Did you know that, if you are 62 or older, you may be able to use a reverse mortgage to purchase a home? In this article we cover how you can use the equity in your current residence to purchase property; different Reverse Mortgage options on the market today, and how this financial decision will impact your heirs.
Using a Reverse Mortgages to Buy a Home
You may have heard of using a Reverse Mortgages to supplement your income after you’ve reached a certain age. Typically, these financial vehicles can be used to tap into the equity of your home to receive payments, and at the end of the loan, your house is sold and the profit is used to repay the lender.
But what about purchasing a home with a reverse mortgage, say to downsize or move closer to family? The same logic applies: your are using the equity in your current residence to finance the purchase.
When using a reverse mortgage to purchase a home, the borrower provides a down payment for the home using the sale of the previous home or other savings. The equity earned through the down payment and the new home’s value is then used to calculate the reverse mortgage loan amount. All or part of the reverse mortgage funds then cover the remaining cost of the home, just like with a traditional mortgage. However, the two are fundamentally different: you will have no monthly mortgage payments when you use a reverse mortgage to purchase.
“This is not just a mortgage product. It’s a financial, cash-flow tool for retirees,” says Rob Cooper, national director of strategic partners for Reverse Mortgage Funding. “It gives them more purchasing power if they don’t want to drain all their assets. It also gives them the luxury to get a better lot, to add all the upgrades they want and to still have no mortgage payment.”
What if The Equity in the Home Does Not Cover the Loan Balance?
When the loan term ends (at the end of the borrower’s life), if the value of the home does not cover the loan balance of the reverse mortgage, the lender will absorb the loss. Heirs or an estate will not be liable for any remaining balance.
On the other hand, if the home sells for more than what is due on the reverse mortgage, the heirs or the estate are entitled to any remaining funds.
Types of Reverse Mortgages with Home-Purchase Options
Home Equity Conversion Mortgage (HECM)
HECM (pronounced HEKUM) is the commonly used acronym for a Home Equity Conversion Mortgage, a reverse mortgage created and regulated by the U.S. Department of Housing and Urban Development. A HECM is not a government loan. It is a loan issued by a mortgage lender, but insured by the Federal Housing Administration, which is part of HUD.
Proprietary reverse mortgages
Proprietary reverse mortgages are privately insured by the mortgage companies that offer them. They are not subject to all of the same regulations as HECMs; however most companies that offer proprietary reverse mortgages will enforce similar consumer protection rules that are found in the HECM program.
The major appeal of proprietary reverses is that they are not restricted by FHA loan limits, which are now capped at $726,525, meaning they can accommodate borrowers with high-value homes. They can also be used to purchase property that is ineligible for FHA financing — such as units in non-FHA approved condominiums or some planned unit developments (PUDs).
Read more about the growing proprietary reverse mortgage market here.
One of the main benefits of purchasing a home with a reverse mortgage is that there will be no monthly payments as with a typical mortgage. Instead, the loan has to be repaid when the home is sold or the borrower moves out or dies. The repayment to the lender includes the amount borrowed, plus accumulated interest. Any remaining equity belongs to the borrower, heirs or estate.
Seniors often use these investment vehicles to avoid tying up a large portion of their money in a home, as would be the case in an all-cash transaction. In the other scenario, reverse mortgage holders won’t have to dip into their monthly fixed income for monthly payments, as would be the case with a traditional mortgage.
The major pitfall to using a reverse mortgage to purchase a home is that the homeowner is losing equity in the home instead of building it. Because there are no monthly payments, the total loan balance is higher than with a traditional mortgage, and with interest accruing, a large portion, if not all of the equity in the home will go towards repaying the reverse mortgage at the end of the owner’s life. Additionally, when acquiring the reverse mortgage, it’s associated fees may be higher than with a traditional mortgage.
Another important consideration when getting a reverse mortgage is that, if your income changes, your eligibility for needs-based government programs, such as Medicaid or Supplemental Security Income (SSI), may be affected.
To see a list of the pros and cons of reverse mortgages, take a look at this site.
Speak to a Professional
If you are considering a reverse mortgage, we suggest you speak to a professional that specializes in these loan products. If you’d like a referral, please don’t hesitate to contact us.