Taking a deeper dive into the details about reverse mortgages
Many readers reached out to sing the praises — or criticize — their experience with reverse mortgages, a kind of loan I wrote about recently.
I figured we could all use some further details about the reverse mortgage, which is only available to homeowners over age 62.
A reverse mortgage is a kind of home equity loan to borrow in old age without having to make payments, if you don’t want to. A borrower can decide — for life — to never make any principal and interest payment on the loan.
Let’s talk about costs, the calculation of the debt balance against your home, and some nuances of how a lender services reverse mortgages.
Costs
The biggest cost is insurance. Borrowers are charged 2 percent of the appraised home value by the Federal Housing Authority. For a $500,000 appraised home, the FHA would charge $10,000, which would be rolled into your loan balance at the time of origination. The FHA also charges 0.5 percent annually on the balance, as further insurance against losses.
What kind of interest rate should we expect on a reverse mortgage? Most charge a variable interest rate. Greg Groh, a reverse mortgage originator with All Reverse Mortgage, said that last week the starting variable interest rate was 4.32 percent which, added to the insurance cost, would mean a borrower’s cost of 4.82 percent.
What do I think of those rates? They’re slightly higher than a traditional mortgage, but also less than the rate I’m currently charged for my home equity line of credit, on which I pay 5.49 percent, and happily so. So, the interest rate isn’t a big knock on reverse mortgages.
Debt balance
One of the more complicated topics of a reverse mortgage is how much you can borrow. Big picture, you should know two things: First, you can generally borrow much less initially with a reverse mortgage than with a traditional mortgage. Second, the amount you can borrow against your house trends upward over time, at the same rate as your mortgage’s interest rate. Let me fill in a few details on this issue.
Your initial borrowing amount is calculated according to an FHA formula by taking into account three things: The value of your house, your interest rate, and your age.
The FHA says that the younger you are, the less you can borrow against your house. This makes sense since time will eat away at your home equity, and you are not required to make payments on a reverse mortgage. The FHA also says that the higher the interest rate, the less you can borrow. This also makes sense because a higher interest rate, compounding over time with no payments, will also eat away at your home equity.
Here’s a weird quirk of reverse mortgages, though. The amount you can borrow against your house increases over time, precisely in line with the interest rate you are charged. If you’re charged 5 percent interest, your available borrowing limit increases by 5 percent per year. For reverse mortgage borrowers using this as a home equity line of credit, the annually increased borrowing capacity will seem like a cool feature. For people concerned with reverse mortgages eating up your home equity, this increased borrowing capacity may seem pernicious.
Servicing
Many readers asked about the servicing component of reverse mortgages, which is slightly different than for a traditional. Since borrowers must live in their house, does that force a sale if an elderly person moves out to a nursing facility? Yes, and no.
Borrowers may live outside of the home up to 12 continuous months, meaning even an extended hospital stay or stint in a nursing home does not trigger any change with the mortgage.
But if the borrower decides to leave the home for more than 12 months, then in fact the loan would become due.
Final word
So, are reverse mortgages awesome? Or terrible?
My strongest advice would be to fully pay down your home mortgage over 15 to 30 years, don’t borrow against your house, and depend solely on accumulated retirement savings plus Social Security to support you in your old age. There’s nothing wrong with that advice except for the fact that it sounds a bit like: My strongest advice to you is to be rich in your old age.
And, you know, that’s not very actionable advice by the time you retire.
If you can’t be rich, my second strongest recommendation would be to take out a home equity line of credit, since these are revolving lines, they allow you to flexibly borrow as needed, and act like a low-interest emergency credit card. They are awesome and we used one to renovate our kitchen and paint our house. I love my HELOC. A reverse mortgage therefore is really a third-best option, but it seems to me a pretty fine choice under many scenarios.