In 2011 (the most recent numbers available) the average American over the age of 65 had a net worth of around $170,000. Take out the equity in their primary residences, though, and that number drops to less than $28,000.
With such a thin retirement cushion, it makes sense that reverse mortgages are an increasingly attractive option for seniors who want to age in place. Still, these are complicated financial products, and, despite Henry Winkler’s smooth television assurances, they come at a risk to both the homeowners and their heirs. If you or your parents are considering this option, here’s what you need to know about reverse mortgages in simple terms.
- Home Equity Conversion Mortgages (HECMs) have been around since 1987. They were created by Congress to help seniors tap into their home equity to meet day-to-day spending needs. The proceeds of the loan are tax-free, and the loans are guaranteed by the Federal Housing Administration (FHA). Borrowers pay a mortgage insurance premium for the coverage.
- To qualify for a loan, all of the borrowers have to be age 62 or older with significant equity in the house, usually around 40%. To qualify you need to live in the house, and it must be your primary residence. You are still responsible for paying your property taxes and homeowners insurance, and the house must be maintained up to FHA standards. If you fall behind on any of those expenses, you could be in default of the loan and lose your house.
- If you still have a primary mortgage, the initial proceeds from the reverse mortgage will have to go toward paying that off.
- While you won’t have to go through the same level of scrutiny that a traditional mortgage requires, the lender will look at your income and credit history to make sure you can keep up with the taxes and insurance on the house. If that assessment falls short, the bank may set part of your loan aside to cover those expenses.
- You have three payout options with an HECM. In simple terms, you can receive a monthly check, take a lump sum or set up a line of credit. If you choose the monthly income option, you can elect either a “tenure” or a “term” distribution. With the tenure option you will receive a check for as long as you live in the house. A term distribution is for a fixed number of years.
- There will be a cap on the first-year distribution from the loan based on your age, the value of the home and the interest rate on your loan. This is called the “initial principal limit.”
- The “net principal limit” is how much you can borrow after all of the loan expenses are added in. To determine that amount, the lender will use the initial principal limit and subtract the fees associated with loan, including the loan origination fee (2% of the first $200,000 of the value of the house and 1% of the remaining value up to a maximum of $6,000); the initial mortgage insurance premium, which could be either 0.5% or 2.5%, depending on how much of the initial principal limit you are borrowing; and any outside expenses, such as an appraisal fee or a title insurance.
- If both spouses or partners are on the loan, the survivor can stay in the house as long as he or she chooses after the first person dies. If your spouse or partner is not on the loan, he or she will have to either move out or pay off the loan if you predecease them.
- Once all of the co-borrowers have died or moved out, the loan becomes due and payable. The lender has the primary lien on the house and can begin foreclosure proceedings immediately, even if the equity in the house is greater than the balance of the loan.
While reverse mortgages can provide a critical lifeline to cash-strapped seniors, they also can be expensive and limit your options down the road. So before signing away the equity your house, talk to an FHA-approved HECM counselor who can explain the ins and outs of reverse mortgages in simple terms. You can find one through www.hud.gov or by calling (800) 569-4287.