Conventional reverse mortgages are only available to homeowners aged 62 or older, who occupy the home as a principal residence, and who either own their home outright or have substantial equity in the home. Credit worthiness is not a factor, nor is monthly income, but homeowners are expected to pay hazard insurance, pay property taxes and maintain the property.
Approximately 90% of reverse mortgages are conventional loans, or FHA-insured Home Equity Conversion Mortgages (HECM). The HECM guarantees that the FHA will meet the lender's obligations to the borrower, limits loan origination costs, and ensures full repayment of the loan to the lender up to the maximum claim amount, explains Dr. James Gaines, research economist for the Real Estate Centerat Texas A&M University.
"Reverse mortgages are based on the home's current value, borrower's age and existing interest rates," says Dr. Gaines, "Borrowers can choose to receive loan proceeds in a single, lump-sum payment, as periodic predetermined payments, a line of credit or both."
How reverse mortgages work is ingenious, and they can be a blessing to homeowners who want to stay in their homes. With a typical loan, borrowers pay interest added to the total payment. With a reverse mortgage, the interest is subtracted from the current price of the home, and the borrower is given the difference.
According to Dr. Gaines, reverse mortgages have definite pros and cons that should be considered carefully by borrowers and their heirs.
Pros of a reverse mortgage:
- No fixed due date
- No repayment required as long as the home remains the principal residence of the borrower
- Nonrecourse loans -- the amount can never exceed the selling price
- Borrowers hold title to property
- Loan proceeds not taxable
- Flexible payment options
- Loan-to-value ratios typically yield only 65% to 80% of the home's present value
- Upon death, the loan's interest and costs are due and payable, usually requiring the sale of the home. Such inheritance planning may not please heirs, who may have to pay back the loan if they wish to retain the home.
- Foreclosure is still possible, if the borrower fails to remain in the home for 12 months, or fails to pay taxes or maintain the home.
- Terms and conditions of reverse mortgages may be difficult to understand and borrowers may also be targets for aggressive sales pitches or other expensive or inappropriate services or products.
- If you're considering a reverse mortgage, FHA insists that homeowners are counseled to make sure they understand the transaction before they are allowed to sign for the loan.