Putting your mortgage in reverse

Posted by on February 16, 2010 @ 9:58 am in Personal finance

I occasionally participate in webcasts, taking questions from Vanguard investors on various financial topics. Almost invariably, someone asks about reverse mortgages. Should they or shouldn’t they? How do they work? And are they legitimate?

Last question first: Yes, reverse mortgages are legitimate, and they seem to be gaining in popularity. But it’s clear that as with any financial decision, opting for a reverse mortgage requires some homework. You will want to understand not only the provisions and payment stream but also the upfront and continuing costs.

A reverse mortgage is a loan made to a homeowner using all or part of the home’s equity as collateral. For the most popular type of reverse mortgage in the United States—through the Federal Housing Administration’s Home Equity Conversion Mortgage (FHA HECM) program—the amount of the loan is generally computed via a formula that takes into account the age of the owner(s), the appraised value of the home, and the prevailing interest rate environment. There is no repayment schedule, and no income or credit requirements. Payments are made to the homeowners in a lump sum, monthly installments, or even through a line of credit. The homeowners are still responsible for real estate taxes, maintenance, insurance, and utilities. The loan is repaid when the last surviving homeowner permanently moves out (or dies). Any equity remaining after the loan obligation is satisfied flows to the owners’ heirs.

In January 2009, the U.S. Department of Housing and Urban Development introduced a federally insured reverse mortgage program, HECM for Purchase, that allows seniors to apply for a reverse mortgage for the purchase of a new principal place of residence.

Not surprisingly, there are a bunch of complicated rules, and not all financial institutions participate in the program. But it may be worth checking out if you’re 62 or older and are thinking about selling your home to head for a warmer clime or a smaller residence, or maybe to be closer to the grandchildren.

There are no limitations on income, assets, or the value of the home being purchased. As with the original HECM program, the amount you can borrow is limited by a formula derived from the home’s appraised value or the FHA HECM mortgage limit (currently $625,500), whichever is lower. You can even finance your closing costs, though that would lower the amount of money you receive.

In essence, this type of reverse mortgage is actually a mortgage with delayed repayment. Lenders recover their principal and interest when the home is sold or you stop occupying it as your principal place of residence, and any remaining value goes to your heirs. If the sales proceeds are insufficient to satisfy the loan obligation on any HECM loan, the FHA will pay the shortfall; one of the program’s expenses is an insurance premium of 2% upfront plus 0.5% annually. Again—lots of rules, but it just might fit for you.

Have you or someone in your family taken a reverse mortgage? Are you considering it? If so, let me know. I’d love to hear about your experience.

Note: The information provided here is for educational purposes only and is not intended to be construed as legal or tax advice.

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