies or moves out of the house.
To be considered a non-borrowing spouse, you must be married to the borrower when the reverse mortgage is taken out, you must be designated a non-borrowing spouse in the HECM paperwork, and the house in question must be your principal residence.
The appraised value of your house and how much it’s expected to appreciate
Generally speaking, the more your house is worth and the more equity you have in it, the more you’ll be able to borrow.
The current interest rate when you take out the loan
Typically the lower the interest rate, the more you can borrow.
Rules for paying back a reverse mortgage
Once you’ve decided to take out a reverse mortgage loan, when is it time to pay it back? The loan becomes due when the last borrower or the non-borrowing spouse leaves the house permanently, either by moving away or by death. Even if other relatives are living in the house at the time, they won’t be able to stay if neither a borrower or a non-borrowing spouse still lives in the property.
However, there are a couple of situations where the loan may be due before then:
If you stop using the home as a principal residence, either by being away from the house for longer than 12 consecutive months for medical reasons or being away for most of the year for a non-medical reason. Or if you’re negligent of the property, meaning you fail to pay taxes, buy insurance or make necessary home repairs.
Once the loan becomes due, the borrower or the borrower’s heirs must pay it off. “Ninety-nine percent of the time what they are doing is they are putting the house up for sale,” Rittmeyer said. Any proceeds from the sale above the cost of the loan would go to the borrower or the heirs.
If the heirs decide they want to buy the house, they can simply pay what’s left of the loan to do so.
The bottom line
Reverse mortgages have many benefits for seniors who want access to more money to ease their retirement lifestyle. However, it’s important to understand all the rules associated with being approved for a reverse mortgage, as well as the guidelines for accessing your equity and maintaining the loan. If you’re planning to stay in the house until you die, make sure your heirs understand the reverse mortgage rules after death since they will be responsible for paying the loan back. As with all financial decisions, the more information you have, the better equipped you will be.