A reverse mortgage is a home loan that provides cash payments based on home equity. Homeowners normally "defer payment of the loan until they die, sell, or move out of the home." Upon the death of homeowners, their heirs either give up ownership to the home or must refinance the home to purchase the title from the reverse mortgage company. Specific rules for reverse mortgage transactions vary depending on the laws of the jurisdiction.
In a conventional mortgage, the homeowner makes a monthly payment to the lender. After each payment, the homeowner's equity increases by the amount of the principal included in the payment. In a reverse mortgage, a homeowner is not required to make monthly payments. If payments are not made, interest is added to the loan's balance. Although the "rising loan balance can eventually grow to exceed the value of the home," "the borrower (or the borrower's estate) is generally not required to repay any additional loan balance in excess of the value of the home." In Canada the loan balance cannot exceed the fair market value of the home by law.
Regulators and academics have given mixed commentary on the reverse mortgage market. Some economists argue that reverse mortgages allow seniors to smooth out their income and consumption patterns over time, and thus may provide welfare benefits. However, regulatory authorities, such as the Consumer Financial Protection Bureau, argue that reverse mortgages are "complex products and difficult for consumers to understand," especially in light of "misleading advertising," low-quality counseling, and "risk of fraud and other scams." Moreover, the Bureau claims that many consumers do not use reverse mortgages for the positive, consumption-smoothing purposes advanced by economists. In Canada the borrower must seek independent legal advice before being approved for a reverse mortgage.
Australia
Eligibility
Reverse mortgages are available in Australia. However, there is little regulation: the Financial Services Reform Act does not regulate the loans, and although potential borrowers should seek financial advice before applying for a reverse mortgage, there is no legislation that requires the advisor to be licensed.
Eligibility requirements vary by lender. To qualify for a reverse mortgage in Australia,
- the borrower must be over a certain age, usually 60 or 65 years of age; if the mortgage has more than one borrower, the youngest borrower must meet the age requirement
- the borrower must own the property, or the existing mortgage balance must be low enough that it will be paid off with the reverse mortgage proceeds
Loan size and cost
Reverse mortgages in Australia can be as high as 50% of the property's value. The exact amount of money available (loan size) is determined by several factors:
- the borrower's age, with a higher amount available at a higher age
- current interest rates
- property value
- the property's location
- program minimum and maximum; for example, the loan might be constrained to a minimum of $10,000 and a maximum of 425,000
The cost of getting a reverse mortgage depends on the particular reverse mortgage program the borrower acquires. These costs are frequently rolled into the loan itself and therefore compound with the principal. Typical costs for the reverse mortgage include:
- an application fee (establishment fee) = $950
- stamp duty, mortgage registration fees, and other government charges = vary with location
The interest rate on the reverse mortgage varies. Some programs offer fixed rate loans, while others offer variable rate loans.
In addition, there are costs during the life of the reverse mortgage. A monthly service charge may be applied to the balance of the loan (for example, $12 per month), which then compounds with the principal.
Proceeds from a reverse mortgage
The money from a reverse mortgage can be distributed in several different ways:
- as a lump sum, in cash, at settlement
- as an annuity, with a cash payment at regular intervals
- as a line of credit, similar to a home equity line of credit
- as a combination of these.
Taxes and insurance
The borrower remains entirely responsible for the property. This includes physical maintenance. In addition, some programs require that the property is periodically revalued.
Income from a reverse mortgage set up as an annuity or as a line of credit should not affect Government Income Support entitlements. However, income from a reverse mortgage set up as a lump sum could be considered a financial investment and thus deemed under the Income Test; this category includes all sums over $40,000 and sums under $40,000 that are not spent within 90 days.
When the loan comes due
The reverse mortgage comes due - the loan plus interest must be repaid - when the borrower dies, sells the property, moves out of the house, or breaches the contract in some way.
Prepayment of the loan - when the borrower pays the loan back before it reaches term - may incur penalties, depending on the program. An additional fee could also be imposed in the event of a redraw.
"Some providers offer a 'no negative equity guarantee'. This means that if the balance of the loan exceeds the proceeds of sale of the property, no claim for this excess will be made against the estate or other beneficiaries of the borrower."
Canada
Eligibility
Reverse mortgages are available through private corporations in Canada, although none of the programs are insured by the government. Eligibility requirements vary depending on the lender. To qualify for a reverse mortgage in Canada,
- the borrower (or both borrowers if married) must be over a certain age, usually at least 55 or 62 years of age
- the borrower must own the property "entirely or nearly"; in addition, "any outstanding loans secured by your home must be retired with the proceeds" of the reverse mortgage
- there is no qualification requirement for minimum income level.
Loan size and cost
Reverse mortgages in Canada are usually a maximum of 25 to 50% of the property's value. The exact amount of money available (loan size) is determined by several factors:
- the borrower's age, with higher payments for higher age
- current interest rates
- property value, including location and a factor for future appreciation
- program minimum and maximum; for example, the loan might be constrained to a minimum $20,000 and a maximum of $750,000
The interest rate on the reverse mortgage varies by program. The length of loan also varies, with some programs offering no fixed term and some offering fixed terms ranging from 6 months to 5 years.
The cost of getting a reverse mortgage from a private sector lender may exceed the costs of other types of mortgage or equity conversion loans. Exact costs depend on the particular reverse mortgage program the borrower acquires. Depending on the program, there may be the following types of costs:
- Real estate appraisal = $175-$400
- Legal advice = $400-$600
- Other legal, closing, and administrative costs = $1,495
Proceeds from a reverse mortgage
The money from a reverse mortgage can be distributed in several different ways:
- as a lump sum, in cash, at settlement
- as an annuity, with a monthly cash payment
- as a line of credit, similar to a home equity line of credit
- as a combination, with a smaller lump sum at settlement and then a smaller annuity.
Once the reverse mortgage is established, there are no restrictions on how the funds are used. "The money from the reverse mortgage can be used for any purpose: to repair a home, to pay for in-home care, to deal with an emergency, or simply to cover day-to-day expenses."
The borrower retains title to the property, including unused equity, and will never be forced to vacate the house.
Taxes and insurance
The borrower remains entirely responsible for the property. This includes physical maintenance and payment of all taxes, fire insurance and condominium or maintenance fees.
Money received in a reverse mortgage is an advance and is not taxable income. It therefore does not affect government benefits from Old Age Security (OAS) or Guaranteed Income Supplement (GIS). In addition, if reverse mortgage advances are used to purchase non-registered investments - such as Guaranteed Investment Certificates (GICs) and mutual funds - then interest charges for the reverse mortgage may be deductible from investment income earned.
When the loan comes due
The reverse mortgage comes due - the loan plus interest must be repaid - when the borrower dies, sells the property, or moves out of the house. Depending on the program, the reverse mortgage may be transferable to a different property if the owner moves. Prepayment of the loan - when the borrower pays the loan back before it reaches term - may incur penalties, depending on the program. In addition, if interest rates have dropped since the reverse mortgage was signed, the mortgage terms may include an "'interest-rate differential' penalty." In Canada a reverse mortgage can not accumulate debt beyond the fair market value of the property, nor can the lender recover losses from the homeowner's other assets. If the borrower lived long enough that the principal and interest together exceed the fair market value when the mortgage is due, the borrower or heirs do not have to pay more than the house's value at the time.
Origin of reverse mortgages in Canada
In 1986 William Turner, a Vancouver, BC based chartered accountant founded the Canadian Home Income Plan (CHIP) Corporation. CHIP became Canada's first national provider of reverse mortgages.
United States
Eligibility
To qualify for a reverse mortgage in the United States, the borrower must be at least 62 years of age and must occupy the property as his or her principal residence. In addition, any mortgage on the property must be low enough that it will be paid off with the reverse mortgage proceeds. Reverse mortgages follow FHA eligibility standards for property types, meaning most 1-4 family dwellings, FHA approved condominiums, and PUD's qualify. Manufactured housing qualifies based on standard FHA guidelines.
Before starting the loan process for an FHA/HUD-approved reverse mortgage, applicants must take an approved counseling course. The counseling is meant to protect borrowers, although the quality of counseling has been criticized by groups such as the Consumer Financial Protection Bureau.
In a 2010 survey in the United States, 48% of seniors cited financial difficulties as the primary reason for obtaining a reverse mortgage and 81% of seniors stated they would like to stay in the home in which they are currently living for the rest of their lives.
On March 2, 2015 FHA will implement its financial assessment for Reverse Mortgages. For those who are assigned a case number on or after March 2, 2015 you will be subject to the financial assessment. A case number is assigned to a borrower by FHA so that lenders can identify them. The financial assessment means lenders will now be required by FHA to do a much more comprehensive credit, income and asset underwriting. Lenders will look at things like "late payments" on credit reports or unpaid property taxes etc. and determine what they call a "willingness to pay." Borrowers who show that they have not in the past had a "willingness to pay" bills on time, for example, will see "set asides" for items like property taxes and homeowners insurance.
Loan size
The gross amount of money that a borrower can receive under a HECM reverse mortgage (i.e., a reverse mortgage insured by the federal government) is called the principal limit. The principal limit is based on the maximum claim amount, the age of the youngest borrower, and the expected average interest rate. The maximum claim amount is equal to the appraised value of the home or the maximum amount HUD will insure, whichever is less. At least through December 14, 2014, the maximum amount HUD will insure is $625,500. The maximum claim amount is multiplied by a principal limit factor to determine the principal limit. Principal limit factors are determined by HUD and are based on the borrower's age and the expected average rate of interest. The table below gives some examples of what the initial principal limit will be if a home is worth $250,000 and for borrowers of different ages and with different expected average rates of interest.
Loan costs and existing liens may be paid from the principal limit. Other amounts for items such as taxes and insurance may also be subtracted from the principal limit. The result after subtracting these amount is the net principal limit. This is the amount the borrower can actually convert to cash.
Interest Rate
Interest rates on reverse mortgages may be fixed or adjustable. Prior to 2007, all major reverse mortgage programs had adjustable interest rates. Adjustable rate reverse mortgages are typically adjusted on a monthly or annual rate up to a maximum rate. The note rate (or accrual) rate is used to calculate the interest added to the loan balance each month. The note rate may be different from the expected average interest rate used to determine the available loan proceeds.
Proceeds from a reverse mortgage
Cash from a reverse mortgage
The most common reverse mortgage is one in which the owner receives cash or a credit line from an existing home. The money from a reverse mortgage can be distributed in several different ways:
- in a lump sum, in cash, at settlement;
- as a cash payment (cash advance) every month, applied for a fixed term (term) or for the owner's life (tenure)
- as a line of credit, similar to a home equity line of credit
- some combination of the above.
Purchase of a new residence with "HECM for Purchase"
The Housing and Economic Recovery Act of 2008 provided HECM mortgagors with the opportunity to purchase a new principal residence with HECM loan proceeds -- the so-called HECM for Purchase program, effective January 2009. The "HECM for Purchase" applies if "the borrower is able to pay the difference between the HECM and the sales price and closing costs for the property. The program was designed to allow seniors to purchase a new principal residence and obtain a reverse mortgage within a single transaction by eliminating the need for a second closing. Texas was the last state to allow for reverse mortgages for purchase.
Total Annual Loan Cost
The Truth in Lending Act requires lenders to disclose the Total Annual Lending Cost (TALC) for reverse mortgages. The TALC calculation should allow borrowers to compare the costs of the reverse mortgage from one lender to another. The specific formulas to calculate the impact of the factors listed above can be found in Appendix 22 of the HUD Handbook 4235.1.
Taxes and insurance
Unlike common practice in a standard mortgage, funds for taxes and insurance are not typically paid out of an escrow fund; they are paid directly by the homeowner. A lapse in either taxes or insurance could result in a default on the reverse mortgage.
The American Bar Association guide advises that generally,
- The Internal Revenue Service does not consider loan advances to be income
- Annuity advances may be partially taxable
- Interest charged is not deductible until it is actually paid, that is, at the end of the loan.
- The mortgage insurance premium is deductible on the 1040 long form.
The money received from a reverse mortgage is considered a loan advance. It therefore is not taxable and does not directly affect Social Security or Medicare benefits. However, an American Bar Association guide to reverse mortgages explains that if borrowers receive Medicaid, SSI, or other public benefits, loan advances will be counted as "liquid assets" if the money is kept in an account (savings, checking, etc.) past the end of the calendar month in which it is received; the borrower could then lose eligibility for such public programs if total liquid assets (cash, generally) is then greater than those programs allow.
When the loan comes due
The loan comes due when the borrower dies, sells the house, or moves out of the house for more than 12 consecutive months. The loan may also be declared due and payable if the borrower fails to pay property taxes or fails to maintain hazard insurance on the property. Once the mortgage comes due, the borrower or heirs of the estate have an option to refinance the home and keep it, sell the home and cash out any remaining equity, or turn the home over to the lender. If the property is turned over to the lender, the borrower or the heirs have no more claim to the property or equity in the property.
The lender has recourse against the property, but not against the borrower personally and not against the borrower's heirs. A Reverse Mortgage is a non-recourse loan, meaning that the lender can only be repaid on the loan from the proceeds of the sale of the property either when the homeowner decides to sell the home or their estate sells the property. A Reverse Mortgage is not a "loan" that can be "called" at the lender's discretion.
Volume of loans
Home Equity Conversion Mortgages account for 90% of all reverse mortgages originated in the U.S. As of May 2010, there were 493,815 active HECM loans. As of 2006, the number of HECM mortgages that HUD is authorized to insure under the reverse mortgage law was capped at 275,000. However, through the annual appropriations acts, Congress has temporarily extended HUD's authority to insure HECM's notwithstanding the statutory limits.
Program growth in recent years has been very rapid. In fiscal year 2001, 7,781 HECM loans were originated. By the fiscal year ending in September 2008, the annual volume of HECM loans topped 112,000 representing a 1,300% increase in six years. For the fiscal year ending September 2011, loan volume had contracted in the wake of the financial crisis, but remained at over 73,000 loans that were originated and insured through the HECM program.
Loan volume is expected to grow further as the U.S. population ages. The U.S. senior population is expected to increase from 35 million in 2000 to 64 million in 2025, and seniors are expected to make up a larger share of the population.
Criticism
Reverse mortgages have been criticized for several major shortcomings:
- High up-front costs make reverse mortgages expensive. In the U.S., entering into a reverse mortgage will cost approximately the same as a traditional FHA mortgage.
- The interest rate on a reverse mortgage may be higher than on a conventional "forward mortgage".
- Interest compounds over the life of a reverse mortgage, which means that "the mortgage can quickly balloon". Since no monthly payments are made by the borrower on a reverse mortgage, the interest that accrues is treated as a loan advance. Each month, interest is calculated not only on the principal amount received by the borrower but on the interest previously assessed to the loan. Because of this compound interest, the longer a senior has a reverse mortgage, the more likely it is that most or all of the home equity is depleted when the loan becomes due. That translates to "less cash for your estate or to pay your bills." That said, with the FHA-insured HECM reverse mortgage, the borrower can never owe more than the value of the property and cannot pass on any debt from the reverse mortgage to any heirs. The sole remedy the lender has is the collateral, not assets in the estate, if applicable.
- Reverse mortgages are confusing. Many seniors entering into reverse mortgages don't fully understand the terms and conditions associated with the loans, and it has been suggested that some lenders have sought to take advantage of this. 46% of seniors understood the financial terms of reverse mortgages very well when they secured their reverse mortgage. "In the past, government investigations and consumer advocacy groups raised significant consumer protection concerns about the business practices of reverse mortgage lenders and other companies in the reverse mortgage industry" But in a 2006 survey of borrowers by AARP, 93 percent said their reverse mortgage had a mostly positive effect on their lives, compared with 3 percent who said the effect was mostly negative. Some 93 percent of borrowers reported that they were satisfied with their experiences with lenders, and 95 percent reported that they were satisfied with the counselors that they were required to see.
See also
- Compare reverse mortgage with home equity loan and home equity line of credit.
- Negative amortization
- Bankruptcy
- Equity release, the United Kingdom equivalent
- Yung-Ping Chen#Home-equity conversion (reverse mortgage)
- Life estate
References
External links
- Reverse mortgages at DMOZ
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