Reverse Mortgage Mini-Series: Part II
Thanks to new regulations and requirements that made a reverse mortgage a more appealing planning strategy for aging clients in multiple scenarios, we’re dedicating time to a mini-series that share more information on what a reverse mortgage is, how it works, and more. In the first article of this mini-series, we provided a basic overview of Home Equity Conversion Mortgages (HECM), which are federally-insured reverse mortgages offered and regulated by the U.S. Department of Housing and Urban Development (HUD).
In Part II of the mini-series, we will cover additional details on HECMs including what factors affect the calculation of the loan value, additional costs to consider, how the payments work and how the loan is repaid. We will also include a brief overview of using HECMs to purchase new homes.
What goes into the loan value calculation?
The loan value for which a borrower qualifies is based on three things:
- The age of the youngest borrower on the loan (or an eligible non-borrowing spouse)
- The current interest rate; and
- The lesser of the appraised value of the home or the HECM FHA limit ($822,375) or the sales price
In general, the amount one can borrow increases with age.
What are all of the costs associated with an HECM?
As with traditional (or forward) mortgages, there are costs associated with closing and servicing the loan. With an HECM, the associated costs include:
- A Mortgage Insurance Premium (MIP)
- At closing, a borrower will pay between 0.5% and 2.5% for FHA mortgage insurance. These costs can be paid out of pocket or financed as part of the loan (thereby reducing the total loan value available to you).
- An Origination Fee
- The borrower will pay a fee to the lender for the processing of the HECM loan. This fee is the greater of $2,500 or 2% of the first $200,000 of the home value plus 1% of the value over $200,000. The maximum origination fee for an HECM is $6,000.
- Third Party Charges
- The borrower will pay applicable third party fees to cover items such as an appraisal, inspection, credit checks, title search and insurance, and more.
- Servicing Fee
- Throughout the life of the loan, lenders can charge the borrower up to $30 per month (for loans with fixed or annually adjusting interest rate loans; $35 for monthly adjusting interest rate loans) for servicing the HECM with things like disbursing the loan proceeds, monitoring that the borrower is meeting loan requirements (paying real estate taxes and other requirements), and sending account statements.
How do the payments work?
As discussed in Part 1 of this mini-series, there are five payment types: tenure, term, line of credit, modified tenure and modified term. Four of the five options (all but the line of credit) involve some level of equal monthly payments to the borrower, generally paid directly to a bank account.
The line of credit option (and the line of credit portion of both modified payment options), provides the borrower access to a line of credit equal to the loan value (up to the amount of the loan value, or whatever portion of the loan value not paid in monthly installments for the modified options). The line of credit can be used any time and in any amount (up to the loan value), and any portion borrowed may be paid back at any time.
Unlike a Home Equity Line of Credit (HELOC), however, the HECM line of credit is not required to be paid back monthly or paid back at all until the last borrower dies or leaves the home. And over time, the unused portion of the line of credit actually grows, due to the inner workings of reverse mortgages, which provides the borrower access to additional funds.
While income received from a reverse mortgage is not taxable income, and thus does not affect things like Medicare premiums, there are specific programs for aging Clients that measure assets, and a reverse mortgage may cause a borrower to become ineligible. For example, if the surviving spouse needed to go to a nursing home, the home would have to be sold to repay the reverse mortgage. Any proceeds from the sale of the home not used to repay the HECM then become assets of the surviving spouse (and are no longer sheltered by any sort of home exemption).
How is the loan repaid?
With HECMs, the loan is required to be repaid when the last borrower dies or permanently leaves the home. In many cases, the home will be sold (by the borrower, if leaving, or the heirs) to repay the loan in full, but it does not have to be. If it is, any proceeds from the sale of the home above the loan repayment are kept by the seller. If the home sale value happens to be less than the loan repayment, only the sale value will be required to be paid back. The seller of the home will not be required to pay more than that; The Department of Housing and Urban Development takes that hit (which is part of the reason why insurance is required on each HECM).
If the borrower or heirs have enough cash to pay off the loan, he/she/they can do so and keep ownership of the home.
Using HECMs to purchase new homes
In addition to acquiring a HECM for a currently owned home (for reasons like paying off the last bit of a traditional mortgage or increasing cash flow, to name a couple), borrowers can use HECMs to purchase new homes, too (called a Home Equity Conversion Mortgage for Purchase or H4P). Identical to the requirements for a HECM on a currently owned residence, the house to be purchased must meet be a primary residence that is a:
- Single-family home
- 2- to 4-unit home with 1 unit occupied by the borrower
- Condominium approved by the U.S. Department of Housing and Urban Development (HUD); or
- FHA-approved manufactured home.
The borrower, too, must meet the same requirements like being age 62 or older and showing willingness and ability to pay property taxes and insurance.
The difference in this scenario is that the borrower must have a large sum of money up front to pay for the remainder of the new home. This sum can come from other investments or the proceeds from selling the current home.
HUD will calculate this figure by looking at the age of the youngest borrower, the value of the home being purchased and the closing costs. HUD will then subtract the available HECM loan amount to come up with the final amount the borrower must pay up front. Again, older borrowers generally have higher HECM loan amounts available, and thus would pay less up front. In general, the amount a borrower pays is between 45-55% of the sale price of the home.
Summary
In summary, reverse mortgages can be a useful planning tool for some. HECMs can be used to pay off the last bit of remaining traditional debt, increase monthly cash flow to support regular spending, pay for in-home nursing care for a borrower who wants to age in place, or even to purchase a new home. The loan values are calculated by age, interest rate and home value; payable to the borrower in five different ways; and do not require any repayment until the borrower’s death or departure from the home permanently.
The information we’ve shared in Parts I and II of our mini-series are specific to the HECM, a HUD regulated product. There are also proprietary reverse mortgage products available now that have higher lending limits. Stay tuned for Part III of our mini-series with more information about these products.
Every Client’s situation is different and a thorough review of each Client’s full financial picture is required to give a fiduciary recommendation. Don’t hesitate to contact us if you would like to discuss reverse mortgages in further detail.