Whether the goal is to provide income, pay for specialized medical treatment or to enjoy the freedom and choices that help make retirement years more memorable, unleashing home equity can be the key to a well-planned retirement.
Designed to help homeowners 62 or older remain in their homes and improve their quality of life in retirement, reverse mortgage is a non-recourse loan that releases home equity and converts it into tax-free income. It may allow seniors to be self-sufficient and not deplete existing savings.
Many of them have seen the values of their homes sky-rocket over the last 5 years. You may think of a reverse mortgage as the opposite of a conventional mortgage. With a conventional mortgage, the homeowner borrows a large sum of money and makes monthly payments.
As payments are made, the loan balance gets smaller and the equity grows. In contrast, during the life of a reverse mortgage, the loan balance gets larger while the equity gets smaller and no monthly mortgage payments are required. So, instead of using income to gain equity, the reverse mortgage borrower is using equity to increase income. The non-recourse feature basically means, that the homeowner
will never owe more on the reverse mortgage than the value of the home.
WHAT ARE THE RATES?
With a reverse mortgage, while you don’t currently pay mortgage interest or principal, they do accrue at a particular rate. Depending on the type of the loan, the interest rate may be linked to either the LIBOR, variable CD rate or T bills. The lender will then add a margin and “cap”it at a certain rate. The loans will come in at least
three types: FHA (Federal Housing Administration), Fannie Mae and some sort of proprietary loan that is specific to a particular lender. Many institutions’ proprietary reverse mortgage products will link the accrual rate with LIBOR index. LIBOR is an abbreviation for “London Interbank Offered Rate,” and is the interest rate offered by a specific group of London banks for U.S. dollar deposits of a stated maturity. LIBOR is used as a base index for setting rates of reverse mortgages, some adjustable rate financial instruments, including Adjustable Rate Mortgages (ARMs) and other loans. For example, a lender may charge a 6 month LIBOR (Index) + 5% (Margin) for a total of 8.75%. The rates reset every six months and they will generally be higher than your traditional, fixed interest mortgages.
Let’s consider an example: A 69 year old widow lives home alone. Her kids are grown and with jobs they have moved away to different states. Her only income is Social Security and she can’t afford to visit them when she wants to. She can also use some extra monthly income, because her $1,100 social security check only provides for bare necessities. She bought her home 30 years ago and owns it clear. Similar homes sell for $550K in the neighborhood. She decides to dig into the home’s equity and gets a reverse mortgage.Let’s say the interest rate is 9% and her home appreciates at 4% per year. In this scenario, she may take $140,000 or so from the equity. The funds may provide her with an increased income and she may have the lump
sum available for any trips to see the grandchildren, any gifting, renovation or uncovered medical expenses. Since the interest accrues, she does not have any mortgage payments. If she keeps the loan for 20 years, for example, her home may be worth $1.2 mln (at assumed 4%) and the accrued interest and principal may be about $882,000, leaving about $322,000 in equity. At death, the children may sell the house, pay off the loan and keep the remainder, or refinance the loan and keep the home. A reverse mortgage is a lien against the property and must be repaid when the borrower permanently leaves it. Let’s examine the programs in more detail.
FHA REVERSE MORTGAGE PROGRAM-“HOME EQUITY CONVERSION MORTGAGE” (HECM)
FHA is a government insured program available to homeowners 62 years and older, where the interest rate is based on Treasury Bills and is adjusted annually or monthly. The maximum amount you can take out via the reverse mortgage is
determined by the county where you live. The proceeds are tax free and their use is not restricted. Eligible properties include single family principal residence in 10 unit dwelling, some condos and co-ops.
FANNIE MAE PROGRAM:
Fannie Mae is a government sponsored enterprise program with similar to FHA eligibility requirements. The maximum lending limit is set nationally (currently at $359,650) and the interest rate is based on variable CD rates. You can take the proceeds in a number of ways. Homeowners can take a lump sum, use part of it for immediate expenses and perhaps invest the rest for income. They can also use it in a form of a line of credit-using only the amounts they need.Lenders may also give proceeds in a form of lifetime income.
The closing costs may include an appraisal, title search, surveys, inspections, recording fees, mortgage taxes and credit checks. Lenders will then charge an origination fee, which may be in a 2% range, bringing the total closing cost to as much as $10,000 to $15,000 for an average size loan. In addition, FHA loans will also require initial Mortgage Insurance Premium of about 2%. Ongoing fees may include 0.5%
per year for MIP and other servicing fees. Most such costs may be financed by the loan itself. The total cost of any
reverse mortgage loan depends on how long you keep the loan and how much your house appreciates in value.
Generally, the longer you keep such loan, the lower the total annual loan cost may be. As always, you should shop
around for the best deal.
The reverse mortgage may not be the least expensive option to release equity from a home, however, it may be the only option for some. It is certainly the only option not requiring a monthly mortgage payment.
What makes the entire reverse mortgage process more transparent is the need for an independent counseling.To
close a loan, lenders require that you attend a counseling meeting with an unaffiliated, third party counselor. There are a number of approved HUD or Fannie Mae counselors in a given geographic area, who will review the reverse mortgage process and facilitate your understanding of the loan. Since the mortgage reduces the equity in ones home, I would recommend that you involve your children in the decision. In many cases the adult children are financially established themselves and will be happy to suggest you use the home’s equity to improve your retirement lifestyle.
This material is provided for informational purposes only and should not be construed as a recommendation. The information discussed does not consider your particular financial situation and may not be suitable for you. Individuals should contact the appropriate professionals to help answer questions about their specific situations or needs prior to taking any action based on this information. We believe the information provided is reliable, but do not guarantee its accuracy, timeliness, or completeness. Securities offered through NEXT Financial Group, Inc. Member NASD/SIPC.Vision is not an affiliate of NEXT Financial Group, Inc.