The Ultimate Guide to Reverse Mortgages
TABLE OF CONTENTS
WHAT IS A REVERSE MORTGAGE?
A reverse mortgage is a loan for homeowners age 62 and older. This special type of loan converts a portion of a borrower’s accumulated home equity into cash. The borrower does not have to sell their home or move. The most popular reverse mortgage is the Home Equity Conversion Mortgage (HECM) program, which is the Department of Housing and Urban Development’s (HUD) reverse mortgage insured by the Federal Housing Administration (FHA).
In a traditional “forward” mortgage, borrowers send their monthly mortgage payment to the lender. With a reverse mortgage, lenders pay borrowers. Payments can occur monthly or in one lump sum.
When the borrower no longer lives in the house (due to selling, moving or dying), the loan and accrued interest comes due. Most often, the house is sold. If the house sells for more than what is owed, then the homeowner (or heirs) get the remainder. If the house sells for less than the loan amount and accrued interest, FHA (the insurer of the loan) covers the remaining balance. Neither the borrower nor their heirs will owe any money as reverse mortgages are non-recourse loans.
Before you read any further, let’s be very clear that a reverse mortgage is a loan. They are not free. There are fees. And it’s a loan, so there’s accrued interest. Just like any loan, in the end, it must be paid back to the lender. The goal of this guide is to explain reverse mortgages as clearly as possible. Sorry for the interruption, but It seemed important to emphasize the “it’s a loan” message right up front.
WHY PEOPLE GET A REVERSE MORTGAGE
Reverse mortgages tap into a resource that would otherwise be hard to use. Before these kinds of mortgages existed, getting at one’s stored up home equity required selling the house or taking out an equity line of credit. Reverse mortgages have grown in popularity over the years. There’s an expectation for ever more demand as more and more baby boomers retire.
Homeowners reverse mortgages as a way to improve their quality of life in retirement without selling their home. People have strong emotional ties to their home and like to live in them as long as possible. It’s easy to understand why; many seniors still live in the house where they raised their children. It’s a tough thing to give up.
When other resources like pensions or Social Security do not supply sufficient cash flow, seniors and their adult children often start researching how a reverse mortgage can help. Here are some typical reasons for taking out a reverse mortgage:
- Pay for everyday expenses
- Pay for healthcare expenses
- Pay for home improvements
- Prepare for emergencies and unexpected expenses
- Stop current monthly mortgage payments
- Supplement retirement income
History is a good guide to understanding just about anything. Knowing how and why reverse mortgages came into existence often helps folks get a better sense of them. Here’s a little background…
HISTORY OF REVERSE MORTGAGES
In 1961, private lender Nelson Haynes of Deering Savings and Loan was looking for a way to help one of his customers, Nellie Young of Portland, Maine. Nellie wanted to stay in her home after the loss of her husband’s income. The very first reverse mortgage was created from a pretty basic idea; what if Nellie’s home equity could be turned into a monthly payout to cover living expenses?
When Nellie took out the world’s first reverse mortgage, it kicked off a whole new type of mortgage lending. A period of experimentation followed.
In the 1970s, academic institutions and congressional committees continued to gather data and study reverse mortgages’ increasing popularity as well as their risks. In the early 1980s, the U.S. Senate Special Committee on Aging recommended the creation of standards around reverse mortgage lending practices.
By 1987, HUD created a reverse mortgage pilot program called the Home Equity Mortgage Demonstration. In 1988 President Reagan signed the law that that allowed FHA (a division of HUD) to insure reverse mortgages. In 1989, the first federally-insured FHA reverse mortgage was put together by lender James B Nutter Co. and made to Marjorie Mason of Fairway, Kansas.
Since 1998, Home Equity Conversion Mortgages (HECMs) became a permanent loan product overseen by HUD and FHA.
Prior to the housing collapse around 2008, borrowers could take out the full principal amount of their home’s equity. Many used this lump sum disbursement to pay off existing mortgages. Many did not hold money in reserve to pay for ongoing costs like property taxes and homeowner’s insurance. That didn’t work out to well for some folks. By 2012, 10% of HECMs were in default.
HUD responded by implementing some new reforms. In 2014, guidelines were created for a Financial Assessment of a borrower credit history and financial capacity to meet ongoing property expenses. This extra evaluation step went into effect in 2015. Furthermore, caps were set on the amount of the initial cash disbursement in the first year of the loan to prevent folks for burning through the money to quickly.
Protection for non-borrowing spouses was also added. Prior to the FHA rule update, spouses who were not listed as a borrower would have to pay back the loan or risk foreclosure if borrowing spouse moved (e.g. into an assisted living center) or died.
The original intent of a reverse mortgage holds up today. Seniors who’ve built up home equity over the years (it’s typically one’s largest asset) can tap into it later in life. And they don’t have to sell their home or move out. Legislation and regulation have improved the safety of revere mortgages over time.