 Personal Finance PowerPoint Presentation. Reverse mortgage. Get ready to get financially fit by practicing personal finance. Most of this information can be found at Investopedia Guide to Reverse Mortgages, which you can find online. Take a look at the references, the resources. Continue your research from there. This is by Amy Fontinier, updated April 4th, 2022. What is a reverse mortgage? In a word, a reverse mortgage is a loan. So typically, when we're talking about real estate, when we're talking about a home, we can't usually purchase it outright. We typically have a loan, the home being security on that loan to safeguard the lender, typically the bank or other financial institution. A home owner who is 62 or older and has considerable home equity can borrow against the value of their home and receive funds as a lump sum, fixed monthly payment or line of credit. So this is typically we're talking about retirement type of situations. Oftentimes at that point in time, people might have a significant amount of assets, meaning they've got assets over liabilities. They're looking pretty good from a net asset type of standpoint. But a lot of those assets could be tied up and non liquid because they're in the home. And obviously at that point in time, we would like to have some kind of steady income stream to be using the assets for, for what our needs during that point in time. So how could we liquidate some of the assets that are in the value of the home in the equity of the home, which is the difference between the loan value and the market value of the home. So unlike a forward mortgage, the type used to buy a home, a reverse mortgage doesn't require the homeowner to make any loan payments. Instead, the entire loan balance up to a limit becomes due and payable when the borrower dies moves out permanently or sells the home. So now instead of us basically lowering the loan balance, you can imagine, obviously when you purchase the home, the typical thing you're going to take out the loan, you're going to be paying off of the loan, lowering the loan balance as you lower the loan balance, you're increasing the equity in the home, assuming like the home stays at the same value. Let's assume that or hopefully it goes up, but if it stays at the same value, when you pay off the loan, the gap, the difference between the home value and the loan value goes up. Well, you can kind of, you can think about or imagine reversing that if the bank would allow that, right? You can say, well, now I'm going to have the loan balance, the gap between the value of the home and the loan balance decrease in a reverse type of fashion. So federal regulations require lenders to structure the transaction so that the loan amount won't exceed the home's value. So you have the same kind of considerations that you would think would want to be in play, meaning we don't want the loan value to go above the value of the home because you have the same kind of concerns from the lender side of things that you have in a normal loan. That would mean the person is not as invested in the home, more likely to kind of walk away from the home. For example, so you still want that investment in the home to be sufficient to make the lender comfortable to do the agreement. So federal regulations require lenders to structure the transaction so that the loan amount won't exceed the home's value. Even if it does, though, a drop in the home's market value, or if the borrower lives longer than expected, the borrower or borrowers of state won't be held responsible for paying the lender the difference thanks to the program's mortgage insurance. So mortgage insurance can kind of help out with that situation. You can imagine different structures on how this would be set up, this reverse mortgage would be set up, but if you're saying there's going to be a fixed amount of payments into the future, you're probably making estimates based on someone's life expectancy, right, and in some way. So now you've got to estimate and what if they live longer than that? Well, now they're going to get payments for longer than that, or you could try to set the end time frame or how many payments are going to be there, for example, but you can see the estimates that are going to be taken into account, and that's going to be the estimate made at home value in the future, and an estimated home value now, and then the life of the individual, how long are they going to be living are going to be considerations if you were to structure something in this reverse fashion, although there's a couple different options to structure it in kind of like a reverse faction. So cash in equity, reverse mortgages can provide much needed cash for seniors whose net worth is mostly tied up in their home equity. So they got, they've got assets, but they're not liquid. They're in the home, they need the assets at that point in time, they need a steady income to be living on when they're not in their working years. So the home market value minus the amount of any outstanding home at Lowence is the equity, yet these Lowence can be costly and complex as well as subject to scams. So because of the complexity involved, you know, you got to keep that into consideration because, you know, you want you want things that you can basically understand when you're doing your investments in them and they get a little complex and the different structures that could be involved here. So this article will teach you how reverse mortgages work and how to protect yourself from the pitfall so you can make an informed decision about whether such a loan might be right for you or a loved one. According to the National Reverse Mortgage Lenders Association, homeowners ages 62 and older held 10.19 trillion in home equity in the third quarter of 2021. So that's a lot of money tied up in the home equity. The number marks an all time high since measurement began in 2000, underscoring how large a source of wealth home equity is for retirement aged adults. So clearly a lot of money tied up there in retirement age, they might need to tap into some of that money since they don't have the same kind of cash flow they did during the earning years. Home equity is only usable wealth if you sell or downsize or borrow against that equity. So how can you tap into that? Well, you could take another loan against it, you could sell the home. But if you sell the home, then you'd have to move somewhere else where the homes are cheaper or downsize the home or some way to get the actual cash flow that's in the equity. That's the problem. That's where reverse mortgages come into play, especially for retirees with limited income and few other assets, but also for retirees who want to diversify their income and reduce investment risk, sequence risk and longevity risk. So in other words, if all of your money is tied up into the home at that point in time, although the home is a good asset to be invested in, it's not a diverse form of investment. So another way to diversify maybe to break that up a bit. How a reverse mortgage works with a reverse mortgage instead of the homeowner making payments to the lender, the lender makes payments to the homeowner. What? How can that be possible? Because of course, instead of paying down the loan, the loan is actually going up, which means the difference between the home value and the loan is getting smaller instead of bigger. Normally it gets bigger when you pay down the loan, the gap gets bigger, meaning you have more equity, you're going to have less equity as the bank pays you and a reverse mortgage making it reverse of the norm. So the homeowner gets to choose how to receive these payments. We'll explain the choices in the next section and only pays interest on the proceeds received. The interest is rolled into the loan balance so that the homeowner doesn't pay anything upfront. The homeowner also keeps the title to the home over the loan's life. The owner's debt increases and home equity decreases. So they still have the title to the home and so on and so forth. It's not like you're, it's not like they have an equity interest in the home, the bank can't come over and tell you what color to paint your house or anything like that. But obviously, the liability is going up, reducing the equity as with a forward mortgage, the home is the collateral for a reverse mortgage. So clearly, it's the collateral if you were, if there was a problem, then the lender has the home as recourse to that. When the homeowner moves or dies, the proceeds from the home sale go to the lender to repay the reverse mortgage principle, interest, mortgage insurance and fees. So clearly, this is at the end of the life. And so you would think that at the time of death, because you're basically getting the payment from the equity of the home, that's when things get settled due to the value of the home. Any sale proceeds beyond what was borrowed to the to the homeowner is still living or the homeowner's estate, if the homeowner has died. In some cases, the heirs may choose to pay off the mortgage so that they can keep the home so you can still pay off the mortgage. But obviously, the mortgage is going to be higher because it's been increasing during that timeframe. Reverse mortgage proceeds are not taxable. Well, they might feel like income to the homeowner, the Internal Revenue Service IRS considers the money to be a loan advance. So they, which seems correct to me, it seems a correct consideration considering the loan is going up. So it's basically, you know, a loan it's not even though you're getting paychecks, money, cashflow, you're really, you know, getting part of the equity and you didn't really realize it yet, you're increasing the loan. So type of reverse mortgages. There are three types of reverse mortgages. The most common is the home equity conversion mortgage, the HECM. The HECM represents almost all the reverse mortgages that lenders offer on home values below the confirming loan limit set annually by the federal housing finance agency and is the type that you're most likely to get. So that's the type that this article will discuss. Also called a federal housing administration FHA reverse mortgage. This type of mortgage is only available through an FHA approved lender. If your home is worth more, however, you can look into a jumbo reverse mortgage. Also called a property reverse mortgage. Number one lump sum get all so this is when you take out the reverse mortgage, you can choose to receive the proceeds in one of six ways. So it gets a little bit complex in terms of how you're going to get that money. One, you might say, give it to me all, give it to me now. Give it to me. Just like I won the lottery, I want a lump sum. So number one lump sum, get all the proceeds out at once when your loan closes. This is the only option that comes with a fixed interest rate. The other five have adjustable interest rates. So you got to take that interest rate into consideration. Number two, we've got the equal monthly payments annuity. So now we're going to get the payments kind of like when you won the lottery. This isn't really winning the lottery because it's your money and the equity, but you know, you can now you're going to get the payments. I want to give it to me in payments for as long as at least one borrower lives in the home as a principal residence, the lender will make steady payments to the borrower. This is also known as a tenure plan. Number three, we got the term payments. The lender gives the borrower equal monthly payments for a set period of the borrowers choosing such as 10 years. So you can see number two takes a little bit more estimation going on because you're going to say, well, how long is that going to be going to use some actuarial tables or something, get some fancy math in there to figure out that one. Over here, you got the term limits. So you're just going to set the term for 10 years. But what if I live past 10 years? That's an issue. That's why you got to take that into consideration if it's if it's number four, line of credit money is available for the homeowner to borrow as needed. So you might say, Hey, I don't really need the cash flow per se, but I'd like it to be available to me in the event that I do need it kind of like a credit card. And so I'm on a line of credit on this thing. The homeowner only pays interest on the amounts actually borrowed from the credit line. Number five equal monthly payments plus a line of credit. So now we're doing some mixing, some maximum, some combination action. So the lender provides steady monthly payments for as long as at least one borrower occupies the home as a principal residence. If the borrower needs more money at any point, they can access the line of credit. And then number six, we got the term payments plus a line of credit. So another mixing matching kind of combo situation. The lender gives the borrower equal monthly payments for a set period of the borrowers choosing like 10 years or something. So we set the period. But if the borrower needs more money during or after that term, they can access the line of credit. It's also possible to use a reverse mortgage called a HECM for purchase to buy a different home than the one in which you currently live. So you might be using that in some form to move to another home, for example, in any case, you will typically need at least 50% equity based on your home's current value, not what you paid for it to qualify for a reverse mortgage. So clearly this would be a situation where you would expect someone had the home for quite some time and the equity has increased in part possibly from paying down the loan that they had and or the value of the home goes up. So we're talking about the value of the home. You would think at this point in time the current value of the home, which would require some appraisal process on the part of the finance or the bank or financial institution. Would you benefit from a reverse mortgage? Yes or no? I want yes or no here. That doesn't look like a yes or no. Let's see what they say. A reverse mortgage might sound a lot like a home equity loan or home equity line of credit, a HELOC, indeed similar to one of these loans, a reverse mortgage can provide a lump sum or a line of credit that you can access as needed based on how much your home you've paid off and your home's market value. But unlike a home equity loan or a HELOC, which we talked about in prior presentations, if you want to dive into that in a bit more depth, you don't need to have income or good credit to qualify and you won't make any loan payments while you occupy the home as your primary residence. A reverse mortgage is the only way to get access home equity without selling the home for seniors in situations like these. So these are the types of situations you might most likely be in the consideration of it. They don't want the responsibility of making monthly loan payments. So clearly you're not making loan payments at that point in time because they're going to be dipping into the equity of the home, the bank paying you possibly can't afford the monthly loan payments. So you can't afford the monthly loan payments anymore, but you've got substantial equity in the home, want to stay in the home, don't want to sell the home. Possibly it could be a situation. Can't qualify for a home equity loan or refinance because of limited cash flow or poor credit. So you could go through the refinance process in order to get better terms, adjust the loan, possibly get some cash flow, but you can't do that because of some other circumstances such as cash flow or credit. Then this would be a consideration in that instance. What is required for a reverse mortgage? Property type. So if you own a house condominium or town home or a manufactured home built on or after June 15th, 1976, then you may be eligible for a reverse mortgage under F A F H A rules. Corporative housing owners cannot obtain reverse mortgages since they don't technically own the real estate they live in. They own shares of a corporation in New York. Your co-ops are common state law further prohibits reverse mortgages in co-ops, allowing them only in one to four family residences and condos. So age, equity and fees while reverse mortgages don't have income or credit score requirements, they still have rules about who qualifies. You must be at least 62 years old and you must either own your home free and clear or have a substantial amount of equity at least 50 percent borrowers must pay an origination fee and upfront mortgage insurance premium, other standard closing costs ongoing mortgage insurance premiums, M.I.P.s loan service fees sometimes and interest. The federal government limits how much lenders can charge for many of these items. Counseling, the U.S. Department of Housing and Urban Development, otherwise known as HUD HUD requires all perspective reverse mortgage borrowers to complete an H U D approved counseling session. So this counseling session, which usually costs around $125 should take at least 90 minutes and cover the pros and cons of taking out a reverse mortgage, given your unique financial and personal circumstances. It should explain how a reverse mortgage could affect your eligibility for Medicaid and supplemental security income S S I, which obviously could be a significant impact. If those are significantly impacted, things to consider the counselor should also go over the different ways that you can receive the proceeds, which we went over, which can be quite complex with those mixing and matching combinations and so on, six, six ways to do it. While that's a lot of choices, collateral protection, your responsibilities under reverse mortgage rules are to stay current on property tax and homeowners insurance. He can't be now now not paying your property tax, just because you're on the reverse mortgage, because obviously the lender will not like that. And homeowners association fees, if you have them and keep the home in good shape. So just because you're in the reverse mortgage, you shouldn't be punching holes in the walls or anything like that. Is that because that's not good for the for the banks either. So and if you stop living in the house for longer than one year, even it's because you're living in a long term care facility for medical reasons, then you'll have to repay the loan, which is usually accomplished by selling the house. So what are the costs of a reverse mortgage? You might ask HUD adjusted insurance premiums for reverse mortgages in October 2017, since lenders can't ask homeowners or their heirs to pay pay up if the loan balance grows larger than the home value, the insurance premiums provide a pool of funds that lenders can draw on so that they can't lose the money when this happens. So one one change was was an increase in the upfront premium from point 5% to 2% for three out of four borrowers and a decrease in the upfront premium from 2.5% to 2% for the other one out of four borrowers. The upfront premium used used to be tied to how much borrowers took out in the first year with homeowners who took out the most because they needed to pay off an existing mortgage paying the higher rate. Now all borrowers pay the same 2% rate. The upfront premium is calculated based on the home's value. So for every 100,000 in a praised value, you pay $2,000. That's $6,000 on a $300,000 house for example. In fact, the fee is capped at $6,000, even if your home is worth more. All borrowers must also pay annual MIPs of 0.5% formally 1.25% of the amount borrowed. This change saves borrowers $750 a year for every $100,000 borrowed and helps offset the higher upfront premium. It also means that the borrowers debt grows more slowly, preserving more of the homeowner's equity over time, providing a source of funds later in life and increasing the possibility of being able to pass down the home to errors. Reverse mortgage interest rates only the lump sum single disbursement reverse mortgage, which gives you all of the proceeds at once when your loan closes has a fixed interest rate. So if you take that lump sum one, which probably isn't the one that most people are thinking of because they're probably thinking they want to get payments. But if you get all the money upfront, then they can more easily calculate things kind of upfront and you got that fixed rate. In that case, otherwise you got the variables rates, which you got to deal with that changing rate situation. The other five options have adjustable interest rates, which makes sense since you're borrowing money over many years, not all at once. And interest rates are always changing. Variable reverse mortgages are tied to benchmark index, often the constant maturity treasury, the CMT index. So how do they figure the interest rate? They're going to tie it to an index, which is a standard kind of practice for that type of thing. In addition to one of the base rates, the lender adds a margin of one to 3% points. So if the index rate is 2.5% of the lender's margin is 2%, then your reverse mortgage interest rate will be 4.5%. So they're going to say it's the base rate plus a margin or 2% in this case. As of January 2022, lender's margins range from 1.5% to 2.5% interest compounds over the life of the reverse mortgage and your credit score does not affect your reverse mortgage rate or your ability to qualify, though it does affect whether the lender may require a life expectancy set aside account for your property taxes, homeowners insurance and other required property charges. How much can you borrow with a reverse mortgage? The proceeds that you'll receive from a reverse mortgage will depend on the lender and your payment plan for an HECM. The amount that you can borrow will be based on on the youngest borrower's age, the loan's interest rate and the lesser of your home's appraised value or the FHA's maximum claim amount, which is $970,800 as of January 1st, 2022. So obviously, if you're going to get payments throughout a time frame and there's no end date on it, so you've got to do some life expectancy calculations, so that's going to be on the age and the equity in the home and the interest rates and so on to help figure that out. So however, you can't borrow 100% of what your home is worth. So you can't borrow up to 100% because that would be too risky for the lender because if they sold the home just because of the closing cost, they would lose money on that so they still want some equity in the home. Or anywhere close to it, part of your home equity must be used to pay the loans expenses, including mortgage premiums and interest. Here are a few other things that you need to know about how much you can borrow. The loan proceeds are based on the age of the youngest borrower or so that's going to be because their life expectancy. If you're going to say we're going to keep making payments until this person is out of the home, possibly dies at that point, right? So if the borrower is married, the younger spouse, even if the younger spouse is not a borrower, the older, the older, the youngest borrower is the higher the loan proceeds, the lower the mortgage rate, the more you can borrow the higher your properties appraisal value, the more you can borrow a stronger reverse mortgage financial assessment increases the proceeds that you'll receive because the lender won't withhold part of them to pay property taxes and homeowners insurance on your behalf. How much can you actually borrow is based on what's called the initial principal limit. The federal government lowered the initial principal limit in October 2017, making it harder for homeowners, especially younger ones, to qualify for a reverse mortgage. On the upside, the change helps borrowers preserve more of their equity. The government lowered the limit for the same reason that it changed insurance premiums because the mortgage insurance funds deficit had nearly doubled over the past fiscal year. This is the fund that pays lenders and protects taxpayers from reverse mortgage losses. To further complicate things, you can't borrow all of your initial principal limit in the first year when you choose a lump sum or a line of credit. Instead, you can borrow up to 60% or more if you're using the money to pay off your forward mortgage. If you choose a lump sum, the amount that you get up front is all you will ever get. If you choose the line of credit, then your credit line will grow over time, but only if you have unused funds in your line. Avoiding reverse mortgage scams with a product as potentially lucrative as a reverse mortgage because obviously now you're getting cash flow out of this, that could be a place for scammers to try to scam because you got a lot of cash flow going on in it. And a vulnerable population of borrowers, clearly you're talking about people that might be in financial need and in a time in their lives where they don't have the capacity to do other things for cash flow, who may either have cognitive or impairments or be desperately seeking financial salvation scams abound, of course. Unscrupulous vendors and home improvement contractors have targeted seniors to help them secure reverse mortgages to pay for home improvements, in other words so they can make bank. So the vendors or contractors may or may not actually deliver on promised quality work. They might just steal the homeowner's money. So relatives, caregivers and financial advisors have also taken advantage of seniors either by using a power of attorney to reverse mortgage the home, then stealing the proceeds or by convincing them to buy a financial product such as an annuity or whole life insurance policy that the senior can only afford by obtaining a reverse mortgage. So obviously these things have so these transactions is likely to be only in the so-called best interest of the financial advisors, relative or caregiver. These are just a few of the reverse mortgage scams that can trip up unwitting homeowners. So do this to avoid foreclosure from a reverse mortgage. Another danger associated with a reverse mortgage is the possibility of foreclosure, even though the borrower isn't responsible for making any mortgage payments and therefore I can't become delinquent on them. A reverse mortgage requires the borrower to meet certain conditions. Failing to meet these conditions allows the lender to foreclose. So a reverse mortgage borrower, you are required to live in the home and maintain it. So you got to actually be in the home. So if the home falls into disrepair, it won't be worth fair market value when it's time to sell. So clearly the bank wants you to be in the home because if you're not in the home, it's going to deteriorate and won't be worth the fair market value. And the lender won't be able to recoup the full amount that it has extended to the borrower. Reverse mortgage borrowers are also required to stay current on property taxes and homeowners insurance. Because if they're not, then that would impede the ability for the bank to sell the home at the point of death or when the home converts or is going to be sold. Again, the lender imposes these requirements to protect its interest in the home. If you don't pay your property taxes, then the local tax authority can seize the house. If you don't have homeowners insurance and there's a house fire, the lender's collateral is damaged. Is a reverse mortgage expensive? Home equity conversion mortgages, the HECMs, the most common type of reverse mortgage, bring a number of one time fees and ongoing costs. The most significant of these are origination fees, closing costs, and mortgage insurance premiums, along with the interest the borrower accumulates on the loan balance. When do you have to repay a reverse mortgage? The lender will require the borrower to repay the reverse mortgage if the borrower does any of these things. Sells the home, resides outside the home for more than a year, passes away, fault failed to maintain property, stops paying your homeowners insurance premiums or property taxes. There are some exceptions to these rules for eligible non-borrowing spouses who want to keep living in the home after their borrowing spouse passes away. Can you refinance a reverse mortgage? Yes, you can refinance a reverse mortgage because of the origination fee, upfront mortgage insurance premiums and other closing costs. Refinancing a reverse mortgage should be reserved for situations where a spouse needs to be added to the loan. More equity is needed or the interest rate can be lowered substantially.