Can you explain a reverse mortgage and its benefits?

/in /by

Question of the week: Can you explain a reverse mortgage and its benefits?

Answer: For several years I have been saying that reverse mortgages (RM for the remainder of the WR&MU) are the most misunderstood financial tool available to consumers. Because the lack of knowledge of RMs, how they work and the benefits, many eligible homeowners do not consider using a RM as part of their financial planning and stability.

Before we get into whether you should get a RM, let’s go through some basics of the product.

  • First and foremost, and most importantly, the lender cannot take your home as long as you are living in the property.*  More on this below.
  • You can use a RM to purchase or refinance your primary residence, note this does not include second, or vacation, homes; though proceeds from a RM may be used to purchase a vacation home.
  • Eligible properties are 1-4 units, as long as you occupy one unit, condominiums, and certain manufactured homes depending on requirements from lender.
  • The most common RMs are HECM (Home Equity Conversion Mortgage), which are government insured by the Federal Housing Administration, yes, the same entity responsible for FHA mortgages used by millions to purchase or refinance their homes. To be eligible for a HECM you must be 62 years old or older.
  • Other RMs in the market have a minimum age of 55, these products are not insured by FHA and have different guidelines and features.
  • For HECM products there is an equity line feature, as well the amount of the available funds on the equity line increases over time. This feature is flexible depending on what funding options you select at closing. Some borrowers obtain a RM and have an amount of funds available they may draw on in the future, with no proceeds being disbursed at closing. For example, they obtain a $450,000 HECM with no funds paid to them at closing. Over the life of the loan the they can draw on the equity line, either in lump sums or regular payments.
  • For the life of the loan, you do not need to make payments on the mortgage, but you must make payments for taxes, insurance, homeowners association fees, etc. While you are not required to make payments on the RM, you may do so.
  • Some RMs have higher closing costs and more features, other RMs have lower closing costs and fewer features. Some RMs have adjustable rates, other RMs have fixed rates. It is important that you understand the options available and compare features, rates and costs.
  • All potential borrowers must go through counselling about RMs, the benefits, the costs, the risks, the options. This counselling is done by a third party who is not affiliated with the loan originator or any lender. A final and complete application for a RM cannot start until seven days after the counseling is completed. This allows time for the borrower to do more research and make a decision.
  • Loan amounts are determined by value of the property, age of the youngest borrower, and the current interest rate and fees on the RM.
  • The loan is due when the home is no longer the primary residence for any borrowers; i.e. when relocate to a senior facility, purchase or rent another home as primary residence, borrowers have died. If a husband and wife have a reverse mortgage and one of them dies, the loan is still in place until the surviving spouse no longer occupies the property.
  • When the last spouse vacates the property, the loan becomes due. At this point communication between whoever is legally able to make decisions and enter agreements for the property and the RM lender to allow time for the title of the property to be transferred.
  • Homes with RMs can inherited. Depending on the value of the property and the balance on the RM, heirs can retain the property provided the RM is paid off, either with a refinance. This must be done within one year of the passing of the borrower on the RM. (Side note, over the years we have assisted may clients with refinances to pay out other beneficiaries to retain a home with a RM and the parents have passed away.)
  • If the balance of the loan exceeds the market value of the home the home can either be sold with an agreement from the lender to accept a lower payoff to enable the sale, or the property may be deeded to the lender.

*This is the most misunderstood aspect of RMs. A lender cannot kick a borrower out of the home. A lender cannot prevent an heir from obtaining the property as long as the RM is paid in full. Depending on the value of the property and the balance on the RM, the heirs may choose to deed the property to the lender.

Here are some issues that come up when discussing RMs options with clients.

  • A lender can foreclose on a home with a RM. Keep in mind a foreclosure occurs after the lender files a notice of default, meaning the borrower has violated one or more closes of the Note; if the default is cured there is no foreclosure. Here are the factors that can lead to default.
    • Homeowner does not pay property taxes or other required expenses such as insurance or homeowners association fees.
    • Property is no longer primary residence.
    • Borrower dies, as mentioned above, while this will trigger a notice of default calling the loan due, there are time frames heirs have to retain the home by paying off the balance due.
    • Borrower does not use the home as primary residence for more than twelve consecutive months, i.e., relocates to a senior care facility.
  • If your loan balance is higher than the value of the home the lender cannot make you pay the loan balance down. If the lender does foreclose and the loan balance is higher than the proceeds from the foreclosure the lender cannot come after you for any balance due.
    • Scenario: Senior purchased a home twenty years ago in a retirement community in Beaumont. The balance on the RM is $350,000. The property is worth $340,000. The homeowner wants to relocate to a senior facility. Contacts the lender and deeds the property to the lender. The lender sells the property and after expenses nets approximately $300,000. The lender cannot file any claims or suits against the borrower for the $50,000 difference between the loan balance and the proceeds following the sale.
  • If you do turn the property back to the bank it will have negative impact on your credit. In scenario above, if the senior is no longer going to purchasing property, automobiles or otherwise access new credit the impact of a negative rating on the credit report is negligible.
  • The rates on RMs are higher than rates on traditional mortgages. This is due to the lender not receiving any interest payments until the loan is paid off, plus the risk that they may have a property that is worth less than the amount they loaned plus accumulated interest.
  • A very common reason eligible borrowers do not obtain RMs is because they are concerned with losing equity in their home due to the increasing balance of the RM for accruing interest. Interestingly, this is often more a concern for the potential borrower’s children worried about inheritance than the borrower. Yes, the loan balance is increasing, but in most markets, especially in coastal Southern California, home values are increasing as well. With the calculations involved to determine the amount of the loan at funding, and any potential equity line, the math is whether or not the RM balance is increasing faster than the value of the property, and at what rate.

Many people have a difficult time understanding how a reverse mortgage works because they have imprinted in their consciousness that when you get a loan you make monthly payments until it is paid off. Perhaps the easiest explanation is it is an interest only mortgage, but you don’t pay the interest until the loan is paid off.

You and your spouse are both 68 years old are down-sizing, you sell your home for $1,100,000 and pay off your $350,000 mortgage. After costs of sale, you have about $675,000. The home in Palm Desert you are buying costs $850,000. Your income is social security payments for you and your spouse and accessing funds from your IRAs.

Option 1, you purchase the property with $450,000 down using a traditional 30-year fixed mortgage of $400,000 with an interest rate of 6.5% for a monthly payment of $2525 per month. As well you have association dues of $300 per month, your monthly housing expense is about $2825 monthly before real estate taxes (which you can transfer from your current property). With your housing costs and other expenses, plus enjoying your retirement you need to pull about $3000 per month out of your IRAs, which is taxed as ordinary income.

Option 2, you purchase the property with a reverse mortgage. Based on your ages you are eligible for about $300,000 mortgage and put $550,000 down. Your monthly payment for the mortgage is zero, your housing costs is your $400 per month for HOA fees and estimated insurance. You to pay housing and other expenses, plus enjoying your retirement you pull about $400 per month from your IRAs.

In this scenario, there is a difference of over $31,000 per year that is not accessed as taxable income from retirement accounts. Estimating federal and state taxes to be about 30%, that is an additional $9400 per year, or $780 per month, you will pay in taxes due to having the traditional mortgage.

As well, while your mortgage balance is decreasing with the traditional mortgage, so are your IRA balances from the additional withdraws to pay the higher housing expense, and taxes. Further, by removing the additional funds you are also removing the funds from growth in the markets, dividend and interest reinvestment.

You are widowed and have lived in your home for over 30-years, you have no mortgage. Your property value is $750,000. You are experiencing difficulties and rather than move to a senior assisted living facility want to have in-home care where someone cooks and cleans for you, as well a nursing professional come to check on you on a regular basis. Estimated cost for this care is $6000 per month. Based on your age and the value of your home you can obtain a HECM line of credit for about $460,000.

Accessing $6000 per month to pay for the care you obtain $72,000 per year, tax free, to cover the costs. After five years you owe about $500,000 on the mortgage (remember the line of credit increased annually).

During this time your home value has increased an average of 3% per year to about $1,200,000. You are 83 and it is time for you to move into an assisted living facility. The RM enabled you to age in your home for five more years, after which you sell your home, and net approximately $600,000 to pay for your assisted living and medical needs until no longer needed.

As you can see, in these scenarios, while the RM balances do grow and reduce equity, they are enabling the preservation of liquid assets, enabling stay-at-home aging, with little to no risk to the homeowner.

I used “you” for my examples, however some of those receiving the WR&MU are not in the viable age range for reverse mortgages; substitute “your parents” for “you” to see how your family may benefit from this useful financial tool. Especially with rising rates and inflation putting more pressure on older homeowners looking to downsize or maintain quality of life and lifestyle.

If you, a family member, or friend are interested in learning more about reverse mortgages please contact me.

To schedule an initial meeting by phone or Zoom, click here for my calendar, please feel free to forward to a friend or family member!

Have a question? Ask me!

Some good news this week. Inflation data came in much lower than expectations. March CPI showed prices dropped 0.1% from February, the lowest inflation figures since May 2020 and well below Wall Street’s estimate of 0.1% increase in prices. Year over prices increased 2.4% against expectations of 2.6% growth.  Core price (energy and food stripped out) grew at 0.1% for the month and 2.8% year over year. The two components removed for the core data went in opposite directions in March. Gass prices dropped 6% in the month, while food prices increased 0.4%, with eggs increasing 6% for the month and 60% since last March*. Hotels, airlines and other discretionary spending industries saw prices drop as consumers unsure of their economic future pulled back on spending.

In ordinary times the data would push interest rates lower as lower inflation increases the chances the Federal Reserve will lower rates. But we are in interesting times not ordinary and investors have been very skittish as they watch for news from the White House on tariffs on, tariffs off, tariffs up, tariffs down (somewhere in there is a Broadway song). Key to the mortgage market has been the activity in the Treasury markets, which has seen prices drop (rates up) this week, not good for mortgage rates.

Rates for Friday April 11 2025: The pull back in Treasury markets was exacerbated in the mortgage backed securities market, pushing 30-year rates to their highest since January, with the largest Friday to Friday rate increase since February 2023.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30-year conforming                             6.75%          Up  0.625%

30-year high-balance conforming        6.875%        Down 0.375%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

*Coming out of Ralph’s and heading to my car I was accosted in the parking lot by a guy who said, “stick ‘em up.”

I raised my right and with my left I reached from my front pocket and said, “Here’s my wallet.”

“No body carries cash; I don’t want your wallet! Give me your eggs!”

While Spring may have arrived in March, this week is the official start for many, especially golfers. The Masters is underway, starting the one a major a month schedule for pro golfers finishing with the British Open in August.