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If you are age 62 or older and are
"house-rich, cash-poor," a reverse mortgage (RM) may be an
option to help increase your income. However, because your home is
such a valuable asset, you may want to consult with your family,
attorney, or financial advisor before applying for an RM. Knowing
your rights and responsibilities as a borrower may help to minimize
your financial risks and avoid any threat of foreclosure or loss of
your home.
This article explains how RMs work.
It describes similarities and differences among the three RM plans
available today: FHA-insured; lender-insured; and uninsured. It also
discusses the benefits and drawbacks of each plan. Each plan differs
slightly, so be careful to choose the plan that best meets your
financial needs. Organizations and government agencies that offer
additional information about RMs are listed at the end of this
brochure.
How Reverse Mortgages Work
A reverse mortgage is a type of home
equity loan that allows you to convert some of the equity in your
home into cash while you retain home ownership. RMs works much like
traditional mortgages, only in reverse. Rather than making a payment
to your lender each month, the lender pays you. Unlike conventional
home equity loans, most RMs do not require any repayment of
principal, interest, or servicing fees for as long as you live in
your home. Funds obtained from an RM may be used for any purpose,
including meeting housing expenses such as taxes, insurance, fuel,
and maintenance costs.
Requirements and Responsibilities
of the Borrower
To qualify for an RM, you must own
your home. The RM funds may be paid to you in a lump sum, in monthly
advances, through a line-of-credit, or in a combination of the
three, depending on the type of RM and the lender. The amount you
are eligible to borrow generally is based on your age, the equity in
your home, and the interest rate the lender is charging.
Because you retain title to your home
with an RM, you also remain responsible for taxes, repairs, and
maintenance. Depending on the plan you select, your RM becomes due
with interest either when you permanently move, sell your home, die,
or reach the end of the pre-selected loan term. The lender does not
take title to your home when you die, but your heirs must pay off
the loan. The debt is usually repaid by refinancing the loan into a
forward mortgage (if the heirs are eligible) or by using the
proceeds from the sale of your home.
Common Features of Reverse
Mortgages
Listed below are some points to
consider about RMs.
 |
RMs are rising-debt loans. This
means that the interest is added to the principal loan balance each
month, because it is not paid on a current basis. Therefore, the
total amount of interest you owe increases significantly with time
as the interest compounds. |
|
All three plans (FHA-insured,
lender-insured, and uninsured) charge origination fees and closing
costs. Insured plans also charge insurance premiums, and some impose
mortgage servicing charges. Your lender may permit you to finance
these costs so you will not have to pay for them in cash. But
remember these costs will be added to your loan amount. |
|
RMs use up some or all of the
equity in your home, leaving fewer assets for you and your heirs in
the future. |
|
You generally can request a loan
advance at closing that is substantially larger than the rest of
your payments. |
|
Your legal obligation to pay back
the loan is limited by the value of your home at the time the loan
is repaid. This could include increases in the value (appreciation)
of your home after your loan begins. |
|
RM loan advances are nontaxable.
Further, they do not affect your Social Security or Medicare
benefits. If you receive Supplemental Security Income, RM advances
do not affect your benefits as long as you spend them within the
month you receive them. This is true in most states for Medicaid
benefits also. When in doubt, check with a benefits specialist at
your local area agency on aging or legal services office. |
|
Some plans provide for fixed rate
interest. Others involve adjustable rates that change over the loan
term based upon market conditions. |
|
Interest on RMs is not deductible
for income tax purposes until you pay off all or part of your total
RM debt. |
How Reverse Mortgages Differ
This section describes how the three
types of RMs -- FHA-insured, lender-insured, and uninsured -- vary
according to their costs and terms. Although the FHA and
lender-insured plans appear similar, important differences exist.
This section also discusses advantages and drawbacks of each loan
type.
FHA-insured. This plan
offers several RM payment options. You may receive monthly loan
advances for a fixed term or for as long as you live in the home, a
line of credit, or monthly loan advances plus a line of credit. This
RM is not due as long as you live in your home. With the line of
credit option, you may draw amounts as you need them over time.
Closing costs, a mortgage insurance premium and sometimes a monthly
servicing fee is required. Interest is charged at an adjustable rate
on your loan balance; any interest rate changes do not affect the
monthly payment, but rather how quickly the loan balance grows over
time.
The FHA-insured RM permits changes in
payment options at little cost. This plan also protects you by
guaranteeing that loan advances will continue to be made to you if a
lender defaults. However, FHA-insured RMs may provide smaller loan
advances than lender-insured plans. Also, FHA loan costs may be
greater than uninsured plans.
Lender-insured. These RMs
offer monthly loan advances or monthly loan advances plus a line of
credit for as long as you live in your home. Interest may be
assessed at a fixed rate or an adjustable rate, and additional loan
costs can include a mortgage insurance premium (which may be fixed
or variable) and other loan fees.
Loan advances from a lender-insured
plan may be larger than those provided by FHA-insured plans.
Lender-insured RMs also may allow you to mortgage less than the full
value of your home, thus preserving home equity for later use by you
or your heirs. However, these loans may involve greater loan costs
than FHA-insured, or uninsured loans. Higher costs mean that your
loan balance grows faster, leaving you with less equity over time.
Some lender-insured plans include an
annuity that continues making monthly payments to you even if you
sell your home and move. The security of these payments depends on
the financial strength of the company providing them, so be sure to
check the financial ratings of that company. Annuity payments may be
taxable and affect your eligibility for Supplemental Security Income
and Medicaid. These "reverse annuity mortgages" may also
include additional charges based on increases in the value of your
home during the term of your loan.
Uninsured. This RM is
dramatically different from FHA and lender-insured RMs. An uninsured
plan provides monthly loan advances for a fixed term only - a
definite number of years that you select when you first take out the
loan. Your loan balance becomes due and payable when the loan
advances stop. Interest is usually set at a fixed interest rate and
no mortgage insurance premium is required.
If you consider an uninsured RM,
carefully think about the amount of money you need monthly; how many
years you may need the money; how you will repay the loan when it
comes due; and how much remaining equity you will need after paying
off the loan.
If you have short-term but
substantial cash needs, the uninsured RM can provide a greater
monthly advance than the other plans. However, because you must pay
back the loan by a specific date, it is important for you to have a
source of repayment. If you are unable to repay the loan, you may
have to sell your home and move.
Reverse Mortgage Safeguards
One of the best protections you have
with RMs is the Federal Truth in Lending Act, which requires lenders
to inform you about the plan's terms and costs. Be sure you
understand them before signing. Among other information, lenders
must disclose the Annual Percentage Rate (APR) and payment terms. On
plans with adjustable rates, lenders must provide specific
information about the variable rate feature. On plans with credit
lines, lenders also must inform you of any charges to open and use
the account, such as an appraisal, a credit report, or attorney's
fees.
For More Information
If you are interested in obtaining a
current list of lenders participating in the FHA-insured program,
sponsored by the Department of Housing and Urban Development (HUD),
or additional information on reverse mortgages and other home equity
conversion plans, write to:
AARP Home Equity Information Center
American Association of Retired Persons 601 E Street, N.W.
Washington, D.C. 20049
For additional information, you also
may contact the:
National Center for Home Equity
Conversion 7373 - 147 St. West, Suite 115 Apple Valley, MN 55124
This organization requests that you
send a self-addressed stamped envelope.
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