If you’re over 62 and own a home, you may have heard of reverse mortgages. This financial tool offers a way to turn your home equity into cash, either in a lump sum or on a monthly basis. For many who struggle with a fixed income, reverse mortgages can provide financial leeway while allowing you to stay in your beloved home.
The concept of a reverse mortgage is relatively simple, but there are three different types, depending on your income level. We will discuss the differences between a home equity conversion mortgage (HECM) and a homeowner or jumbo mortgage.
How a Reverse Mortgage Works
A reverse mortgage is a loan that borrows against the equity in a home. Reverse mortgages are only available to people over the age of 62 with substantial equity in their property. After the application, the borrowed money is paid to the owner in the form of a lump sum, a monthly payment or a line of credit.
The owner must be able to keep up to date with all property taxes and keep the house in good repair. The loan is repaid when the owner dies, sells the house or leaves the house for more than 12 consecutive months. Once they leave the house for one of these reasons, the house is sold and the sale proceeds pay the lender the amount borrowed plus interest and service charges.
Key points to remember
- Exclusive Reverse Mortgages offer the ability to borrow larger sums of money with fewer regulations.
- HECMs offer more protection to owners.
- You must use an FHA-accredited lender for a HECM.
- A proprietary reverse mortgage has lower upfront costs, but overall costs are lower with a HECM.
How a HECM works
Home equity conversion mortgages (HECMs), also known as HUD FHA reverse mortgages for seniors, are reverse mortgages that the Federal Housing Authority (FHA) backs. With that tie to the government comes more regulations, but it also comes with a measure of security for you.
Because HECMs are FHA-insured, they can only be offered by an FHA-approved lender. They also require every borrower to attend a mortgage counseling session, where an advisor can help show how the HECM will impact the borrower’s financial life. This helps reduce mortgage scams, which can be a big problem.
The standards for a HECM are simple:
- You must be 62 or older.
- You must occupy the house, condo or multi-family unit as your principal residence.
- You must have “considerable” equity – this is generally interpreted to mean 50% or more.
- You need to be able to pay your property taxes, home insurance, and maintain the home.
- You must not be past due on any federal debt.
HECM amounts are based on your principal and age, current interest rate, and the lesser of appraised value or mortgage limit of $970,800. This prevents people from borrowing way too much and ending up under mortgage water.
The only downside to a HECM is that there are additional fees. HECMs are considered non-recourse loans, which means that even if you end up borrowing more than your available capital, the lender cannot force you to move. To help protect lenders, each HECM is subject to upfront mortgage insurance premiums of 2% of the total loan at closing, and during the term of the loan you will be required to pay an annual mortgage insurance premium of 0.5% of the outstanding mortgage balance.
HECMs also require origination fees, such as title fees, appraisals, etc., necessary for any loan closing. All service charges are capped at $35 per month.
How an Exclusive Reverse Mortgage Works
A homeowner or jumbo reverse mortgage may be in order for those with higher value homes. Since a HECM has a cap on how much you can borrow, those who are home wealthy may want to tap more than the allowed amount. A homeowner’s reverse mortgage can exceed the FHA limit, although it rarely comes close to borrowing your full principal amount.
Since homeowner reverse mortgages are not FHA guaranteed, they are not subject to FHA regulations, such as mandatory counseling or initial and ongoing mortgage insurance payments. While this may sound like a good thing, it also removes the layer of protection from the elderly. Lenders who may not qualify for FHA support may offer exclusive reverse mortgages.
Proprietary reverse mortgages also tend to have lower upfront costs than HECMs. Eliminating mortgage insurance is a big part of that. However, HECMs tend to have lower interest rates than proprietary reverse mortgages. You will need to do the math to determine which option is the most cost effective for your specific situation.
Most exclusive reverse mortgages offer a lump sum payment at closing only. If you want monthly payments, a HECM is the best choice.
Are Exclusive Reverse Mortgages Susceptible to Scams?
There are many reliable companies offering giant reverse mortgages. However, since there is no requirement for mortgage advice or FHA support for the lender, they are more susceptible to scams. Since more valuable homes are on the chopping block, there is more incentive to persuade seniors to consider exclusive reverse mortgages.
Is there an age limit for Exclusive Reverse Mortgages?
Yes. The general standard for Exclusive Reverse Mortgages is 62, as are HECMs. However, some companies offer them from the age of 60. A company has announced that it will begin offering exclusive reverse mortgages to homeowners age 55 and older, but only in certain states. Check with the mortgage lender to find out the age limit in your state.
Is there a limit to how I use my Exclusive Reverse Mortgage Funds?
No. You can use the funds from your giant reverse mortgage to pay off the current mortgage, repair your home, consolidate debt, or even take a vacation. Keep in mind that the borrowed money will still have to be repaid when you sell the house or die, in which case your heirs will have to sell the house or repay the loan with other funds.
While both products offer the ability to borrow against your principal, HECMs do so with more protections in place for you. HECMs are also much more common than proprietary reverse mortgages, so finding the right lender for a jumbo can be more difficult. If you have a high-value home and need a large sum of money, a jumbo reverse mortgage may be your only option. Remember that you should always speak with a trusted advisor about the pros and cons of each type of reverse mortgage.