Oftentimes, questions arise from borrowers, family members and basically every other person who isn’t vested in reverse
mortgages and does not exactly understand how it works.
People have various opinions that they have picked up along the way probably
from what they’ve heard other people say, but more often than not, they are
not the facts.
In order to clearly show how reverse mortgages work, it would be essential to
include a number of examples that most people can easily relate to. This way,
they would realize that some of the facts that they heard or learned are quite
wrong.
First off, reverse mortgages are really not for everybody. This an underlying
fact that most people need to understand. Although they may be a great way to
settle from retirement, it isn’t suited to all prospective borrowers.
It is a loan, and as with any loan, it would be paid back with interest.
Usually, the repayment is done by either the borrower or his heirs upon sales
of the house or refinancing the home if you don’t have the cash lying around.
And more often than not, selling the house is usually the path that most
people toe.
We have considered all of these and would also talk about why a reverse
mortgage may not be suited to your needs.
Here are Some Examples
Before the examples, here are some basics.
A reverse mortgage basically allows borrowers or homeowners to trade a
portion of the equity on their home in return for some cash.
This cash does not come with a required monthly payment provided that the
borrower doesn’t vacate that house and all loan requirements are continually
met.
Therefore, borrowers who you would recall having to be 62 years or older
still have to pay insurance, taxes as well as HOA due and maintain the
structural integrity of their home.
When you’re receiving a reverse mortgage loan, you would never get 100% of
your home’s value. This is because borrowers may continue to linger in that
home for years without having to make any payment. Usually, what you get is
less than half the value of your home.
Now, the exact amount that you would be eligible to receive would be based on
a number of factors that are built into the calculator used by HUD.
Some factors that impact the amount that a borrower would receive include the
age of the borrower, the prevailing interest rates, the value of the property
or the maximum limit that the HUD offers, and if it is a purchase, the amount
that a borrower would be eligible for would be affected by the purchase price
too.
The formula that the HUD uses factors in actuarial tables given that an
80-year-old borrower would have less propensity to accrue interest over what
is left of their life expectancy compared to a 62-year-old borrower.
The examples below show the difference in proceeds obtained by a borrower who
is 62 years old and the other who is 80 given that their homes are valued the
same and loan interest rates are identical as well.
Example 1
Property Value: $500,000 Existing Mortgage: $0
Primary Borrower Age: 62
|
3.91% Annual |
| Current Annual Rate |
3.91% |
| Max Lifetime Rate |
8.91% |
| APR |
n/a |
| Mortgage Payoff |
$0 |
| Cash At Closing |
$122,630 |
|
Cash Available (after 12 months)
|
$93,800 |
| Total Available |
$216,430 |
Property Value: $500,000 Existing Mortgage: $0
Primary Borrower Age: 80
|
3.91% Annual |
| Current Annual Rate |
3.91% |
| Max Lifetime Rate |
8.91% |
| APR |
n/a |
| Mortgage Payoff |
$0 |
| Cash At Closing |
$159,433 |
|
Cash Available (after 12 months)
|
$117,600 |
| Total Available |
$277,033 |
Example 2
Property Value: $500,000 Existing Mortgage: $0
Primary Borrower Age: 80
|
3.91% Annual |
4.41% Annual |
| Current Annual Rate |
3.91% |
4.41% |
| Max Lifetime Rate |
8.91% |
9.41% |
| APR |
n/a |
n/a |
| Mortgage Payoff |
$0 |
$0 |
| Lender Origination |
$4,050 |
$0 |
| FHA Insurance |
$10,000 |
$10,000 |
| 3rd Party Fees |
$2,917 |
$2,917 |
| Lender Credit |
$0 |
$1,157 |
| Total Fees |
$16,967 |
$11,760 |
| Cash At Closing |
$159,433 |
$157,140 |
| Cash Available (after 12 months) |
$117,600 |
$112,600 |
| Total Available |
$277,033 |
$269,033 |
One of the main observations that you should make in the second example below
is the amount of funds that become available to borrowers after the rates
increase by one half to one percent.
Although properties do appreciate, they rarely ever do so enough to make up
for the reduction in amounts that the borrower received with an increase in
rates that were only about half of a percentage.
This doesn’t imply that present values of property haven’t helped borrowers
get a higher sum from reverse mortgages, however, an increase in rate would
eliminate this if borrowers decide to stay put and wait for an increase in
values.
Borrowers basically get the same benefits but it is based on the results
gotten after calculation with factors such as interest rates, age, and
property values taken into consideration.
One factor that would have a major impact on the amount of funds that most
borrowers would be able to access is whether or not the reverse mortgage is
the only loan on the title at the point in time when the borrower is closing
the loan.
All mortgages or liens at that time period must have been paid in full. This
is due to the simple fact that any mortgage on the house would have to be
settled first and then the borrower would be given whatever amount is left
over.
For instance, if two borrowers get $250,000 each as benefits from the reverse
mortgage loan program and one of them has a current mortgage of $150,000 while
the other borrower’s home is clear, the first borrower would have to clear up
the loan on ground and be left with $100,000 while the second borrower would
have access to all of his $250,000.
And although the first borrower wouldn’t end up with as much cash as the
second borrower, at least he would not have to make any more monthly mortgage
payments.
Borrowers are usually told exactly how much they would have access to before
the loan closes. This way, they can always decide in what form they want to
get their money.
After previously existing loans have been cleared up, borrowers can then
decide to either opt for a lump sum payment using either a fixed rate or
adjustable rate. Fixed-rate draws usually have limits in the first year
especially if the funds are not being used to acquire a new joke or to clear
up existing liens.
With a line of credit, you can always get cash when you want. Borrowers can
decide to go for an option of payment for life (otherwise known as tenure)
whose sum is usually determined by the calculator and this would keep going on
for as long as they stay in the home.
There is also the option of receiving monthly payments for a period of time
that they would choose (otherwise known as term payment) provided there are
still funds to access.
Example 3
Property Value: $500,000 Existing Mortgage: $0
Primary Borrower Age: 75
|
3.91% Annual |
4.18% Fixed |
| Current Annual Rate |
3.91% |
4.18% |
| Max Lifetime Rate |
8.91% |
4.18% |
| APR |
n/a |
5.57% |
| Mortgage Payoff |
$0 |
$0 |
| Cash At Closing |
$146,444 |
$144,883 |
|
Cash Available (after 12 months)
|
$109,200 |
n/a |
| Total Available |
$255,644 |
$144,883 |
The examples above show the options available to a 75-year-old borrower who
has no pre-existing mortgage to pay off.
The various options have pros and cons that are specific to them. For
instance, if the borrower opts for a fixed-rate loan, he would draw the total
sum once and for all. This option may be great for paying off a loan or
purchasing a home and it is a great way to keep your interest rate in check
too.
But if the borrower decides to opt for a monthly payment option or line of
credit, then only adjustable rate options are available. Although there are
annual and lifetime caps, the interest rate can increase significantly with
time.
The upside to adjustable-rate options is the fact that the amount you leave
without drawing would keep growing at identical rates to your loan interest
and mortgage insurance.
This implies that if there is some money that you can access on your line,
then that amount would be growing by the interest rate as well as the rate of
annual mortgage insurance accrual.
So, for a $250,000 line of credit with a 5% interest in addition to the MIP
accrual rate, this would result in about $10,000 in the first growth
year.
The following year, the line of credit would grow at the same rate, however,
it would be based on a $210,000 balance instead of a $200,000 balance.
The interest that your funds accrued is a result of the fact that you didn’t
spend all of the funds available to you and it doesn’t exactly come from
anyone.
If you make use of the line, later on, the interest accrued is part of the
borrowed funds and would be paid back when the loan is due. It is unlike
interest that accumulates on funds in a bank account where you can take it out
of your account and not have to pay back.
Here’s an Example of Line of Credit Growth
| Year (after 12 months) |
Available line of credit (starting at $200,000) |
| 1 |
$211,281 |
| 2 |
$223,119 |
| 3 |
$235,789 |
| 4 |
$249,090 |
| 5 |
$263,140 |
| 6 |
$277,983 |
| 7 |
$293,664 |
| 8 |
$310,229 |
| 9 |
$327,728 |
| 10 |
$346,215 |
This example uses an annual LIBOR margin of 2% and the total interest rate
accrual and growth are at 5.5%. Given that a reverse mortgage is a loan, the
money that you borrow accrues interest.
You don’t have to pay back the conventional way, so the balance keeps
growing, and as it does, so would the interest accruing.
A reverse mortgage loan never has a payment due, however, prepayment doesn’t
attract any penalties either.
Therefore, borrowers who do not want their balance to grow significantly as a
result of interest accumulation can repay any amount whenever they
wish.
This implies that you would be paying at your own convenience given that
there is no due date, no mandatory monthly payments, and no negative impact on
your credit as well.
This gives borrowers the ultimate control. They can decide to let their
balance grow or they could keep it in check by paying interest due or even
extra.
And all they have to do is regard the home as their primary residence, pay
the necessary bills such as insurance and taxes and basically maintain the
home as you would any home.
The other factor there is to consider is the impact of the loan on
heirs.
Heirs and Other Family Members
Most heirs who are spouses but were not with the borrower as at when the loan
was taken out are usually pretty surprised to hear that they cannot remain in
the home given that the original borrower(s) are no longer residing there.
Other family members are usually either surprised to learn that there is a
reverse mortgage existing or the fact that they cannot remain there
too.
Various factors are taken into consideration when determining benefits. In
line with this, a reverse mortgage does not allow the loan to be transferred
to new borrowers or spouses who were not present when the loan was
closed.
In the event that a borrower wants to include a new spouse in reverse
mortgage security, they would have to refinance into a new mortgage that would
bear the names of both borrowers.
If any discussion had to take place, it should have been before the passing
of the borrower who felt it necessary to take out a reverse mortgage.
In the event that a senior homeowner requires assistance and the heirs would
not want their inheritance impacted, they can always create an informal form
of a family reverse mortgage to cater to the senior’s needs and they can get
their money back after the home is sold.
This way, the heirs can avoid all the extra costs and interest, however, they
would need to be financially stable enough to contribute to taking care of the
senior in addition to paying their own bills.
If that isn’t feasible, then a senior can always get a reverse mortgage loan
that would give them the freedom and financial security that is treasured in
retirement. In addition, they would not have to bother family members for
funds given that they can meet all their needs now.
It presents them the option of paying their bills without having to draw from
their savings and since the home is theirs, the home can be sold off to pay
off the loan whenever they want without any penalty.
Whether or not a reverse mortgage is a good idea should be determined by the
borrower and not the heirs who feel that way because they would not get the
inheritance that they had so anticipated.
