A reverse mortgage is a type of specialty loan for individuals who are 62 or older and have 50% or more equity in their home. With a reverse mortgage, homeowners borrow against their home equity (tax-free). It gives the homeowner access to the equity in their home without having to sell the home or refinance for cash out. Instead of making mortgage payments, they receive payments, hence the name “reverse mortgage.” There are reverse mortgage programs that allow you to purchase a new home. They’re discussed in this article.
Misconceptions about Reverse Mortgages
There are some common misconceptions about reverse mortgages. Some people mistakenly believe that all reverse mortgages are scams. While it’s true, there are unscrupulous people who try to defraud senior citizens with mortgage scams, legitimate reverse mortgages programs do exist.
Another common misperception: They will take your house once you deplete your equity. That’s not the case. For example, if you start a reverse mortgage at the age of 65 and live to be 90, you will likely end up depleting your equity. But you won’t have to leave your home and the negative equity won’t be passed along to your children. Basically, the FHA takes this financial hit.
Types of reverse mortgages
If you’re sitting on a significant amount of equity in your home, then you have some options.
Reverse Mortgage for Purchase
This reverse mortgage works a little differently than a standard reverse mortgage, but it opens up options for homeowners to downsize, relocate, or move into a home that will accommodate their needs as they age.
Here’s how it works. Betty and Jack are 70 years old. They want to downsize and buy a smaller retirement home closer to their children and grandchildren. With a reverse mortgage for purchase, they find their new home and using the proceeds from the sale of their former home, they make a sizeable down payment on the new home.
The amount of down payment depends on the age of the youngest borrower, interest rates, and the price of the new home. It starts at approximately 50% of the value of the new home for someone who is 62. Because Betty and Jack are 70, they will put down about 45% of the value of the new home. The balance will be financed by a reverse mortgage
While they live there, the reverse mortgage requires mortgage insurance premium (MIP) and accrues interest, but Betty and Jack will not have to make a monthly payment. As time passes, the loan value increases, but ideally, so does the property value which means their equity in the home increases as well.
Typically, this loan is not repaid by the homeowner unless they move in with family or need to move to an assisted living facility. In which case, the home is sold, and the loan will be paid off. The equity is theirs to keep. If they spend their remaining days there, then when they die, the loan is re-paid, and the remaining proceeds go to the estate. If the heirs would like to keep the home, they can refinance it with a traditional mortgage.
Besides age, the down payment is the most significant requirement for the reverse mortgage for purchase. The down payment can come from the proceeds of the sale of your former home, your savings or retirement fund, or a gift from a family member without any interest or stake in the transaction. The down payment percent required is based on the age of the youngest borrower. The total down payment also depends on interest rates and the price of the new home. The lending limit for this mortgage is approximately $970,000.
Advantages and Disadvantages of Reverse Mortgage for Purchase
- Government issued reverse mortgages for purchase come with the same benefits and protections as other HECM loans. This includes the non-recourse feature which protects the borrower from having to repay more than the home is worth at the time of sale.
- This loan makes the process easier and faster while saving you money because you buy a home and get a reverse mortgage in one single transaction.
- Allows you to eliminate monthly payments and enjoy a new home.
- Upfront and ongoing insurance premiums required
- Standard closing closes
- It’s not the solution for everyone. Consult with a mortgage broker you can trust.
What other mortgage options do you have?
For homeowners who plan to move soon or would like to leave the home to their loved ones, there are other options. Consider a cash-out refinance. With the equity you already have, you can refinance your mortgage. Borrow more than you owe on the house and receive cash (the difference) to put towards your retirement expenses or plans. This is not a second mortgage.
When you retire and you have built up significant equity in your home, you have options. Talk to a trusted broker to find the best way to take advantage of your equity during these years.