Reverse mortgages have continued to evolve and increase in popularity since they were first introduced in 1961. They have also grown safer every year. This is due primarily to the Federal Housing Administration’s (FHA) rules and regulations. It continually updates its reverse mortgages regulations with new guidelines designed to protect borrowers.
If you’re not familiar with reverse mortgages they can be part of a happier retirement for your parents by increasing their income. It does this by allowing them to borrow against their home’s equity, while continuing to own it.
The best part
Reverse mortgages are unlike conventional mortgages or debt consolidation loans because your parents won’t be required to make any payments. What happens, instead, is that the lender pays your parents in one single sum, as a line of credit, similar to a home equity line of credit, or in monthly payments. The lender gets repaid when your last surviving parent dies, your parents move away from the house permanently or they sell it. The borrower must be over the age of 62 to qualify and it’s important for you and your parents to understand that they may see their equity reduced.
How a reverse mortgage would benefit your parents
First and foremost, it can be a great source of income for your parents if they need more more money in order to have a comfortable lifestyle. It allows them them to stay in their home while boosting their income and without increasing their monthly payments.
What are the requirements for a reverse mortgage?
The thinking behind a reverse mortgage is that it’s a way for seniors to use the equity in their home to generate income. As a result, the four most important rules for your parents to qualify for one of these mortgages are as follows:
- The borrower must be over the age of 62
- Your parents must own their home
- They must own their home outright or have a lot of equity
- They must live in the home as their primary residence
Three other obligations
If your parents decide to get a reverse mortgage it’s important for them to know they will continue to have obligations they must uphold to ensure they won’t default on the loan. So it’s important that they understand that they are responsible for the following:
- They must immediately use the funds from the reverse mortgage to pay off any other mortgage
- They must continue to make payments on their property taxes, home insurance and basic home maintenance
- They must comply with all of the terms of the loan such as continuing to live in their house as their primary residence
Two more benefits
Reverse mortgages come with two other important benefits because they are technically Home Equity Conversion Mortgages (HECM) and are non-recourse. This means that if your parents do not repay the loan after it becomes mature, the lender is not allowed to take any asset, other than the home itself, to pay off the loan. Second, If the amount of your parents’ debt is more than the home’s value, they won’t owe more than whatever it sells for.
The regulations you and your parents need to know
There are some regulations the FHA has established that you and your parents need to understand about reverse mortgages. For one thing, before the loan is approved your parents will be required to meet with a counselor to ensure they know all their options and have all the information about reverse mortgages they need to have to make an informed decision.
A second issue is that your parents may be able to access only 60% of the approved loan amount in the first year of the mortgage or the amount needed to pay off their current mortgage plus 10%, whichever is greater. After the second year, they can then access the remaining amount. The idea behind this is to prevent them from pulling out their equity too quickly.
One really good condition of the loan is that the lender can’t require your parents to purchase other loans or financial products as a condition of its loan.
A financial assessment
The lender of the reverse mortgage is required to fill out a financial assessment and analyze your parents’ income versus expenses ratio. If this ratio shows they might have a problem paying their home insurance premiums, recurring taxes or other obligations, the lender may set aside money from their loan funds to pay these obligations.
Finally, your parents will have three business days after the loan closing to change their mind and cancel the reverse mortgage. And the lender cannot charge your parents interest during this three-day period.
The downsides of reverse mortgages
The biggest downside of reverse mortgages is their cost. There’s a cost attached to all mortgages and a reverse mortgage is no exception. In fact, the cost of a reverse mortgage can be extremely high as it will include the interest, a mortgage insurance fee, a loan origination fee, a fee to cover the cost of an appraisal, title insurance fees and miscellaneous other closing costs. While these costs vary they can be as much as $40,000. However, this fee is included in the loan so that your parents are not required to pay it.
There can be a problem if your parents move permanently from their home so that the loan immediately becomes due. This may not be a problem now but if your parents ever needed to move to a full-time care facility, their loan would be due. The same is true if they were to leave their home for a year for some reason.
The final negative of a reverse mortgage is how it would affect your parents’ estate. It is almost certain that it will shrink the equity in their home so there will be less money left for you and any other heirs.
An even simpler explanation
If you’d like simple explanation of reverse mortgages in video form here it is as presented by a Certified Aging-in-Place Specialist.
Frequently Asked Questions about a reverse mortgage
Q. What happens if your parents have an existing mortgage?
A. While they may still qualify for a reverse mortgage it must be in the first lien position so that any existing mortgage must be paid off. Your parents could pay off the existing mortgage with money from the reverse mortgage, from their savings or with financial help from a friend or family member.
Q. How much money could my parents get?
A. This will depend on several factors including the age of your youngest parent, the home’s appraised value and the loan’s interest rate. If the loan is in a government program, the FHA has a lending limit, which is now $625,5000. If your parents’ home is worth more than this then the amount of money they could get will still be based on the $625,500 loan limit.
Q. How does the interest work on one of these mortgages?
A. Your parents will be charged interest only on the money they receive. It may have either a fixed or variable rate. Their interest rate will not be paid out of the proceeds from the reverse mortgage but instead compounds over the life of the loan until it is paid off.
Q. What could my parents do with the proceeds from their reverse mortgage?
A. The money they would get from a reverse mortgage can be used for anything – to supplement their retirement income, repair or modify their home, cover their daily living expenses, pay off existing debts, cover their property taxes – or even to prevent foreclosure.
Q. Could my parents deduct their interest charges for income tax purposes?
A. Your parents can deduct their interest charges only when they have paid them. If they have not made any interest payments on the reverse mortgage they won’t be allowed to deduct any interest charges for income tax purposes.
Q. Will my parents receive statements from the lender?
A. The company that services your loan must issue to your parents a statement of account after each credit activity. It must also provide them with a statement about any impending interest rate charges that may impact their mortgage. Finally, the loan servicer is required by law to provide your parents with an annual statement of account by January 31. This statement will detail all of the account’s activity of the previous year.
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