Defining the Reverse Mortgage
Stephen Foster
Defining the Reverse Mortgage
A reverse mortgage is, quite simply, a real estate transaction that allows you to tap into the equity in your home. It is, as the name suggests, the reverse, or opposite, of a traditional mortgage. Rather than making payments to a mortgage lender to satisfy your home loan, your lender, in a reverse mortgage, makes payments to you, according to a strict set of rules. These payments may take various forms, and they are generally tax-free. The borrower need not pay back the loan; it will be settled when the home is sold or vacated.
Taking out a reverse mortgage constitutes a serious financial transaction and should not be undertaken without rigorous research and analysis.
Having said that, a reverse mortgage may be an ideal way for you to receive income from your principal residence—and this is especially true if, for example, your retirement savings are not sufficient to support you when you cease working.
The three types of reverse mortgages are:
Home Equity Conversion Mortgage (HECM);
Single-Purpose Reverse Mortgage; and
Proprietary Reverse Mortgage.
The latter two options are not insignificant, but it’s the HECM that is easily the most popular of the three, even though obtaining one will likely end up being expensive upfront.
Here’s how HECM works.
HECM is federally insured and backed by the U.S. Department of Housing and Urban Development (HUD). If you have significant equity in your home—and the greater the equity the better—you apply to a financial institution for a reverse mortgage. In order to apply, you must be at least age 62. You will need to go through financial underwriting, just as you would if you were purchasing a traditional 30-year mortgage. If approved, you will need to pay upfront and ongoing property-related fees, and these may seem excessive to potential applicants.
That’s because they can be.
Following is a list of one-time fees that must be paid:
Mandatory HECM counseling. Each borrower must undergo a counseling session with a HUD-approved representative. The point of the consultation is that the federal government wants you to understand fully how a reverse mortgage works and why it might, or might not, be a good option for you. There is a fee for this consultation, and it ranges, typically, between $150 to $250 dollars.
Appraisals. In order to establish a reverse mortgage, a home appraisal must be initiated. This is similar to an appraisal used for the purposes of purchasing a property. Your residence’s value will need to be assessed, and you’ll need to pay the appraiser. There is no set amount for the appraisal; it can vary from individual to individual or by geography. This will usually fall in the $400 to $600 range. The size of your house, too, is another factor in arriving at an appraisal figure. The larger the house, the higher the appraiser’s cost.
Third-party closing costs. These are like the closing costs you pay when you purchase a home.
Loan origination fees. These may be substantial but are capped at $6,000 dollars. You may be able to roll origination fees into your loan, but you’ll still feel their effects.
Mortgage insurance premium. This is due at closing and is 2 percent of the loan value.
Property taxes and insurance must be paid over the course of the loan.
Before starting down the road toward a reverse mortgage, begin by using an online reverse mortgage calculator. It will give you a good idea of the financial dynamics at play. It is a necessary precursor to reaching out to an HECM counselor.