Joanne Marie Tucker

Joanne Marie Tucker
Residential Mortgage Loan Originator

o: FAX817-329-3487

Reverse Mortgages

A reverse mortgage is a loan taken by senior citizens on the equity of their home-a loan that they will not pay back as long as the home is their principal residence. Although there are no monthly payments, the interest does build up. However, the lender will not loan all the equity; only a portion of the value of the house will be used to calculate the amount available. Usually the first mortgage is paid off, or only a very small balance remains. Sometimes any remaining balance on the first mortgage is paid off from the proceeds of the reverse mortgage. The reverse mortgage money can be taken in several ways:

  • Equal monthly payments
  • A line of credit,
  • A combination of the two.

While a reverse mortgage and a home equity loan both rely on the borrower having equity in the home, a reverse mortgage is different from a home equity loan in many ways. The major difference is that a reverse mortgage does not have payments as long as the home is the borrower's principal residence. However, there are other differences as well. The reverse mortgage is based on age, current interest rate, equity, and the value of the home, but is not based on income; whereas, a home equity loan is based on the borrower's qualifications for a loan, such as a high enough debt-to-income ratio.

The most popular reverse mortgages are the HUD federally-insured private loans. HUD reverse mortgages, offered through the Federal Housing Administration (FHA), require that the borrower:

  • Be a homeowner
  • Be 62 years or older
  • Own the home, or have a low mortgage that is paid off with proceeds from the reverse mortgage at closing
  • Must live in the home as a principle residence

Along with no payments, another advantage of a reverse mortgage is that there are no restrictions on how the loan proceeds must be spent. The terms of the loan specify the length of the loan.  For instance, as the homeowner, you may take out a 20-year reverse mortgage loan.  Even if you outlive the loan, you still don't have to pay it back as long as it is still your principal residence.  And even better, the money is tax free.

So does this all sound too good to be true?

There are some disadvantages. For instance, reverse mortgages are  expensive. Also, they are not really free. The equity in your home is disappearing. Not only is the loan going against your equity, so is the interest on the loan and the interest on the interest. So why is that a problem? The very real worry is that the money will run out before all the many future expenses that may come your way. So before taking out a reverse mortgage, you should weigh all the possible risks, determine a financial plan for the future years, and look at other options first.  An educated decision is always best.

How Do I Get a Reverse Mortgage?

The major steps in getting a reverse mortgage are deciding whether or not you want one, if you do, don't procrastinate but don't accept any uninvited solicitations, either. Educate yourself about the topic, explore state and local programs that might meet your needs, determine how much money you can draw on the national programs and what it will cost, get counseled, decide how you want to draw funds, and select a lender.

"I am running short of money and friends tell me that I should take a reverse mortgage, but the thought of a complicated transaction involving my house just terrifies me. It would help a lot if you would lay out the steps in 1, 2 3 form?"

With a reverse mortgage, it is as important to know what not to do as what to do. So let me start with that first.

Don't Respond to Any Uninvited Solicitations


There are freeloaders about, some calling themselves estate planners, who would like to be paid for directing you to a lender, or to an insurance company selling annuities. You don't need them, just follow the steps described below. Note: Under legislation passed in 2008, originators of reverse mortgages are barred from offering any other financial products to customers for whom they are originating a reverse mortgage.

Don't Procrastinate

Procrastinating on a reverse mortgage is easy because, unlike the situation when you took your first forward mortgage, you already have shelter and the children are grown and out. Fight the tendency by making an informed decision, which is selecting one of three options:

    *A reverse mortgage is not for you.

    *A reverse mortgage is for you, but you prefer to wait and allow the amount you can draw to rise as you age.  

    *A reverse mortgage is for you right now.

Yet a final decision should wait until you complete the next three steps at least.

Explore State and Local Programs That Might Meet Your Needs

Many states and localities have single purpose programs for seniors directed to property improvement or payment of property taxes. These programs are invariably good deals, but they usually have eligibility criteria that limit their availability. A good place to start looking for them is the directory of "homes and communities organized by state" on http://www.hud.gov/.

Educate Yourself About Reverse Mortgages


Call AARP at 800 209 8085 highlighting for a free copy of Home Made Money, an excellent pamphlet on reverse mortgages. You can also order it online at http://www.aarp.org/money/personal/reverse_mortgages

Determine How Much Money You Can Draw on the National Programs, and Select a Lender


You can usefully combine these steps. See How Do You Shop For a HECM?

Formulate a Preliminary Plan of How You Will Draw Funds


Will you take a line of credit, a monthly payment, or some combination?

Which Reverse Mortgage Option Should I Choose?

 The Net Principal Limit

The different options can be visualized as different ways of removing money from a pot with a fixed amount in it. HECM borrowers can draw a maximum amount immediately and none thereafter; take a credit line on which they can draw at their convenience; take a fixed-payment annuity over a period of their choice; or some combination of the last two. The starting point for all the options, however, is the amount in the pot at the outset.

Assume a hypothetical owner Smith aged 70 with a house worth $400,000 and no existing mortgage, selecting a monthly adjustable-rate HECM. Based on the shopping I did for Mr. Smith on December 1, 2009, the "principal limit" (PL) on his house was $216,800. The PL is the value of Smith's house now to an investor who must wait for Smith to die or move out permanently before they can take possession.  The PL is affected by the borrower's age, the value of the house, and the interest rate.

But Smith can't actually draw the PL without paying all the upfront expenses connected to a HECM: origination fees, mortgage insurance, third party closing costs, and a servicing-fee set-aside. These expenses are deducted from the PL to yield a "Net Principal Limit" (NPL), which is $193,340. NPL is the money in the pot that Smith could withdraw as a lump sum immediately, or use to support the other withdrawal options discussed below.

Selecting an ARM Versus an FRM

Most HECM borrowers take a credit line for the full NPL, and use a sizeable chunk of it right away. They pay off debts, fund overdue maintenance, or treat themselves, perhaps to a long-deferred vacation. They may use the balance of the credit line to fund a monthly payment, but more often they hold it as a reserve against future contingencies.

The portion of the line that is not used grows over time at a rate equal to the rate the borrower pays on the HECM. Some conservative borrowers limit their draws to the growth in their line, keeping the entire NPL for the future. In the example, Smith could draw about $7500 a year without cutting into the NPL.  

Selecting a Monthly Annuity Payment 

The borrower can also elect to receive monthly annuity payments over any period. Where the credit line provides maximum flexibility, monthly payment options provide discipline and convenience.

If the entire NPL is used to purchase an annuity, Smith could draw about $3860 for 5 years, $2250 for 10 years, $1480 for 20 years, or $1269 for life. Smith would commit, although not irrevocably, to using up the NPL over the period selected.

If Smith elects to take $3860 a month for 5 years, for example, the entire NPL of $$193,340 is set aside for this purpose. So long as Smith is on this path, he can't draw any more funds. If he goes the full 5 years, he is maxed out.


But he can change his mind before the period is over. If he does, the portion of his NPL that is unused at that point becomes available for a new plan, which could be a different monthly payment or a credit line. After one year of drawing $3860, for example, about $153,800 of Smith's NPL would remain unused and available.

Smith can also select any combination of credit line and monthly payment. For example, he could select a 5-year payment of $1930, which would use only half the NPL, leaving the other half as a credit line which would grow if not used, but which could be drawn on at any time.  

Selecting an ARM Versus an FRM

Before the financial crisis, mortgage selection involved choosing between 2 ARMS, one on which the interest rate adjusted monthly and one that adjusted annually. But the ARM that adjusts annually is no longer competitive while a new and very competitive fixed-rate HECM has emerged. In December, 2009, the FRM version was priced better than the ARM, generating a higher NPL. The downside of the FRM is that the entire NPL must be drawn immediately. No unused credit line and no annuities are permitted. Borrowers who want to leave some of the NPL for future contingencies, or purchase an annuity will select the ARM.

The FRM meets the needs of one important group of seniors: those who want to sell their existing house and buy one that better meets their current needs. They may want to exchange a large house for a smaller one, for example, or move to a condominium in a retirement community. The FRM is appropriate for this purpose because its NPL is larger than that of the ARM, although this could change.

Under a "HECM for Purchase" program authorized by Congress in 2008, seniors can buy a house and take out a reverse mortgage on that house at the same time. Absent this program, the senior would have had to purchase the new house with a forward mortgage, then take out a HECM to retire the forward mortgage, incurring two sets of settlement costs in the process. With the fixed-rate HECM, the senior incurs only one set of settlement costs.

Get Counseled


Counseling by a HUD-approved counseling agency is mandatory, regardless of what kind of loan you select so use it as part of your education. You can find a counselor on your own by going to http://www.hud.gov/offices/hsg/sfh/hcc/hccprof14.cfm, clicking on your state, and selecting from among the agencies that list "HECM counseling". Alternatively, you can wait until you select a lender, who will give you a list of counselors in your area.


Borrower Protection on FHA Reverse Mortgages

"I fear that some elderly homeowners who take out FHA reverse mortgages will not receive all the payments to which they are entitled. FHA insurance protects the lender, not the borrower. When you consider that payments to the borrower must continue for life -- which can be forty years or more -- there is a distinct possibility that some lenders will just not be there to complete the payments. They will profit from the shorter-lived borrowers, then default on those who live too long."

Not so, there is no way this will happen.

The FHA reverse mortgage program has been growing in popularity, and the protection it provides the elderly homeowners who participate is a major reason. They have the right to live in their house until they die or voluntarily move out, and any annuities or draws against their credit lines that they are due, are certain to be paid.

It is true that the FHA insurance, in the reverse mortgage program as well as in all other FHA programs, protects the lender rather than the borrower. In the event that the amount owed by the borrower exceeds the value of the property, the loss to the lender will be covered by FHA. But under the reverse mortgage program, any payments due the borrower are also protected. HUD has a legal obligation to make such payments in the event that the lender does not.

When the reverse mortgage loan balance gets to 98% or more of the "maximum claim amount", which is the maximum amount that can be collected, lenders are allowed to assign the loan to HUD and be paid the balance. HUD then assumes responsibility for making any additional payments that are due the borrower. HUD will also take over responsibility if, for some reason, the lender cannot make the required payments.

The upshot is that borrowers are fully protected. The only possible blip in their lives arises from the transfer of servicing from the original lender to a servicer working for HUD, and that should be inconsequential.

"My mother has had an FHA Home Equity Conversion Mortgage for some time and has reached her $70,000 credit limit. The lender has sent her a letter saying that they are transferring the account to HUD. She is worried she will lose her home...?"

Not to worry, so long as she is paying her property taxes and home owners insurance, doesn't change the name on the deed, and doesn't rent out rooms, her home is safe.

Under HUD rules, a lender can assign a loan to HUD once the total amount owed by the owner - the sum of all payments to her, upfront fees that were financed and accumulated interest -- equals the "maximum claim amount." This is the largest amount the lender can collect - it is $70,000 in your mother's case.

On assignment, the lender is paid that amount and HUD becomes the owner. HUD will appoint a servicer to handle the loan, who could be but probably will not be the one your mother has been dealing with. The switch to a new servicer is the only change your mother will notice.

Costs of a Reverse Mortgage

Origination Fees on Reverse Mortgages


The settlement charges on a reverse mortgage cover pretty much the same costs that are involved on a forward mortgage, but there are some differences. Instead of a list of lender charges, which can very from lender to lender, reverse mortgages have one "origination fee" which covers all lender costs.

On HECMs, the origination fee is set by regulation at 2% of the FHA loan limit, with a minimum fee of $2,000 and a maximum of $6,000. The loan limit was raised in 2009 to $625,500 nationwide.

Other Reverse Mortgage Costs Paid at Origination


HECM borrowers must pay FHA an upfront mortgage insurance premium of 2% of the lower of home value and the maximum loan limit, and an annual premium of 1/2 percent of the loan balance. Other upfront fees cover title insurance, appraisal, credit report, flood certification, document preparation, closing, property survey and pest inspection.

None of the upfront costs are out-of-pocket, they can all be included in the loan amount. But a chunk of the borrower's equity is used up in the process, which makes the transaction very expensive if it terminates within a short period.

Servicing Costs

Borrowers pay a monthly charge of $30-35 to cover the cost of servicing. In addition, to assure that there will always be enough equity in the property to cover servicing costs, a sum of money is earmarked for servicing at the o utset of the transaction. Called a "set-aside", the loan limit used in calculating the credit line or annuity is reduced by that amount.

A reverse mortgage is a loan taken by senior citizens on the equity of their home—a loan that they will not pay back as long as the home is their principal residence. Although there are no monthly payments, the interest does build up. However, the lender will not loan all the equity; only a portion of the value of the house will be used to calculate the amount available. Usually the first mortgage is paid off, or only a very small balance remains. Sometimes any remaining balance on the first mortgage is paid off from the proceeds of the reverse mortgage. The reverse mortgage money can be taken in several ways:

  • Equal monthly payments
  • A line of credit,
  • A combination of the two.

While a reverse mortgage and a home equity loan both rely on the borrower having equity in the home, a reverse mortgage is different from a home equity loan in many ways. The major difference is that a reverse mortgage does not have payments as long as the home is the borrower's principal residence. However, there are other differences as well. The reverse mortgage is based on age, current interest rate, equity, and the value of the home, but is not based on income; whereas, a home equity loan is based on the borrower's qualifications for a loan, such as a high enough debt-to-income ratio.

The most popular reverse mortgages are the HUD federally-insured private loans. HUD reverse mortgages, offered through the Federal Housing Administration (FHA), require that the borrower:

  • Be a homeowner
  • Be 62 years or older
  • Own the home, or have a low mortgage that is paid off with proceeds from the reverse mortgage at closing
  • Must live in the home as a principle residence

Along with no payments, another advantage of a reverse mortgage is that there are no restrictions on how the loan proceeds must be spent. The terms of the loan specify the length of the loan.  For instance, as the homeowner, you may take out a 20-year reverse mortgage loan.  Even if you outlive the loan, you still don't have to pay it back as long as it is still your principal residence.  And even better, the money is tax free.

So does this all sound too good to be true?

There are some disadvantages. For instance, reverse mortgages are extremely expensive. Also, they are not really free. The equity in your home is disappearing. Not only is the loan going against your equity, so is the interest on the loan and the interest on the interest. So why is that a problem? The very real worry is that the money will run out before all the many future expenses that may come your way. So before taking out a reverse mortgage, you should weigh all the possible risks, determine a financial plan for the future years, and look at other options first.  An educated decision is always best.

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