Curve

Is now the time to get a reverse mortgage?

Peter Miller
The Mortgage Reports contributor

Reverse mortgage demand is spiking due to COVID-19

Thinking about a reverse mortgage? You’re not alone. Demand is soaring.

In 2019, there were only 2,600 reverse mortgages opened per month, according to the National Reverse Mortgage Lenders Association (NRMLA).

Recently, that number has nearly doubled.

Reverse Market Insight reports 5,000 reverse mortgage originations in May 2020 alone.

For some affected by the COVID-19 economy, who need quick cash and lower monthly costs, a reverse mortgage may be appealing.

But there are serious drawbacks to consider, too. Here’s what to know before using a reverse mortgage to tap your home equity.


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Why the new interest in reverse mortgages?

The COVID-19 pandemic has had a serious financial impact across the U.S.

More than 40 million people have lost their jobs during the past few months. And as the pandemic lingers, household budgets are starting to thin out.

This is where reverse mortgages come in.

A reverse mortgage can quickly convert real estate equity into cash, end monthly payments for current mortgages, generate monthly income, and let people stay in place.

Here’s how it works.

How a reverse mortgage works

Reverse mortgages are a type of real estate financing, but they work differently from other home loans.

A reverse mortgage lets you borrow money from the equity in your house, without any monthly payments. The loan is only repaid when the house is sold or the property owner passes away.

Many of the rules and standards associated with most home loans simply don’t apply to reverse mortgages.

  • You can only get an FHA-backed reverse mortgage if you’re age 62 and above
  • Nearly all reverse mortgages are insured through the FHA
  • The FHA calls reverse mortgages “home equity conversion mortgages” or HECMs
  • You largely qualify for a reverse mortgage on the basis of home equity
  • The amount you can borrow depends largely on the borrower’s age, interest rate, whether the rate is fixed or adjustable, and the property’s value
  • Monthly payments for principal and interest are not required
  • The loan is repaid when the borrower moves, sells the property or passes away
  • An FHA-backed HECM is a non-recourse loan. It’s secured by the property’s value and not other borrower assets

So, how do you know if you should use a reverse mortgage?

Reverse mortgages: Benefits

To understand reverse mortgages better, it helps to look at a scenario.

Think of the Smiths. They’re both 66, and together receive $3,500 a month in Social Security benefits.

Their monthly mortgage payment is their biggest expense. They own a home worth $400,000. Their remaining loan balance is $50,000 with a $492 monthly mortgage payment for principal and interest.

The Smiths elect to refinance with a reverse mortgage. They choose a loan with an adjustable-rate based on the 1-year LIBOR index.

Given their age, location, and property value, the Smiths qualify for $222,400 in financing according to the MyHECM reverse mortgage calculator. The loan results look like this:

  • The $50,000 remaining loan balance is paid off. The Smiths save $492 a month in mortgage payments
  • They also receive a $615 monthly payment for life
  • They are now ahead by $1,107 per month ($492 plus $615)
  • Instead of lifetime payments, they might elect to get a $1,512 monthly check for ten years

That sounds like a sweet deal. But there are inherent drawbacks to the reverse mortgage model that need to be considered.

Reverse mortgages: Drawbacks

Reverse mortgages are not for everyone and here’s why.

FHA-backed reverse mortgages are simply unavailable for most homeowners. FHA-backed HECMs are only available to those aged 62 and above.

There are also costs to originate a reverse loan.

For example, the Smiths might pay $8,000 for the up-front mortgage insurance premium, a $4,000 origination fee, and $2,800 in closing costs.

That’s a total of $14,800 in up-front expenses. They also have a 0.5% ongoing mortgage insurance fee calculated monthly. Those are big fees to stomach for someone on a tight budget.

And, a reverse mortgage can be foreclosed. This may seem odd for a loan with no required payments for principal and interest, but other obligations continue. Borrowers must keep paying taxes, insurance, and HOA fees. Stop paying those, and a reverse mortgage can be foreclosed.

Perhaps most importantly, seen over the long run, reverse mortgage benefits may decline in value because of inflation.

Think of the $615 fixed monthly payment received by the Smiths. It will buy a lot less over time as inflation eats away at buying power.

Who qualifies for a reverse mortgage?

To participate in the FHA reverse mortgage program — by far the most popular — you need to be at least 62 and have plenty of real estate equity.

The largest available FHA reverse mortgage at this time is $765,600 for a single-family home.

According to the Consumer Financial Protection Bureau, “your borrowing limit is called the ‘principal limit.’ It takes into account your age, the interest rate on your loan, and the value of your home.

“In general, loans with older borrowers, higher-priced homes, and lower interest rates will have higher principal limits than loans with younger borrowers, lower-priced homes, and higher interest rates.

“If you are married or co-borrowing with another person, the principal limit is based on the age of the youngest co-borrower or Eligible Non-Borrowing Spouse.”

How do you pay off a reverse mortgage?

A reverse mortgage is a form of debt that grows every month. So how do you pay it off?

First, a reverse mortgage only needs to be repaid when one of these things happens:

  • The property is sold
  • The borrower moves away
  • Repayment is due because the borrower has passed away

What if the remaining loan balance is more than the value of the property?

An FHA-backed reverse is non-recourse financing. The debt is secured by the value of the home and nothing else. If the value of the property is not sufficient to repay the debt then the difference is paid by the FHA insurance program.

Reverse mortgage alternatives

No mortgage works for every borrower in every situation. You may want to consider alternatives if a reverse mortgage is not for you because of age or economics.

Home equity line of credit (HELOC)

A home equity line of credit (HELOC) can be an attractive option because such loans generally have small up-front costs. To get a HELOC you need equity plus a lender willing to offer such financing.

Here’s another example: The Smiths have a $400,000 property and $50,000 in mortgage debt. They have roughly $350,000 in equity, though some lenders might calculate a lower value.

If lenders will finance 80% of the property’s value, that’s $320,000. Subtract the $50,000 in outstanding mortgage debt, and the Smiths can get as much as $270,000 in HELOC financing.

The catch is that with a HELOC, the borrower has to make monthly payments. The Smiths have a limited monthly income. While a HELOC may be attractive, it does not solve the Smiths’ need for more monthly cash or lower monthly costs.

Lender practices can be another problem. Lenders may no longer offer HELOCs. The reason is that a HELOC is a second lien. Lenders worry that in the COVID-19 economy, home values might fall. That concern makes HELOCs too risky for some lenders.

Cash-out refinancing

Instead of a HELOC why not a cash-out refinance? The Smiths have plenty of equity, so a cash-out refinance might work.

Lenders might also prefer a cash-out refinance because, unlike the typical HELOC, it is a first-lien loan. If home values go down, that’s the loan lenders want. It gives them the most protection in case of a foreclosure.

But, just like a HELOC, a cash-out refinance creates a new and additional monthly cost. That’s something the Smiths are trying to avoid.

The option to move

The Smiths may elect to downsize and move. They have substantial equity. What if they sell the property and buy a smaller or less expensive home for cash?

Sellers can sometimes wind up with a mortgage-free property plus cash in the bank. Also, if they move to a jurisdiction with no state income tax, the Smiths can save even more.

The urge to move has increased not only as a result of the coronavirus but also because of changing work opportunities.

“During the first month of the pandemic, interest in rural areas skyrocketed while interest in cities fell, with many urbanites dreaming of packing up and heading for the hills,” said Redfin lead economist Taylor Marr.

“Some of that boost in rural areas proved to be temporary, but it appears to be more sustainable in small towns, which may be a more realistic option for those looking to work from home primarily or commute into the office once or twice a week.”

Who to talk to about a reverse mortgage

If you’re considering a reverse mortgage, your first step will be to speak with a professional. HUD maintains a nationwide network of reverse mortgage consultants who can help counsel you on whether or not a reverse mortgage is the right decision for you.

If you’re more interested in a cash-out refinance or home equity line of credit, your next course of action is to check rates and speak with a lender to see which option best suits your needs.

Verify your new rate (Jul 5th, 2020)