Can a reverse mortgage pave your financial future?
Posted On May 17, 2017
There are TV commercials aplenty that tout reverse mortgages, guaranteeing “income for life.” Perhaps you’ve wondered if one could supplement your retirement income, or that of your parents. The retirement span has increased, and a reverse mortgage can pay for rising health-care costs, travel, or home maintenance.
Reverse mortgages are home loans that allow people, ages 62-plus, to convert a portion of their home equity into cash, as long as a home remains the primary residence. The loan is repaid when a person dies or sells the home, or when it’s no longer the primary residence. Most reverse mortgages are offered through the Department of Housing and Urban Development (HUD) and guaranteed by the Federal Housing Administration (FHA) through the Home Equity Conversion Mortgages (HECM) program.
New rules pertaining to reverse mortgages took effect on September, 30, 2013. Now more than ever, it’s advisable to carefully review the pros and cons of reverse mortgages, says financial expert and author Jean Chatzky, a frequent Today show contributor who offers money classes through her website, Jeanchatzky.com.
“Reverse mortgages tend to be the most worthwhile for retirees who don’t have a large income, but who have homes that are valuable,” Chatzky says. “I recommend putting off a reverse mortgage until you truly need the money. If you exhaust all of the equity in your home when you’re younger, you won’t have a nest egg for later in life.”
Chatzky says it will be harder for consumers to qualify for a reverse mortgage. Beginning January 14, 2014, new underwriting standards took effect for these applications to ensure that borrowers have the ability to pay property taxes and insurance over the life of the loan. The new regulations also reduce the maximum home equity that borrowers can access. It will still depend largely on the borrower, value of the home, and interest rate.
“Lenders will be required to ensure that borrowers will be able to pay their required tax and insurance premiums over the life of the loan by examining all sources of income and credit history,” Chatzky says. “If a lender determines you might not be able to keep up with your taxes and insurance payments, they will be authorized to set aside a certain amount of funds from your loan to pay for future charges.”
For those on a fixed income, or who plan to leave their home to their heirs, a reverse mortgage may not be the best option. Other options include a home equity line of credit (HELOC)—a loan in which the lender agrees to lend a maximum amount within an agreed period, where the collateral is the buyer’s equity—or a REX agreement that enables homeowners to tap their home equity without interest or monthly payments.
Chatzky recommends taking the following costs under consideration before applying for a reverse mortgage loan:
Origination fee. This covers the lender’s operating expenses associated with originating the reverse mortgage. Under the HECM program, which accounts for most reverse mortgages made in the US today, the maximum origination fee allowed is 2 percent of the initial $200,000 of the home’s value and 1 percent of the remaining value, with a cap of $6,000. Some lenders waive or reduce the origination fees on certain products.
Mortgage Insurance Premium (MIP). This fee is paid by the borrower to the FHA to provide certain protections for both the lender and borrower in a reverse mortgage. As of September 30, 2013, a new upfront MIP was adopted and the fee is based on the amount of funds drawn within the initial year. Borrowers who take out more than 60 percent the first year will have to pay a higher upfront MIP (2.5 percent of the appraised value of the property) than those who withdraw less than 60 percent (0.5 percent of the appraised value).
Appraisal fee. An appraiser assigns a current market value to your home. Appraisal fees vary by region, type, and value of home, but average around $450.
Closing costs. Expect to pay certain closing costs, which are the same for any type of mortgage, including items such as a credit report, recording, escrow, title policy, and so on. These costs vary per state, with Hawaii and Alaska ranking as the states with the highest closing costs in Bankrate’s 2013 survey (with fees totaling $2,919).