HistoryCongress authorized the Federal Housing Administration to offer reverse mortgages through a demonstration project in 1989. In 1990, reverse mortgages expanded into all markets, and in 1998 were made permanent. Although private lenders can offer reverse mortgages, they do not offer the government-backed insurance that the FHA does. The insurance protects the lender from home values that don’t appreciate enough to cover the loan balance, and protects borrowers who take their loans in the form of monthly payments or credit lines from banks that may fail and go out of business. Not surprisingly, FHA loans are the source of most reverse mortgages.
ProcessAny homeowner age 62 or older can apply for a reverse mortgage. The maximum loan available for an FHA loan depends largely on the lesser of home value or a regional cap set by the FHA. The cap often approximates local median home prices. Another factor that influences the loan amount is borrower age; the older the borrower, the more money he can borrow. The interest rate at the time and the loan type will also have some effect; the higher the rate, the less a homeowner can borrow. The loan is repaid after the homeowner moves away for a period of 12 consecutive months, sells the home or dies. Generally, the home is sold to make the repayment. A reverse mortgage is a non-recourse loan, meaning neither the homeowner nor his heirs are responsible for any part of the loan that cannot be repaid from equity in the home.
OptionsA reverse mortgage may be taken out as a lump sum, a line of credit, monthly payments or some combination of these options. The lump sum can be based on an adjustable or a fixed interest rate. The line of credit and monthly payments are based on an adjustable rate. Although no repayments of the loan are required while the borrower remains living in the home, there are also no prepayment penalties. This means that the borrower can choose to make interest or principal payments if he wishes--an option that may make sense if he comes into a windfall and wants to preserve equity in the home for heirs.
AdvantagesThe biggest advantage to a reverse mortgage is that no payments have to be made while the borrower remains living in the home. If the borrower uses the reverse mortgage to pay off his existing mortgage, his expenses go down. If he started out lien-free, his income goes up. Either way, the borrower ends up having greater flexibility in his monthly budget. If the home value declines, he is also protected. The loan amount is based on the value of the house at the time of loan approval. If the home price declines, the borrower can hang onto the lump sum, line of credit or monthly payment. If the home value rises tremendously, he or his heirs will also benefit from equity that may remain in the house after the loan is repaid.
DisadvantagesReverse mortgage loan costs are high, interest compounds on the loan balance and equity must be significant to make use of the loan. These are all disadvantages of the reverse mortgage. Closing costs associated with a standard mortgage run, on average, $3,741. The same costs associated with a reverse mortgage can be as high as $20,000. Because no payments are made on the loan, interest compounds on the principal. The resulting final loan balance can be several times the original loan amount, leaving little or no equity for heirs. The formula determining the maximum loan amount typically yields a figure of about 50 to 60 percent of the home value. If the borrower already owes 80 percent of the home value on an existing mortgage, he cannot take out a reverse mortgage because all existing liens must be repaid before approval or with loan proceeds.
Source: SF Gate