Even if you try your best to have a reasonable amount of money in your retirement plan, there's no telling what sorts of curveballs life throws. And with the average life expectancy and cost of living going up, sometimes, a pension won't be enough to cover unexpected emergencies like home renovations and medical care.

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Enter the reverse mortgage – a way to help senior homeowners supplement their cash flow without the burden of paying monthly bills, selling property, or relying on help from relatives. But reverse mortgages are pretty tricky, so it's best to read up before deciding to take a reverse mortgage. Here, we'll clue you in on the basics of reverse mortgages, from how they work to how you can get one.  

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Reverse Mortgage Defined

A reverse mortgage allows a senior homeowner to borrow part of their home equity to increase their monthly cash flow or to have money available in an emergency. Contrary to a regular mortgage, in which the borrower borrows from a lender and makes payments to the lender to pay back the mortgage (i.e., a forward mortgage), a reverse mortgage is set up so that the lender disburses payments to the borrower.

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Thus, payments from reverse mortgages can be used as supplementary income by seniors going through financial difficulties or as a reserve in case of unexpected bills. The best part about reverse mortgages is that the home's title remains with the borrower. Fair warning: A reverse mortgage doesn't exempt you from paying your property taxes, homeowners insurance, and all the other costs of owning a home. The benefit is that the homeowner can draw on the equity in the house, and monthly payments are not required.

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Reverse mortgages are not a new type of mortgage loan. The concept of mortgage reversal was first introduced in 1961, with the first reversible mortgage written to Nellie Young of Portland, Maine. Since then, the reverse mortgage has evolved through the years, with more types of reverse mortgages being developed (more on that later) and policy changes made to ensure less risk for borrowers.

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How Does A Reverse Mortgage Work?

To understand how a reverse mortgage works, you must first consider how a regular home mortgage (forward mortgage) works. In a traditional mortgage, your home equity – or the estimated market value of your home minus the balance of any mortgage loans on the property – increases as you continue to make payments and pay down the balances of any outstanding mortgage loans on the property. Conversely, a reverse mortgage allows you to access the equity in your home while you're living in it, thus decreasing your home equity each time your lender disburses payments from your reverse mortgage.

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But when is the mortgage paid back, and who pays for it? A reverse mortgage is paid back when the borrower passes away or moves out of their home/no longer occupies the house as a principal residence. Each borrower must be 62 or older to be on a reverse mortgage. The reverse mortgage is not due until both borrowers pass away or no longer live in the home as their principal residence. The heirs to the property or a spouse who is not on the mortgage will pay back the mortgage. A spouse who is not on the mortgage can either pay back the reverse mortgage or, if there are insufficient assets in the estate to do so, may be allowed to make payments but will not be allowed to draw on the equity in the home through the reverse mortgage. Often, the house is sold to repay the loan.

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The most important thing is that the reverse mortgage balance does not need to be repaid until such time that the borrower passes away or no longer lives in the home as a primary/principal residence.

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Interest is assessed on the outstanding balance outstanding on a reverse mortgage, but no payments are due until the above-referenced events.

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What Is Reverse Mortgage For?

There are many reasons why someone would want or need a reverse mortgage. Here are a few:

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• To pay for medical bills and in-home care: Reverse mortgages were developed for seniors who are homeowners and 62 years old or older. Seniors typically will need more money to spend on things like hospital visits and surgeries and physical therapist and caregiver visits at home.
• To pay for home improvements: Just as our bodies age, so do our homes. Seniors who have stayed in their homes for decades may need financial assistance to take care of significant repairs and renovations required to accommodate their changing lifestyles.
• To establish an emergency fund: No matter how diligent we are about saving in our younger years, all sorts of problems and challenges can deplete our resources, from sudden accidents to loss of employment. And it can be terrifying not having an emergency fund for future challenges. A reverse mortgage provides seniors a safety net should an unexpected event or expense occur.
• For debt consolidation: A reverse mortgage must be in the first lien position so that debt consolidation may be necessary. You can use a reverse mortgage to pay off other liens against the property or even to consolidate other debts.
• To purchase a second home or investment property: The funds available from a reverse mortgage can be used for many purposes, including buying a second home or an investment property.

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Who Can Get A Reverse Mortgage?

Reverse mortgages are not for everyone. There are specific criteria that a borrower must meet and rules they should follow to attain and maintain a reverse mortgage:

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• Age: As mentioned earlier, reverse mortgages are only available to homeowners who are 62 years and older. Each borrower on the reverse mortgage must be at least 62 years of age or older.
• Residence: The home must be your primary residence. In other words, you must own and live in the house.
• Equity: Besides having to live in the home, you must also have substantial equity in the house. An appraiser will determine your home's current fair market value, and the lender will decide whether your home equity is enough to qualify for a reverse mortgage.
• Mortgage payments: You must pay off the remaining balance on any existing mortgages on your home. Payoffs can be completed using the proceeds of your reverse mortgage.
• Resources: Again, you must have enough money to cover property taxes, homeowners insurance, homeowners association fees, and property maintenance, as well as the cost of opening a reverse mortgage, from closing costs to origination and servicing fees.
• Property maintenance: As a homeowner, you must ensure that your property remains in good condition throughout your mortgage.
• Home type: The types of homes approved for reverse mortgages are single-family homes, multi-unit properties with up to four units, townhouses, condominiums, and manufactured homes built after June 1976.
• Counseling: To qualify for a reverse mortgage, you must attend a counseling session with a HUD-approved housing counseling agency near you. This is to ensure that you have someone not related to the lender who will review the reverse mortgage loan and terms with you to understand the reverse mortgage and your obligations fully.

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Types Of Reverse Mortgages

There are three types of reverse mortgages: the home equity conversion mortgage (HECM), the proprietary reverse mortgage, and the single-purpose reverse mortgage.

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Home Equity Conversion Mortgage (HECM)

The home equity conversion mortgage (HECM) is the most popular type of reverse mortgage. This federally-insured mortgage is backed by the United States Department of Housing and Urban Development or HUD. While HECM loans are more expensive than regular mortgages, they offer flexibility. You don't need to meet a particular income requirement, you can use the proceeds from your reverse mortgage for virtually anything, and you have various payment options.

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However, there is a trade-off. As mentioned earlier, the borrower must meet with a HUD-approved housing counselor for a one-on-one consumer information session. In this session, the counselor will explain the ins and outs of the HECM, as well as alternative options, such as the other two types of reverse mortgages. Aside from counseling, the borrower will also be assessed on their capacity to maintain their monthly property taxes and homeowners insurance payments.

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As for the payment options, HECMs allow the following:

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• Single disbursement or a one-time payment
• Term option or fixed monthly cash advances over a set amount of time
• Tenure option or fixed monthly cash advances throughout your stay in the home
• Line of credit that allows the borrower to withdraw funds whenever they want until the set limit is reached
• Combination of line of credit and monthly payment

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Proprietary Reverse Mortgage

This is a private loan that any government agency does NOT back. Proprietary reverse mortgages may come with higher interest rates but are typically processed faster than government-backed loans. Thus, this type of loan is better suited to a borrower with a higher-valued home who wants to close quickly and have access to the equity in their home.

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Single-Purpose Reverse Mortgage

This is the least popular type of reverse mortgage as it isn't as readily available as the first two. The single-purpose reverse mortgage is a type of reverse mortgage that can only be used for one specific purpose, which the borrower and lender agree upon closing the reverse mortgage. For example, if you decide to use the loan to pay off a home renovation, you may only use the money for that purpose alone. The amount offered for this kind of loan is also typically smaller than HECM and proprietary reverse mortgages.

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Some state and local government agencies offer this type of loan. A select number of non-profit organizations offer this loan as well.

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What Are The Costs Involved?

Since HECMs are the most popular reverse mortgage, we'll focus on this type of loan from here on out. These are a few of the costs you'll have to shoulder as you process your HECM:

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• Mortgage Insurance Premiums (MIP): The MIP protects your lender in case you default on your loan. MIP is paid at the time of closing (upfront MIP or UFMIP) and then monthly (annual MIP). The UFMIP is 2 percent at closing with a 0.5 percent yearly premium (assessed on the amount outstanding). The annual premiums are paid monthly and added to the reverse mortgage balance.
• Origination fee: Think of this as a processing fee for your loan. According to FHA guidelines, the origination fee is 2 percent of the first $200,000 of your home's value plus 1 percent of the remaining value. The maximum charge is $6,000.
• Servicing fee: Depending on your lender, you can also be charged a monthly servicing fee for administering the loan. Per the guidelines, your servicing fee cannot exceed $30 on a fixed rate and $35 on an adjustable rate.
• Appraisal fee: Before a lender can process your reverse mortgage loan, you must have it appraised. The estimated value of your home will depend on several factors, including its location, size, and age. Appraisal fees vary by lender and property type but can cost anywhere between $500 and $700.
• Interest rate: Mortgage rates differ per lender. Make sure to consult with your lender regarding your interest rate and options for repayment.

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How To Apply For A Reverse Mortgage

Applying for a reverse mortgage and closing on our reverse mortgage loan can take anywhere from one to two months. To hasten the process, be sure to follow these five steps:

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1. Meet The Eligibility & Requirements

Before anything, approach a lender and discuss your situation in detail. Be prepared for questions about your current financial status, your reason for taking out the reverse mortgage, and personal and financial information such as age, income, credit history, and home equity.

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Next, go over the rules mentioned above and ensure you can confidently check all the boxes. Then, prepare the following paperwork:

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• Identification such as a driver's license or a passport
• A list of assets, such as your home and other properties you may own
• A mortgage statement and other relevant documentation to prove that you own and reside in your home
• Proof of income, Social security income, retirement plans, and bank statements
• A counseling certificate, which you will be given upon completion of the second step below

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2. Get HUD-Approved Counseling

Once you apply to a lender for a reverse mortgage, you must attend counseling with a HUD-approved counseling agency before the lender can begin to process your application.

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Search for a housing counseling agency near you and secure a session. Your lender can help with this. Counseling is essential because you must ensure you're prepared for the obligations of such a reverse mortgage loan and that you can pay property taxes and homeowners insurance on time.

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Remember that the counseling session is more than just a way for the government to ensure you're capable enough to maintain your taxes and homeowners fees. It's also a way to familiarize yourself with the ins and outs of reverse mortgages and prepare for what's ahead of you. Ask as many questions as possible, and cover everything from closing costs to the interest rate on the type of loan you're considering.

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A typical session costs about $200 and takes between one and two hours. After the session, you will receive a counseling certificate to provide to your lender.

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3. Home Appraisal

Before a lender can set a credit limit on your reverse mortgage, the lender will engage an appraiser's services to determine your home's current market value. The appraiser will look at external factors like your home's location, construction quality, roof and foundation integrity, age, and overall condition, as well as its internal elements, from its functional layout to health and safety accouterments. Aside from these, an appraiser will look at the market value of homes similar to yours in size, age, and location.

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An appraisal costs between $500 and $700, depending on the property location and property type.

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How to prepare your home for an appraisal:

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• Clean up your yard: This goes for the rest of your house – you want to keep it as tidy as possible. Mow the lawn, clear any pathways of debris, and repair minor damages.
• Deep-clean your home: The presence of mold, mildew, and pests can affect the overall value of your home, so make sure it's in tip-top shape before the appraiser arrives.
• List all the upgrades done to your home: Home improvements increase the value of your home. If you want to get a good deal for your home, make sure your appraiser knows precisely what you've done to deserve a good market value. Some of the improvements that can add to the market value of your home Include an upgraded kitchen, landscaping, practical basements, and new and improved flooring.

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4. Closing And Receipt Of Credit Line

Once you're approved for your reverse mortgage, settled on the payment scheme, and signed the documents, you must pay the upfront fees and wait until you can access your funds.

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Reverse Mortgage Pros And Cons

Still undecided if a reverse mortgage is right for you? Here's a rundown of the pros and cons of reverse mortgages:

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Pros

• The proceeds fund essential expenses such as medical bills, in-home care, and medication. The monthly disbursements from your reverse mortgage can supplement daily expenses, repay debts, and attain a better quality of life in retirement.
• As a borrower, you are not required to pay the loan balance out of pocket or to make monthly mortgage payments. Instead, any remaining loan balance is taken out of your home equity and repaid with the proceeds from selling your home in the future.
• As a result, you only have to pay for the upkeep of your home, including things like property taxes and homeowners insurance.
• You have various payment options, including monthly payments, a line of credit, or a combination of monthly and a line of credit.

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Cons

• Upfront fees such as closing costs, appraisal fees, and insurance can be too much for some people who are already in need of financial assistance.
• Your property can no longer be inherited by your surviving spouse or heirs unless they opt to repay the loan balance when you pass away or move out.
• Scams are typical for this type of loan. Be very careful and deal with reputable lenders. See more on scams below.
• You will still have to maintain your home and pay property taxes, insurance, and the like.

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Reverse Mortgage Scams

Unfortunately, the reverse mortgage loan market is also the demographic most susceptible to financial scams. A recent study showed that older Americans are more likely to be the target of online financial fraud and more likely to lose large sums of money.

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What types of scams should you watch out for? The following are three of the most popular types of reverse mortgage scams:

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Contractor Fraud

If you're looking into starting a home renovation project soon, be wary of contractors who might be adamant about convincing you to secure a reverse mortgage. While you can take out a reverse mortgage loan to finance some renovations, your contractor is honest and not using you to get out of debt or, worse, to get paid for a renovation that is never completed.

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Remember, a reverse mortgage is meant to give you an additional source of income to help improve your quality of life in retirement.

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Financing New Property

There are many tricks under this umbrella, but the main idea is that fraudsters will attempt to convince a senior to take out a reverse mortgage and invest in a new property. In some cases, the scammers will pose as real estate agents hoping to get seniors to invest in property for them.

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Inheritance Jumping

Unfortunately, some seniors are manipulated by their relatives or caregivers into taking out a reverse mortgage, only to be left with little to no equity. Some scammers who are close to their senior relatives may even be able to convince their elders to assign them a power of attorney, giving them access not only to their loan balance but to all their money.

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Alternatives To Reverse Mortgages

If, after all of this, you've realized that a reverse mortgage might not be what you're looking for, you can consider the following options:

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Refinancing

Refinancing a mortgage means replacing an old mortgage with a new one. People opt to refinance when they want to reduce the amount they have to pay in interest, lower their monthly loan payments, or borrow additional money and use their current home equity.

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Refinancing is a good option for a borrower who might not necessarily need assistance with their expenses but can maintain their current monthly mortgage payments or even a higher mortgage payment due to drawing on the home's equity.

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Take Out A Home Equity Line Of Credit

A home equity line of credit, also known as a HELOC, is very similar to a reverse mortgage in that it allows you to borrow against your home equity. It also works similarly to a credit card in which you can borrow up to your approved credit limit on an as-needed basis. Unlike a reverse mortgage, you must begin to repay the loan balance once the draw period ends and make monthly interest payments on the outstanding balance during the draw period.

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HELOCs are more challenging to qualify for than reverse mortgages, as lenders usually require their borrowers to have a strong credit score, proof of employment, a sizable income, and sufficient home equity to cover the lender's loan-to-value requirements. HELOCs are attractive to those who want to treat their home equity as a revolving fund, accessing it whenever needed and being able to repay the line of credit when the draw period ends.

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Downsizing

If you've already paid off your mortgage loan balance completely, one way to improve your cash flow is to downsize to a smaller, lower-maintenance home. Your current home could be a financial burden, especially if you live in an expensive neighborhood or are maintaining a home that's too big for you.

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Downsizing also allows you to access your current home's equity. When you sell your existing home, you can use the money to pay cash for your new home or get a new mortgage on a smaller, less expensive home, then pocket the remaining money.

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The Bottom Line: Should You Get A Reverse Mortgage?

Whether you need funds for a significant medical expense, a home renovation project, or to improve your quality of life at home, a reverse mortgage can make things a lot easier for you and your family. It is essential to factor in the closing costs and ongoing costs for a reverse mortgage as well as how your heirs will repay the reverse mortgage balance when you no longer live in the home.

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At the end of the day, whether or not you should get a reverse mortgage is not an easy question to answer. It requires a lot of research, careful consideration, and even counseling from experts.

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Disclaimer: At present, Wesley Mortgage does not offer Reverse Mortgages. We are providing this information to keep you informed of your loan options.

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