Reverse Mortgages
How They Work

by James Robert Deal
Attorney

(I no longer work as a residential loan officer. I only do commercial mortgages. However, I have retained this web page for general informational value.)

THE BASICS

With a "forward mortgage" we generally make payments that include interest and some principal, and the mortgage balance gradually declines. With a reverse mortgage a senior citizen is not required to make a monthly payments and can even draw money out of a reverse mortgage line of credit. The balance owing gradually rises, although in Western Washington the value of the property generally rises faster than the mortgage balance owing.

The interest rate on the FHA HECM 100 reverse mortgage is currently extremely low on the money advanced. To calculate the interest rate on the HECM 100, add the margin to the index. The margin is 1.00%. The index is the one-year constant maturity treasury rate or CMT. To find the current CMT go to Money Cafe on the Internet. The rate since November, 2008, has been under 1.00%, which is extremely low , although it can also go higher too because it is adjustable.

With a "forward mortgage" we must have equity in out property, a sufficient income, a reasonably good credit score, reserves, and a steady job. With a reverse mortgage we only need to show equity in the property, that the property is our personal residence, and that we are at least 62 years old. A low credit score is irrelevant. Low or no income is irrelevant. A senior can even use a reverse mortgage to purchase a property or refinance and bail out of bankruptcy.

If both husband and wife are at least 62 years old and if they have around 50 percent equity in the property, they can generally obtain a reverse mortgage. The size of the line of credit the senior can borrow depends on how much the senior owes now and whether property is generally increasing in value in the area.

When both of the spouses have died or have moved out of the home and been out continuously for a year, then the loan is due. If spouses have died or moved on to a senior home for a year, the spouses or their guardians or heirs can sell the property or refinance it, pay off the reverse mortgage, and keep the property. A senior in a nursing home can come home one day each year to avoid the mortgage coming due.

If one spouse is under 62, the couple can wait until the younger spouse reaches 62, or the spouse under 62 can quitclaim all interest in the property to the spouse over 62. If they do that, they should see an attorney and put estate planning in place that will leave the property to the younger spouse if the older spouse should die first.

The most common reverse mortgages are FHA loans, and FHA requires the senior to consult with an independent counselor. The counseling is sometimes free.

THE ADVANTAGES

With a reverse mortgage, seniors can stay in their homes. They can either have no house payment, except for taxes, insurance, and condo dues. Or they can actually draw money out of their reverse mortgage line of credit and use it to pay taxes, insurance, condo dues, or anything else, whether related to the property or not. They can even take money out of the property and use it to buy a second home.

Many a senior is "house poor." She has great equity in her home but it is just sitting there and not producing income, as would stock or even a savings account. A reverse mortgage turns a non-productive asset into a productive asset. Everyone over 62 should strongly consider having a reverse mortgage.

The senior can refinance and pay off the reverse mortgage at any time with no pre-payment penalty. The senior can sell the home at any time, again with no pre-payment penalty. 

If the senior lives in an area where property values are increasing, the increase might be enough to offset the interest accruing on the loan or even the money the senior is drawing out of the line of credit. When the senior dies he/she might still have significant equity in the property and be able to leave a sizeable inheritance to loved ones.

In Washington state homes have increased in value on average 12 percent per year since 1974. Appreciation flattened out in 2007, and properties declined in value. But, we can presume appreciation will resume in the future: The population is rising, and the economy will recover. It is highly likely that the seniors will be able to draw $500 to $1,000 per month out of their homes continuously and still leave to their heirs a property with more equity in it than when they began their reverse mortgage.

THE MYTHS

Many seniors have a phobia of reverse mortgages. They believe they are signing away their property to the bank. No, the senior retains title.

It is true that in the early days of the reverse mortgage, if property values did not rise enough, the estate could end up owing money to the mortgage company at the time the senior died or moved out. This is no longer the case. The balance owing can never exceed the value of the home. If the senior exhausts the line of credit or if property values fall, the senior can still live there as long as she wants. The worst that can happen is that the estate will have no equity left in the property. It will be sold after the senior dies or moves out, and the mortgage insurance company will pay the lender any shortfall it incurs.

THE DISADVANTAGES

The only disadvantage is that the closing costs are a little on the high side. The standard fee for the loan officer is 2.0% of the appraised value of the home. Note, this is not 2.0% of the loan amount, but 2.0% of the value of the home. And the FHA charges a 2.0% one-time non-refundable mortgage insurance fee. Yes, the closing costs are a little high, and this is not the right loan for someone who plans to keep the loan for only a short time. On the other hand, the interest rate is relatively low, and if these relatively high closing costs are averaged over several years, especially if they are averaged over five or ten years, they are a reasonable price to pay for the benefits to be had.

CONCLUSION: GET ONE

If you are 62, have 50% equity in your home, and are struggling to get by or would like to treat yourself and get greater enjoyment out of your golden years, look into getting a reverse mortgage. If you are under 62, do your parents or grandparents a favor. Talk with them about the clear benefits of having a reverse mortgage.

Call me at 425-774-6611 or 888-999-2022 for further information. The fax number is 425-776-8081. Or e-mail me. The fax number is 425-776-8081. Click here to sign up for our informational e-mail messages.


Copyright 2010 James Robert Deal. All rights reserved.