Southeast Valley Real Estate

What are Reverse Mortgages and why would I want to use one?

First of all you may ask, what is in it for me as a real estate agent, Realtor®, to provide you with information on reverse mortgages? In all likelihood, beyond providing a service to my clients or potential clients, your use or lack of use of this information won't provide me with any benefit - I get paid for my services when people buy or sell a home. But, what I felt was that for those of you that are over 62 or nearing 62, a reverse mortgage is something that you may want to consider as an alternative to selling your home - now. And, for those of you that have parents over 62 or nearing 62 a reverse mortgage may be something to include in financial planning for your parents. At the very least, a reverse mortgage is something many of you should know about.

As the famous baby boomers group reaches 62 in the near future, the use of reverse mortgages will probably expand and they may even become commonplace. At the present time reverse mortgages represent only a small number of the mortgages written each year.

Well what is a reverse mortgage? To put it simply, instead of the home purchaser making payments to the bank and slowly paying off the purchase loan (the loan balance decreases), the bank makes payments to the homeowner and the loan balance increases.

In order to explain reverse mortgages let me compare them with the common purchase mortgage that most of us that have owned a home are familiar with. With a purchase mortgage, an individual or couple makes a relatively small down payment (typically 5 to 20%) towards the purchase of their home and utilizes a mortgage (loan) to pay for the balance.

For example, the future homeowners might purchase a $170,000 home with a $20,000 down payment and a $150,000 dollar mortgage. The mortgage payments are amortized over a period of typically 30 years, although, because of the current low interest rates, a greater number of people have been using shorter terms such as 15 years.

Briefly, the reason(s) for the shorter-term mortgages, which could easily be the topic for another "overview," is that for a given amount of debt a borrower may be able to qualify for a 15-year loan at 5.75% whereas a few years ago at 8.5%, he would have had to go to a 30-year term mortgage. For example, the principal and interest payments would be something like this:

And, what is amortization? Amortization refers to a schedule of payments. A schedule of payments which in addition to paying the interest, payments are made toward the principal, in order that, at the end of a preset period (30 years for example), the loan is paid off. If one does a level payment amortization (the type most frequently used), the early payments on the loan are mostly interest with only a small amount going toward principal. As the loan gets paid down (smaller loan balance), the amount going to interest drops and the amount going toward principal keeps increasing.

For example if one were to look at a $150,000 (loan), 30-year mortgage (level amortization - 360 months) as previously mentioned at 7% (for example). The payments that would look something like the following:

Back to reverse mortgages, there are several different structures available for reverse mortgages. The following numbers were developed for the FHA Home Equity Conversion Mortgage or HECM. Also, there is a similar type conventional loan program (with higher loan limits) available.

*The loan advance (draw) withdrawals would continue for as long as one lived in the home.

Let's take another example keeping everything the same except for the ages. For 72-year-olds, the single lump sum amount would be $95,588 and the monthly draw amount or loan advance (with no existing debt) would be $598.00. The older one is and the longer they wait before drawing money the higher will be the maximum lump sum advance amount or monthly loan advance amount.

While the advances are being drawn, the interest on the increasing principal keeps accruing. The debt (total loan amount) at any one time is a combination of the money advanced and the interest, which has accrued. Although, the lending institution takes the risk that the loan will end up being for more than the value of the home (especially if the home goes down in value). Since, the repayment amount on the loan is capped to never exceed the value of the home. The lender minimizes their risk down by advancing against only a reduced portion of the equity. And, the lender by utilizing a FHA insured loan (as in our example) further reduces their risk.

For example, instead of drawing the monthly payments the homeowner could have taken a lump sum of $81,018. This is considerably less than the $170,000 (current) home value (in our example). This difference gives the lender considerable cushion in order that the loan principal and accrued interest do not exceed the property value before the loan is paid off. On the other hand, the homeowner can continue to live in the home until they die or decide to sell the home. If the owner decides to sell the home, they must repay all the principal advanced and interest that has accrued. If the homeowner dies, their heirs must repay the loan (presumably from the sale of the home).

The above figures (lump sum advance or monthly loan advances) are based upon an AARP mortgage calculator on their web site at www.rmaarp.com/. The home value utilized was again $170,000 and an individual 62 years of age (or two individuals 62 years of age). The exact amounts will vary depending on value of the home, the age of the homeowner(s) and the then current mortgage rate at the time a loan is written.

One may find additional information on reverse mortgages on the National Reverse Mortgage Lenders Association web site at www.reversemortgage.org. And, NRMLA is currently offering free booklets on reverse mortgages.

National Reverse Mortgage Lenders Association
1625 Massachusetts Ave., NW, Suite 601
Washington, DC 20036-2244
202-939-1760
Toll-Free 866-264-4466
Fax 202-265-4435
Email: reversemortgage@dworbell.com

The National Reverse Mortgage Lenders Association indicates, "It is a misconception that reverse mortgages are only for desperate seniors, or for those 'house rich, cash poor.'" "The reverse mortgage is an excellent financial planning tool that has been used by homeowners from all walks of life to enhance their retirement years. While some have needed the cash from a reverse mortgage more than others, the growing popularity of this product is evidence of its benefit in a wide array of financial circumstances."

The National Reverse Mortgage Lenders Association (NRMLA) also dispels some additional misconceptions. It is not true that the homeowner's home must be debt free. But, if there is debt, the proceeds of the reverse mortgage must first be used to payoff the (any) existing mortgages (debt). For example, if there were an existing $25,000 mortgage, a draw in this amount would be made against the maximum draw amount - in our example $81,018. The monthly amount one could draw would also be deceased but the homeowner would be able to discontinue payment of mortgage payments. Not having to make mortgage payments in itself would reduce the living costs of the homeowner. Of course, the homeowner would still have to pay for homeowner's insurance, property taxes, and maintenance of the property.

Nor, does the bank own the home after one gets the mortgage (a common misconception). Similar to a purchase mortgage, you or your estate, if you die, retains ownership to the property subject to the security interest of the mortgage holder. But, the loan must be repaid, once a homeowner permanently moves out of the home, or the home passes to the homeowner's estate.

NRMLA (1-866-264-4466) indicates the following safe guards are in place to protect those obtaining reverse mortgages:

• "Advanced counseling, to ensure that you understand fully about reverse mortgages and your options, so you can select the product and payment option that best fits your needs.
• Limits on the interest rate and origination fee.
• A ceiling on the repayment amount - it can never exceed the value of your home.
• Federally mandated consumer disclosures."

This information is only an overview; it is not complete, and not meant to be definitive. Feel free to contact me with your questions but before making any decisions obtain additional information and discuss it with your accountant and/or financial advisor. As I have indicated, advanced counseling is required before one obtains a reverse mortgage.