How Does a Reverse Mortgage Work and What Are They?

How Does a Reverse Mortgage Work and What Are They?

Reverse mortgages are an innovative way for homeowners, ages 62 and above,** to leverage the equity they have earned in their home. There are several ways a reverse mortgage can help homeowners in retirement, however, it’s crucial to understand how reverse mortgages work to realize the full benefits.

With that in mind, this article examines the following topics related to these products:

• Basics
• Benefits of a reverse mortgage loan
• What your client can do with the proceeds they receive
• How these reverse loans operate
• The process reverse mortgage lenders follow
• Eligibility of reverse mortgage borrowers
• What your client should do to apply for a reverse mortgage
• The types of reverse mortgage products available

What is a Reverse Mortgage: The Basics

Reverse mortgages differ from standard mortgages because the repayment of the loan is deferred. While traditional mortgage loans require borrowers to make a payment every month for a set number of years, reverse mortgages typically require no monthly mortgage payments.* Borrowers are, however, responsible for paying things like property taxes, homeowner’s insurance, and home maintenance.

Reverse mortgages allow borrowers to receive a lump sum upfront or draw down on the loan balance over time through a reverse mortgage line of credit. Borrowers may continue to defer repayment for the life of the loan (so long as they adhere to the loan terms). The loan becomes due if the borrower moves, sells the home, or passes away.

Most reverse mortgages entail a strict list of responsibilities on the part of the borrower. It’s vital to adhere to these conditions or risk the loan falling due.

The Benefits of Reverse Mortgages

Reverse mortgages can work to support homeowners with financial planning for retirement. There are many aspects to the way reverse mortgage loans work that can benefit seniors who are looking to supplement their retirement income.

A common misconception about how reverse mortgages work is that the lender takes ownership of the borrower’s home. This is false. Under a reverse mortgage, the borrower will continue to maintain ownership of their home, as long as they comply with the terms of the loan. Other benefits can include:

• Flexibility to choose a tax-free lump sum payment or drawdowns over time (using the reverse mortgage line of credit feature)
• Protection if the balance of the loan exceeds the home’s value
• Traditionally lower interest rates than conventional mortgages or home equity loans
• Loan proceeds are generally not considered taxable income

Who Is Eligible for a Reverse Mortgage?

Understanding how reverse mortgage eligibility is determined can help borrowers decide if this is the right loan option for them. Eligibility for a reverse mortgage depends on several factors, including:

• Age: Borrowers must be at least 62 years old** to apply
• The primary residence: Borrowers must use their primary residence, they cannot apply using a second home as collateral
• If the property is FHA-approved: Borrowers should speak to an FHA-approved lender to determine if their property qualifies in the eyes of the federal government
• Mortgage insurance: Borrowers must keep these up-to-date for the qualifying property

How Much Might Your Client Qualify For?

The exact amount a borrower qualifies for depends on a few different factors. As your client’s financial advisor and loan officer, you can help them determine what they might be eligible for.

Factors that may influence how much a borrower qualifies for with a reverse mortgage include:

• Age: The older the borrower is, the more they may qualify for
• Interest rates: Lower interest rates typically make it easier to borrow more
• Current equity: To qualify for a reverse mortgage, borrowers must own their home outright or have significant equity built up. The specific percentage varies by lender and the type of reverse mortgage, but a good rule of thumb is to have at least 50% equity in the home.

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Types of Reverse Mortgages

A reverse mortgage is a type of loan specifically for seniors (aged 62 and older).** Reverse mortgages work by allowing homeowners to convert a portion of their home’s equity into cash. The type of reverse mortgage a borrower can receive depends on their personal circumstances. This, in turn, will determine how their reverse mortgage works. There are 4 common types of reverse mortgages:

Home Equity Conversion Mortgage

A Home Equity Conversion Mortgage (HECM) is the only reverse mortgage insured by the U.S. Federal Government and is only available through an FHA-approved lender. HECMs enable seniors to withdraw a portion of their home’s equity to supplement their income. These loans have the reverse mortgage line of credit feature that can be used as a flexible option for borrowers to draw on.

The amount that will be available for withdrawal varies by borrower and depends on factors such as the age of the youngest borrower or eligible non-borrowing spouse, the current interest rate, and the HECM FHA mortgage limit or the sales price.

Home Equity Conversion Mortgage for Purchase

A Home Equity Conversion Mortgage (HECM) for Purchase is a reverse mortgage that allows seniors to purchase a new principal residence using loan proceeds from the reverse mortgage. A reverse purchase mortgage works much like the others, but there’s no cash payout.

With the HECM for Purchase reverse mortgage, the borrower provides a down payment using the sale of their previous home or other savings. The equity earned through the down payment and the new home’s value is then used to calculate a reverse mortgage loan amount.

This type of reverse mortgage may work well for seniors who are looking to transition to a more manageable home or even simply seeking a change of scenery.

Proprietary Reverse Mortgages

While HECMs are federally backed, a proprietary reverse mortgage is a private loan that allows borrowers to convert a portion of their home’s equity into cash.

A proprietary reverse mortgage works to first pay off the current mortgage. Then, any remaining proceeds are provided to the borrower in a nontaxable lump sum. While borrowers must continue to pay property taxes and homeowners insurance (as with HECMs), there are some key differences to be aware of.

As private loans, proprietary reverse mortgages are offered and insured by private lenders. Proprietary reverse mortgages are not federally insured and are not bound by limits set by the Federal Housing Administration (FHA). These loans are often referred to as jumbo reverse mortgages, since lenders can lend greater amounts than the federal limit. Because of this, proprietary loans are considered riskier for the lender, so interest rates for these loans tend to be higher than other loan options.

Single-Purpose Reverse Mortgages

Perhaps the least common reverse mortgages are single-purpose loans. These allow borrowers to leverage their home equity to fund a single, lender-approved purpose. With these loans, the borrower cannot spend the money on anything they’d like, and they must use the funds for the reason stated in their application.

These loans tend to offer less restrictive terms because they’re typically for smaller amounts. Common uses for this mortgage loan include paying property taxes or performing maintenance on the home. While single-purpose reverse mortgages tend to be less expensive than other reverse mortgage loans, they may still come with fees, like closing costs.

What Can a Reverse Mortgage Be Used for?

In situations where regular income or available savings are insufficient to cover expenses, reverse mortgage loan options can help seniors avoid otherwise high-interest lines of credit or other more costly loans. Common uses of reverse mortgages include:

• Debt consolidation
• Paying property taxes and homeowners insurance
• Repaying the existing mortgage quicker
• Paying medical bills or paying for in-home care
• Funding travel or lifestyle improvements
• Paying for home renovations

What’s Needed with a Reverse Mortgage?

Reverse mortgages don’t always have income or minimum FICO score requirements. This is one of the ways in which reverse mortgages differ from a home equity loan or a home equity line of credit (HELOC). The type of loan a borrower chooses will determine how their reverse mortgage works.

With all loan options, lenders are concerned with whether the borrower can meet the ongoing property-related expenses needed to keep the home in good condition. FHA loans (and most proprietary reverse mortgages) still undergo a financial assessment of the borrower to ensure their chosen loan is a good fit. However, not all loan options will have a minimum FICO score requirement. Other considerations include:

Taxes and Insurance

Borrowers are responsible for paying any expenses that might impact the home’s appraised value, such as:

• Mortgage insurance
• Property taxes
• Homeowner association fees
• Condo fees

Not doing so would likely be a breach of the terms of the reverse mortgage loan.

Property Maintenance

Borrowers must typically complete mandatory repairs and reasonable home maintenance during the term for proprietary reverse mortgages. This protects the home’s equity while ensuring that the owner can sell it for its current market value.

Occupancy Requirements

To qualify for proprietary reverse mortgages, borrowers must use their primary residence, meaning they must stay there for at least six months and one day of every year. Other properties that they pay taxes on don’t qualify.

Loan Counseling

Before applying, lenders may require borrowers to undergo a reverse mortgage counseling session. The U.S. Department of Housing and Urban Development requires all reverse mortgage applicants, whether they be obtaining a HECM (Home Equity Conversion Mortgage), Smartfi^® Choice, or other reverse mortgage, to undergo third-party counseling, so that they feel completely comfortable with the process and understand all of their available options.

While this counseling session may seem a little tedious, it’s an excellent way for a borrower to review the reverse mortgage program. Sessions are led by an independent third-party who can adequately assess the reverse mortgage cost for borrowers (and any heirs) and any potential risks.

Processing and Approval 

You can help your clients file their application through Smartfi’s simple and easy platform. Once filed, we will vet the application by conducting a financial assessment and confirming how much the home equity is.

Upon approval, borrowers will need to sign the loan agreement. The operation of a reverse mortgage becomes a little confusing here as there are several payment options for the loan proceeds. Borrowers may select:

• Lump-sum: With this type of distribution, borrowers may apply for a fixed interest rate and receive fixed monthly payments.
• Term or Tenure payments: The lender pays the reverse mortgage loan proceeds in equal installments over an agreed-upon term or for the life of the loan.
• Reverse mortgage line of credit: The borrower may draw loan funds when necessary. They’ll only pay interest on the portion of credit they utilize, making it a cost-effective way of managing the interest accrued.
• Modified Tenure payments and a line of credit: The borrower receives equal monthly payments for the life of the loan with the option to withdraw money from a reverse mortgage line of credit that was set aside.
• Term payments and a credit line: The borrower receives equal monthly payments for a fixed term and the option to draw more money from a reverse mortgage line of credit that was set.

Will a Reverse Mortgage Work for Your Client?

Call Smartfi Home Loans today at (877) 816-6706 or reach out through our website for more information on how reverse mortgages work or to become a partner.