The reverse mortgage is more carefully regulated by the government than other loans – and for good reason: It has its own dangers and pitfalls. If you're an older homeowner struggling to make ends meet, it may still be your best option as long as you know the rules.
Rule no. 1: The reverse mortgage has been renamed Home Equity Conversion Mortgage (HECM) by the Federal Housing Administration (FHA). This is not just the usual, unpleasant federal law. The HECM is the only legitimate reverse mortgage because it comes with rules to protect the consumer.
And, a blunt definition: a reverse mortgage is a mortgage that is not repaid until you and your spouse leave your home forever or die. Most official sources of information on reverse mortgages carefully avoid the "d" word, but that is the point. All the money you spend from your line of credit, as well as any interest and fees charged by the bank, is payable by you when you sell your home, or by your heirs after they inherit it. The point of getting a reverse mortgage is to make it affordable for you to live in your home for the rest of your life.
Rules for you
To qualify for a government-approved reverse mortgage, you must be at least 62 years old. You must own your home outright or at least have substantially paid off the mortgage. And as with any mortgage application, you must prove that you can afford to live in the home once the mortgage is approved.
This last rule forces you to perform a useful budgeting exercise. You need to figure out if a reverse mortgage would free up your monthly income or increase your monthly income to a level that would allow you to stay in your home.
Remember that a reverse mortgage can be received in a lump sum, or it can be drawn in monthly payments that contribute to your regular income, for the rest of your life or for a set period of time. .. Or you can choose a combination of both. The purpose of a lump-sum withdrawal should be to pay off other debts. There's no rule that prevents you from blowing it all on a Ferrari, but that would be a very foolish move.
You can read the rules in full on the government site. When you're done applying, you'll hear all the rules during a one-on-one meeting with a HUD-approved counselor. This counseling session is another requirement for obtaining a reverse mortgage. If you want to consider alternatives to a reverse mortgage, the National Council on Aging has a useful brochure on the pros and cons of different options.
Rules for lenders
Like any mortgage, a reverse mortgage includes prepayments and ongoing maintenance costs.It also includes a federal mortgage insurance premium.
With a reverse mortgage, all of these costs are folded into the loan agreement, along with accrued interest, so they are only collected when the loan is paid off. Federal rules limit the amount a lender can charge for each of these fees.
At the risk of bringing out the "d" word again, the reverse mortgage includes an "origination fee" that ensures the lender gets something out of this transaction even if you die right after signing the agreement. This fee is also capped at $6, 000.
Crucially, reverse mortgage rules prohibit a lender from charging more than the value of the home when it comes time to pay off the loan. In fact, even if the borrower eventually withdraws an amount that exceeds the value of the house, the repayment cannot exceed the value of the house. (Any shortfall will be covered by the federal mortgage insurance program.)
This means you can live forever, and you still won't owe more than your home is worth. Or you or your heirs may not be comfortable paying off an "underwater mortgage" even if the real estate market crashes again.
In fact, the rules include a requirement that the lender must offer to settle for an amount less than the full debt, generally 95% of the total borrowing. The rules also require that the lender give heirs some time to decide what to do with the house before paying off the debt, generally six months with at least one possible extension.
These are good rules to know. Some lenders don't bring up the settlement issue until they are forced to, according to a report in the New York Times. Some have even rushed into foreclosure proceedings against property heirs. Why all the rules?