Considering an HECM Reverse Mortgage? Here’s What You Need to Know.
Demand has been increasing for reverse mortgages year after year. Economic effects of the Covid-19 pandemic and inflation have left many homeowners in difficult financial situations. At the same time, home prices have been soaring in recent years. A reverse mortgage is an option to consider for senior homeowners who want to tap into their home equity.
What is an HECM Reverse Mortgage?
There is one reverse mortgage program that has garnered the most attention. The HECM Reverse Mortgage is the only one backed by the U.S. government. HECM stands for Home Equity Conversion Mortgage, and it is only available through an FHA-approved mortgage lender. It allows homeowners to leverage their home equity and cash out some of that money to be used for other important expenses.
There were only 2,600 reverse mortgages issued per month in 2019, according to the National Reverse Mortgage Lenders Association (NRMLA). By May 2020, that number had nearly doubled to 5,000 a month and that trend continued into 2021 and 2022 as inflation drives up the costs of living up significantly. An HECM reverse mortgage can allow a homeowner to cash out home equity at a lower interest rate compared to personal loans and standard second mortgages. However, there are also some drawbacks to reverse mortgages. You will want to do your research and understand the process before applying for a reverse mortgage.
Skip ahead to the following sections:
How does an HECM reverse mortgage work?
What are the benefits of a reverse mortgage?
What are the drawbacks of a reverse mortgage?
How do I qualify for a reverse mortgage?
How is a reverse mortgage paid off?
What are alternatives to a reverse mortgage?
How do I apply for a reverse mortgage?
How Does an HECM Reverse Mortgage Work?
Reverse mortgages are different than other common types of home loans. They provide financing using real estate ownership and home equity as collateral. A reverse mortgage allows you to borrow cash from the equity in your house without having to make any monthly payments on the amount you borrow. The loan is repaid only when the property is sold or the homeowner passes away.
There are different reverse mortgage programs out there and some are not to be trusted. They may be taking advantage of senior homeowners in tough financial situations. You will want to look for an FHA-approved mortgage lender and ask about HECM reverse mortgages. These are insured by the Federal Housing Administration (FHA) and provide more protection to the lender and the homeowner.
HECM reverse mortgages differ from standard mortgage loans in several ways:
Available only to homeowners aged 62 or above.
The best reverse mortgages are insured through the FHA.
Reverse mortgage qualification is largely based on home equity.
Reverse mortgage amount will depend on borrowers age, existing mortgage rate, and the property’s value.
No monthly payments are required.
The reverse mortgage loan is repaid when property is sold or when the borrower moves or passes away.
HECM reverse mortgages are non-recourse loans, secured solely by the property value and not the borrower’s other financial assets.
What are the Benefits of a Reverse Mortgage?
The primary benefits of an HECM reverse mortgage are the ability to borrow cash from your home equity and not having to make any payments on the loan. You are basically cashing out your existing equity now and not worrying about repayment until the property is sold. Let’s look at a common example of a reverse mortgage loan.
A couple over the age of 65 has owned their home for 25 years. They only have five years remaining on their original loan. Over that time, their property has appreciated significantly. They opt to refinance their remaining mortgage principal with a reverse mortgage. Because of their age and property value, they qualify for a reverse mortgage that allows them to completely pay off their remaining mortgage balance while getting a monthly payment from the bank each month for the rest of their lives. They end up eliminating their monthly mortgage payment while gaining extra money each month in the form of a payment. They could also elect different payment options or a lump sum if they have other expenses (medical bills, credit card debts, car loans, etc.) that they would like to pay off.
In this scenario, a reverse mortgage sounds great. It seems like free money cashed out from their home equity. However, there are some disadvantages and warnings to understand. As we all know, there really is no such thing as “free money.”
What are the Drawbacks of a Reverse Mortgage?
A reverse mortgage is not always as great as it sounds, and it is certainly not the best solution for every senior homeowner over the age of 62. First, a reverse mortgage should not even be considered if you really don’t need the extra money. If you are doing fine with your retirement savings or pension and Social Security payments, there is no point to applying for a reverse mortgage. It is best to keep your equity in your house and pass its full value onto your heirs.
A reverse mortgage will also cost money to originate. There could be thousands of dollars required to originate the loan and pay off certain closing costs. This is money coming out of your pocket or being rolled into the loan to affect how much you are able to cash out. Mortgage insurance is also generally required on HECM reverse mortgages. Though the FHA is insuring the loan, the borrower will also have to pay an additional monthly insurance premium that will eat into their monthly payments.
Another significant concern is that reverse mortgages can lead to foreclosure. Even though there are no payments required from the homeowner, there are other obligations that must be upheld. These can include property taxes, homeowner’s insurance and HOA dues. If the homeowner defaults on any of these required payments, they could lose their home to foreclosure.
Lastly, reverse mortgage benefits can decline because of long-term inflation. You will be getting a fixed monthly payment that seems great now, but may not give you as much buying power in the future. Costs of living will go up while your reverse mortgage payment amount stays the same.
How Do I Qualify for a Reverse Mortgage?
The first qualification standard for a reverse mortgage is you must be 62 or older. You will also need to have an ample amount of equity in your home. This means it is worth significantly more than you currently owe on your existing mortgage loan.
The highest amount an HECM reverse mortgage can be is $822,375 as of 2022. This amount is adjusted each year based on prevailing home values and mortgage rates. Your borrowing limit is also known as the “principal limit.” To determine how much you can borrow, lenders will review your age, the interest rate on your current mortgage loan and the current appraised value of your home. Older borrowers with high equity and lower interest rates will generally have higher principal limits.
If you are co-borrowing with another person such as a spouse or co-signer, the principal limit will be based on the age of the youngest co-borrower on the loan.
How is a Reverse Mortgage Paid Off?
A reverse mortgage is a unique type of loan where the principal amount goes up each and every month. Rather than paying down your loan, you are adding to it as you receive each monthly payment. The longer a reverse mortgage is in place, the more will be owed when the property is sold or when the homeowner passes away.
If the remaining loan balance is higher than the value of the property when that time comes, the homeowner or heirs will not be responsible for the difference. The FHA-insurance provides non-recourse financing. The debt is covered by the value of the home and nothing else, even if the sale of the property is not enough to pay off how much was borrowed over the life of the reverse mortgage.
If your heirs wish to keep the house, they will be responsible for paying off the reverse mortgage amount that has been accrued. If they choose to sell, the loan will be paid off and they will receive any remaining proceeds from the real estate transaction.
What are Alternatives to a Reverse Mortgage?
A reverse mortgage can be a good solution for some homeowners, but it is not the best option for everyone.
Here are a few alternatives to consider:
Cash-out refinancing is another way to cash out some of your home equity while refinancing your existing mortgage loan. You will convert your home loan into a new fixed-rate or adjustable-rate mortgage, ideally at a lower interest rate. At the same time, you will be able to cash out a portion of your equity with a lump sum amount. You will have one new monthly mortgage payment amount that gradually pays off your original principal and the cash you borrowed.
A cash-out refinance may be a better option for someone with good equity who qualifies for a lower mortgage rate than they are currently paying. It may also be better if you have other urgent expenses that need to be paid off sooner, rather than getting monthly payments from a reverse mortgage. Cash-out refinancing is a good solution for homeowners who have other high-interest debts or want to reinvest the money into home improvements (which will effectively increase its resale value and future equity).
There are also no age restrictions for cash-out refinancing, whereas reverse mortgages are only available to seniors.
Home Equity Line of Credit (HELOC)
A home equity line of credit will typically have lower upfront costs. Like a reverse mortgage or cash-out refinance, you will need to have ample equity in your home. A HELOC allows you to qualify for a line of credit that borrows from your home equity. You will be able to withdraw and borrow money only when you need it.
It is kind of a like a credit card, but you are essentially borrowing from yourself and paying much lower interest rates. You only take out what you need when you need it, and then you make monthly payments to pay down the balance. A HELOC is a good option for a homeowner looking to make home improvements. Again, it is not the best solution for everyone, so it is important to talk with a mortgage lender and see if a reverse mortgage, cash-out refinancing or HELOC makes sense. Or, there may be another better solution to consider.
The last alternative may be the most obvious one. If you can’t afford your current living expenses, it may be smart to move out and find a less expensive place to live. This will eliminate the need to borrow any money. You’ll be able to sell your house and cash out your equity directly. Then, you can use that money to live comfortably for your remaining retirement years.
How Do I Apply for an HECM Reverse Mortgage?
Before you can apply for an FHA-insured HECM reverse mortgage, you will have to attend a counseling session with a U.S. Department of Housing and Urban Development (HUD) licensed counselor. They will walk you through the reverse mortgage process and be there to answer your questions.
You will then work with an FHA-Approved lender like Moreira Team | MortgageRight, who can help you explore your lending options and decide which loan program will work best for your specific situation. If a reverse mortgage is the recommended solution, you will be able to apply for the loan and see if you qualify. Your lender can determine your principal limit (how much you are allowed to borrow) based on your age, home’s value and existing mortgage rate.
A licensed home appraiser will be required to calculate the current real market value of your property. This is a very important step to determine your home equity and reverse mortgage limit. If you want to learn more about HECM reverse mortgages backed by FHA Moreira Team.
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