Reverse Mortgage Example

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. 

 

Tyler Plack

About the Author, Tyler Plack

South River Mortgage is one of the nation's top reverse mortgage originators. With a focus on reverse mortgages, South River Mortgage's trustworthy advisors are able to help thousands of seniors each year.

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