New Rules Make Reverse Mortgage Less Risky — But at a Price

Reverse mortgages have always been a costly way to solve your financial problems when you have a lot of home equity and not so much cash during retirement. Now, changes in the program (some happening now, some happening in January 2014) mean some seniors will pay even more to get a smaller amount of money via their reverse mortgage.

Still, if you’re house-rich, cash poor, 62 or older, and you want to stay in your house until they carry you out, a reverse mortgage can get you what you want.

How Reverse Mortgages Work

When you get a reverse mortgage, the lender sends you a monthly payment or a lump-sum payment. In exchange:

  • If you move out of your home, you have to sell it and repay the lender’s payments plus interest.
  • If you die, your heirs have to repay your reverse loan by selling your house or flat-out repaying the loan.

That’s a great deal. You get to spend your equity without leaving your house. Just keep in mind that a reverse mortgage comes with hefty fees; they’ll remind you of the ones you paid for a regular mortgage (mortgage insurance premiums, title, closing, servicing, etc.).

But the fees are based on the value of your home, not the size of your reverse mortgage. If you’re in an expensive home, they’re going to be big even if your reverse mortgage is small.

Why Change the Program?

Many seniors with a reverse mortgage who lost their homes to foreclosure during the recession couldn’t pay their ongoing tax and insurance bills.

So FHA, which insures 90% of all reverse mortgages, decided some reverse mortgages borrowers should have to hold back a bit of equity in case they need to use it to pay those ongoing costs. They also have to be qualified financially (more about this later) and can take out a limited lump sum payment in the first year.

It’s great that FHA has taken steps to protect folks, but likely it’ll mean fewer people will get a reverse mortgage.

As of Oct. 1, 2013:

In general, you can’t borrow as much as before — about 15% less.

You can pull out the greater of:

1.  60% of your principal limit (not your home’s value, but a percentage of its worth calculated based on things like equity, your age, and current interest rate) as a lump-sum payment during the first year of your mortgage; or

2.  Enough to pay off a regular mortgage you already have on your home, plus 10%. (Paying off existing liens is the only way to take out more than 60% as a lump sum in the first year.)

Here’s an example of what you’d get if you were to take out more than 60%, assuming a principal limit of $100,000:

  • Outstanding mortgage amount: $65,000
  • 10% of principal limit: $10,000
  • Initial payout limit: $75,000 ($65,000 + $10,000)

(If there was no mortgage to pay off, you’d get a $60,000 initial disbursement.)

Remember those fees I mentioned? If you do take out more than 60%, you’ll pay a whopping 2.5% upfront mortgage insurance premium for the privilege (compared with the 0.05% upfront mortgage insurance premium you pay by borrowing 60% or less of your home’s value). The annual premium for both is 1.25%.

You have to be able to pay your property taxes and insurance. If your lender deems you a risk, it’ll pay your property taxes and insurance from a set-aside account funded by your proceeds. Otherwise, you can pay them yourself or voluntarily ask your lender to do it for you.

Tip: Avoid using your reverse mortgage payments to pay taxes and insurance. If you must, pay your tax and insurance bills as late as possible before the deadline. You’ll pay less interest if you wait until the bills are due to draw from your remaining equity.

How Much Can I Get From a Reverse Mortgage?

Comparing all your reverse mortgage options is only slightly less complicated than projecting the trajectory of an asteroid, but luckily we can use the Mortgage Professor’s Reverse Mortgage Calculator, which lays out all your options and costs.

Let’s look at some examples. Suppose I’m 64 years old, live in the York, Pa., ZIP code 17403, have no mortgage, and my home is worth $100,000. I’m going to finance my fees.

My options for reverse mortgages include:

Your Choices How Much You Receive Fees You Pay Interest Rate
Maximum lump sum $51,149 lump sum $1,751 4.99% fixed
Credit line you can tap when needed $49,459 credit line $6,741 2.82% ARM

Max monthy fixed payments until you move

$300/month until I move $6,741 2.82% ARM
Smaller monthly fixed payments until you move $251/month until I move $4,741 2.82% ARM
Max monthly fixed payments for 20 years $371/month for 20 years $6,741 2.82% ARM
Smalller montly fixed payments for 20 years $311/month for 20 years $4,741 2.82% ARM
Small lump sum and max credit line $10,000 upfront cash and $39,459 credit line $6,741 2.82% ARM
Small lump sum and smaller credit line $10,000 upfront cash and $31,449 credit line $4,741 2.82% ARM

Must-Do Counseling

All these choices are what make reverse mortgages so complicated. That’s why FHA insists you get help from a financial counselor before you take one out. Protect yourself by getting a referral from the National Council on Aging’s Reverse Mortgage Counseling Services Network.

Here’s the Financial Qualification We Mentioned Earlier

Starting in January 2014, lenders will look at:

  • Your credit history. You didn’t have to have good credit before these changes because you’re not repaying the loan out of income.
  • How much income/cash you have to pay your property taxes, insurance, and other homeownership bills.

FHA hasn’t yet set the rules lenders will use to evaluate your credit for a reverse mortgage.

If you’re shut out of the reverse mortgage market, and even if you’re not, try these suggestions for increasing your cash flow or changing the way you use your home:

Renting a Room in Your House

5 Tips to Make Money Off Your House

Remodeling Your House for Multigenerational Living