Reverse Mortgage Q&A
Pros and Cons of a Reverse Mortgage
What’s up, Squares? Harold Perkins here and today we’re going to talk about reverse mortgages.
So, reverse mortgages are pretty much the B-list celebrities of the mortgage industry. Nobody likes them… but they’re great!
What I mean by this is that if used properly, a reverse mortgage can be a good financial tool for some people. For others, it’s worse than watching an Adam Sandler movie.
First things first, what is a reverse mortgage? Well, as the name would suggest it is the opposite of a regular mortgage. Instead of making a monthly mortgage payment and eventually paying off your mortgage, you don’t make a mortgage payment and your loan balance increases.
In most cases, you must be at least 62 years old and you must live in the house at least six months out of the year to be eligible.
And there are different ways to structure the reverse mortgage. The most common is the Home Equity Conversion Mortgage or HECM. Essentially, the HECM is a line of credit on your house and that’s the one we’re talking about today.
Since you’re not making a mortgage payment, the interest that accrues for that month is charged against the available credit on the line of credit resulting in your loan balance increasing.
So as your loan balances increases because of the accrued interest. Now you are being charged interest on the interest that accrued from the prior month. That’s compound interest.
So as much as compound interest can work for you in your savings, CD or money market accounts, it can work against you if you have a reverse mortgage.
So why would anyone do this? Well, here are a few scenarios of how a reverse mortgage changed people’s lives when they needed it the most.
Fact is, there are many people out there who lived paycheck to paycheck all of their working lives and don’t have a lot of money saved in their retirement accounts. So when they retired, Social Security and maybe a small pension was enough to get by.
But we all know what inflation has done to the cost of goods and services and the cost of living increases by the social security administration are not enough to keep with the rate of inflation.
So what do you do? You can sell your house to cash out your equity, but you still need a place to live and the cost of housing is just as inflated as everything else.
This is where the reverse mortgage can be the life line you need. There are no monthly payments so you have eliminated your housing expense except for your property taxes, homeowners insurance and HOA if you have one.
Well, that scenario is great if you have a mortgage and you are looking to reduce your monthly expenses by eliminating your mortgage payment. But what if you already owned your home free and clear?
In that case, you may not have debts to get rid of but maybe you still need more money coming in. The reverse mortgage can do this for you too!
I recently talked to a client that had lived in her home for 40 years. Unfortunately, her husband passed about 10 years ago. Since her husband passed, she had not done any maintenance on the house.
It needed a new roof, air conditioning and an entire laundry list of repair and upgrades. She had quotes from contractors of nearly $200,000 to complete all of the deferred maintenance that had stacked up over the years.
She did not have that kind of money saved. And could not qualify nor afford the monthly payments on a regular forward mortgage. And she did not want to sell the house where she had raised her family.
Reverse Mortgage was the solution. Since she did not have a mortgage, she had the equity sufficient to fund the repairs. She did not have to make monthly payments. And most importantly for her, she did not have to sell her family home.
Another client that I helped recently was still working but had to take a pay cut a couple of years ago because of Covid. He had also refinanced his regular forward mortgage in 2020 when interest rates were at their lowest.
But unfortunately, his reduction in income was unforeseen, and he found himself in a situation where he could not longer afford to make his full mortgage payment.
As a result, he was getting behind on his other bills and his debt was increasing rapidly. There was no benefit to him refinancing into a different forward mortgage because interest rates are higher now, and his current mortgage payment was as low as it could be.
He could afford to make A payment, just not THE payment he had. And he did not want to sell his house. So the reverse mortgage was the answer.
Yeah, that’s right. While a reverse mortgage does not require a payment, you can choose to make a payment each month! And that’s what he did. His forward mortgage had a payment of $2600 per month but he could only afford $2000 per month. So that’s what he pays now.
The great part about making a payment on a reverse mortgage is that he is covering the interest that accrues each month. Remember earlier when I talked about compound interest? That’s not happening to this client because he’s making a payment to cover the interest.
So if in the future, his employer restores his pay to what it was pre-Covid, he might choose to refinance out of the reverse mortgage back into a regular forward mortgage!
Okay… I’ve talked about a lot of the positives of a reverse mortgage. It’s only fair to also talk about some of the negatives.
The big one is the cost. Reverse mortgages are expensive. The biggest expense being the upfront mortgage insurance. So, reverse mortgages are FHA insured loans and there is a 2% charge for that insurance.
This is collected out of your equity at closing. So if you borrowed $200,000 on a reverse mortgage, you already owe $204,000 before you even get started. That’s a lot.
And on top of that upfront charge, there is an additional .5% charge per year for mortgage insurance. This is on all FHA insured reverse mortgages regardless of the equity in the property. That’s also a lot.
But you also get a lot for that mortgage insurance. I’ll talk about that at the end.
One other negatives is the distribution limit during the first year of your reverse mortgage. Your cash access to your equity is limited to 10% of the credit line. Now, that’s 10% in addition to paying off existing liens on your house.
The reason I categorize this as a negative is that you may have intended to access more than 10% of your equity. But you would be forced to wait until the anniversary of your closing to get the additional money.
Now, this restriction comes from a place of good intentions to protect homeowners. The idea is that it forces a kind of cooling off period after taking a reverse mortgage to protect against an unscrupulous person that might be trying to scam an elderly person out of their equity.
So we’re not mad about that. But it does force careful planning and scheduling if you needed a larger amount of your equity.
The last negative to talk about today is possibly the interest rate. While there is no payment due, there is still interest being charged. Most reverse mortgages are adjustable rates that can adjust every month.
But the funny thing here, is that the adjustable part of the rate isn’t the problem.
Quick side note on how adjustable rates work. They have two components: The index and the margin. The index is that part that changes based on the market. The margin is a fixed number, does not change after closing. Index plus margin equals your interest rate for that month.
Here’s where it’s tricky. Loan Originators make more money if they can sell you on a higher margin because essentially, they are selling you a higher interest rate.
You cant control the index. But you can control the margin. It’s just that most people don’t know about the margin to know to ask about it. Now you know.
Ok… but for most people that reverse mortgages are the right tool, we actually don’t care about the costs or the interest rate. Here’s why.
In most cases, if the reverse mortgage is right for you, you are not trying to payoff your house before you die. This could be because the equity in your house was always intended to be used for retirement.
Or maybe your estate is not counting on the equity in your house as part of future family wealth.
Or maybe your current financial situation is such that there would be no other option other than selling the house.
But remember earlier I talked about what you get for all of that mortgage insurance you paid to get the reverse mortgage? Here’s the biggest benefit. At the time of your passing your estate or heirs can pay off the reverse mortgage to keep the house in the family.
The most they would pay is 95% of the appraised value of the house at that time, regardless of how much is owed on the mortgage.
Yeah, that’s right. So let’s say at the time of your passing your loan balance has increased up to $500,000. But the appraisal on the house is only $450,000 at that time. Your heirs or estate can keep the house in the family and only owe $427,500 to settle the reverse mortgage.
The difference is absorbed by the bank which is why they charged you for that mortgage insurance.
So some of the perceptions of the reverse mortgage are actually misperceptions. You are not selling your house to the bank. You own it the entire time.
Your estate does not have to pay a ridiculous amount of money to buy the house back after your passing. The worst would be that they would have to refinance the mortgage balance but only up to 95% of the appraised value.
It is a non-recourse loan which means that the bank cannot pursue the estate for any deficit caused by a short payoff.
You only have to have enough income to support the property taxes, homeowners’ insurance, maintenance and utilities.
The loan is not credit qualifying. Poor credit history does not disqualify you. However, certain credit histories might cause it to be necessary to set aside part of the credit line for taxes and insurance.
You can choose not to make a payment, make a partial payment or pay the full amount due each month. Totally up to you.
And you can ask me questions in the comments or message me on any of my socials. I’ll write you back right away. Also, if you found this information helpful or you know anyone that is thinking of buying a home or refinancing with a reverse mortgage, please make sure to hit the like button so this video can help other people too!