Most reverse mortgages are Home Equity Conversion Mortgages, which are available through the Federal Housing Administration. Homeowners may be eligible for this option if they are at least 62 years old and own their home or have accumulated substantial equity in it. A reverse mortgage can apply only to a principal residence.
The idea behind a reverse mortgage is that the homeowner receives monthly payments or a line of credit from the lender. The loan increases with each payment or draw on the line of credit. Some reverse mortgages may provide a lump sum payment or may combine these payment methods. The maximum amount of the loan is set according to the sale value of the house. It must be paid off when the homeowner dies, sells the house, moves out permanently, or breaches the terms of the mortgage. Moving out permanently usually means living outside the home for more than a year, even if the homeowner eventually returns to it.
It may be worth consulting an estate planning lawyer before taking out a reverse mortgage to understand how it will affect the heirs of the estate.
Restrictions on First-Year Withdrawals
Reverse mortgages unfortunately have resulted in many defaults and disputes with lenders. As a result, a homeowner no longer is allowed to take out all of the principal limit in the first year of the loan. You can take out 60 percent of the loan amount or the total of the mandatory obligations and 10 percent of the principal limit, whichever is greater. (A mandatory obligation could be the mortgage with which you bought the property or other debts secured by the property.)
If you have no mandatory obligations and choose to receive a one-time lump sum in the first year, therefore, this will consist of only 60 percent of the total amount for which you qualify. You probably should opt for a partial lump sum payment instead, combined with monthly payments or a line of credit. If you do have mandatory obligations, you can get them paid off in the first year and also get 10 percent of the total amount for which you qualify. You can receive the remaining 90 percent in monthly installments or through a line of credit, or a combination.
Total Annual Loan Cost
The mortgage provider should outline the total annual loan cost (TALC) and highlight all the costs associated with a reverse mortgage, such as the interest, insurance, and closing costs.
Issues Involving Taxes and Insurance
A reverse mortgage does not relieve a homeowner of the obligation to pay property taxes and premiums for hazard insurance. If they fail to keep up with their payments, this will be considered a breach of the terms of the reverse mortgage. A lender can demand that the homeowner pay off the loan if this happens, but many lenders would prefer to avoid this problem altogether.
The lender may investigate the financial circumstances of a potential borrower. If they believe that the borrower may not be able to make payments for taxes and insurance, any reverse mortgage that the lender offers may include a set-aside amount. This allows the lender to reserve part of the loan amount to account for payments on taxes and insurance. It reduces the amount that the homeowner receives through the reverse mortgage. However, it does not necessarily reduce the homeowner’s total benefit from the mortgage because a normal reverse mortgage would require them to pay these amounts anyway.