Reverse Mortgages

If you're having trouble paying bills, or you simply want to enjoy a richer lifestyle in your retirement years, then you should give serious thought to tapping into your home's equity via a reverse mortgage.  For many Americans, the single most valuable asset they own is their home.  Reverse mortgages allow seniors to generate a steady stream of income - and here's how they work.

Reverse Home Mortgage

In this article, we're going to help answer the question:  What is a reverse mortgage?  We're also going to explain how a reverse mortgage works, as well as helping you to understand the different types of reverse mortgages offered on the market today.  Finally, we're going to finish up with some information on how reverse mortgages are calculated, their income tax treatment, and the costs associated with this type of loan.

What is a Reverse Mortgage?

A reverse mortgage allows homeowners to release the equity they have in their homes, and turn that equity into a steady stream of monthly income.  The big advantage of a reverse mortgage is the equity in a home can be leveraged without selling the home.

With a conventional mortgage, you're making monthly payments to a lender to pay off a loan.  With a reverse mortgage, the arrangement is just the opposite - you're receiving money from the lender.  That's where the term "reverse" comes from.
 
Since the lender is paying you each month, a reverse mortgage is like slowly selling back a portion of your home to the lender.  You're creating a loan that eventually needs to be paid back.  The loan is usually paid back when you and your spouse pass away, when the home is sold, or when that house is no longer used as your principal residence.

Qualifying for a Reverse Mortgage

While each lender may have a slightly different set of rules, there are generally four requirements to qualify for a reverse mortgage:

• The borrower must be a homeowner.
• The borrower must be age 62 or older.
• The home must be owned outright (no mortgage), or have a low mortgage balance.
• The homeowner must live in the home.

Once obtained, there are three additional requirements you need to agree to:

• The home must be maintained in good condition.
• Continued payment of property taxes and homeowners insurance.
• Title and ownership of the home must remain in your name.

Generally, the home itself must be a single family dwelling or a two-to-four unit property.  Townhouses, detached homes, FHA approved condominiums, and some manufactured homes are also eligible for reverse mortgages.

Information released by the US Department of Housing and Urban Development indicates that over the past 15 years, more than 300,000 senior citizens have taken advantage of the benefits reverse mortgages have to offer.

Reverse Home Loans

Now that you understand how a reverse mortgage works, and how to qualify, we're going to turn our attention to the loans themselves.  There are three basic types of reverse mortgages:

• Single Purpose Reverse Mortgages - that are offered by nonprofit organizations, state, and local government agencies.  These loans generally have very low costs, but availability is limited.  There may also be income restrictions for these loans.
• Federally Insured Reverse Mortgages - these loans are backed by the U.S. Department of Housing and Urban Development (HUD), and are called HECMs (Home Equity Conversion Mortgages).  The amount of money borrowed depends on your age, type of mortgage selected, value of your home, interest rates, and where the home is located.
• Proprietary Reverse Mortgages - these are reverse mortgages that are developed and backed by private lenders.  Like the HECM, these loans tend to have higher upfront costs and can be expensive in the short-term.  One of the more popular proprietary loans is the Fannie Mae HomeKeeper Mortgage.

Statistically, HUD's reverse mortgage program covers almost 90 percent of the reverse mortgage market.  You can find a list of HUD approved lenders, by state, here.

Reverse Loan Payments

In general, there are five ways that you can receive payment with a reverse home mortgage:

• Term - these are equal monthly payments that continue only for a fixed period of months.
• Tenure - these are equal monthly payments that continue as long as at least one borrower is alive and continues to occupy the home as a principal residence.
• Line of Credit - these payments are unscheduled, or occur in installments, at times, and in amounts, that are chosen by the borrower until the line of credit is exhausted.
• Modified Term - these payments are a combination of line of credit with monthly payments that last for a fixed period of months, as chosen by the borrower.
• Modified Tenure - this type of loan is a combination of line of credit with monthly payments that continue for as long as the borrower remains in the house.

Reverse Mortgage Calculations

The factors that go into calculating reverse mortgages are quite complex.  In fact, you'll find there are very few reverse mortgage calculators on the web.  Here we're going to provide you with an example calculation, as well as the factors driving the payment received with this type of loan.

Mortgage Factors

The factors that are used in a reverse mortgage calculation include:

• Interest Rates - the overall rate of interest charged on a reverse mortgage includes an index rate plus a lender's margin.
• Interest Rate Cap - since these mortgages work off an index, there is a cap placed on the loan to limit the interest rate charged.
• Creditline Growth - this is a factor that tells you how fast your credit line will grow each year if you decide not to use the line of credit you're offered.
• Value of Home - this is the current market value of the home you live in.  The net value of the home used to calculate the reverse mortgage will take into consideration liens or other costs to repair the home.
• Fees - this includes appraisal fees ($300 - $500), mortgage insurance premiums ($4,000- $7,000), origination fees ($4,000 - $7,000), closing costs ($500 - $1,000), and loan servicing fees ($30 - $50 per month).

The above numbers demonstrate how costly a reverse mortgage is to the borrower.  The loan itself can easily cost you $5,000 or more in fees.  That being said, and as the example below demonstrates, a reverse mortgage - even with its high fees - can supply retirees with a significant source of retirement income.

Reverse Mortgage Example

In this example, our retiree is a 70 year old living in Middle America with a home value of $300,000.  The table below demonstrates three payment options - a lump sum, creditline, or monthly payments for the two most popular reverse mortgages on the market today.

Please note that although they are not clearly seen in the example above, the fees mentioned in the prior section do apply to these loan amounts.  In fact, for this example the fees were in the $15,000 range.  But as the above numbers show, this borrower can enjoy nearly $1,000 in monthly retirement income, for life, with a reverse home mortgage.

Reverse Mortgages and Income Taxes

The money received under a reverse mortgage agreement is considered a loan, not household income.  As such, the funds received are not subject to federal or state income taxes, and will not have any effect on benefits received under the Social Security program.

Borrowers that receive Medicaid benefits, or Supplemental Security Income (SSI), are not affected if the money received is spent in the same month they are received.  That being said, when in doubt, you should always consult with a tax advisor.

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