Reverse mortgage

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A reverse mortgage is a home loan that provides cash payments based on home equity. Homeowners normally "defer payment of the loan until they die, sell, or move out of the home."[1] Upon the death of homeowners, their heirs either give up ownership to the home or must refinance the home to purchase the title from the reverse mortgage company. Specific rules for reverse mortgage transactions vary depending on the laws of the jurisdiction.

In a conventional mortgage, the homeowner makes a monthly payment to the lender. After each payment, the homeowner's equity increases by the amount of the principal included in the payment. In a reverse mortgage, a homeowner is not required to make monthly payments. If payments are not made, interest is added to the loan's balance.[1] Although the "rising loan balance can eventually grow to exceed the value of the home," "the borrower (or the borrower’s estate) is generally not required to repay any additional loan balance in excess of the value of the home."[1]

Regulators and academics have given mixed commentary on the reverse mortgage market. Some economists argue that reverse mortgages allow seniors to smooth out their income and consumption patterns over time, and thus may provide welfare benefits.[2][3] However, regulatory authorities, such as the Consumer Financial Protection Bureau, argue that reverse mortgages are "complex products and difficult for consumers to understand," especially in light of "misleading advertising," low-quality counseling, and "risk of fraud and other scams."[1] Moreover, the Bureau claims that many consumers do not use reverse mortgages for the positive, consumption-smoothing purposes advanced by economists.[1]

Australia[edit]

Eligibility[edit]

Reverse mortgages are available in Australia. However, there is little regulation: the Financial Services Reform Act does not regulate the loans,[4] and although potential borrowers should seek financial advice before applying for a reverse mortgage, there is no legislation that requires the advisor to be licensed.[4]

Eligibility requirements vary by lender. To qualify for a reverse mortgage in Australia,

Loan size and cost[edit]

Reverse mortgages in Australia can be as high as 50%[5] of the property's value. The exact amount of money available (loan size) is determined by several factors:

The cost of getting a reverse mortgage depends on the particular reverse mortgage program the borrower acquires. These costs are frequently rolled into the loan itself and therefore compound with the principal.[5] Typical costs for the reverse mortgage include:

The interest rate on the reverse mortgage varies. Some programs offer fixed rate loans,[5] while others offer variable rate loans.[8]

In addition, there are costs during the life of the reverse mortgage. A monthly service charge may be applied to the balance of the loan (for example, $12 per month[6]), which then compounds with the principal.[5]

Proceeds from a reverse mortgage[edit]

The money from a reverse mortgage can be distributed in several different ways:[5]

Taxes and insurance[edit]

The borrower remains entirely responsible for the property. This includes physical maintenance.[5] In addition, some programs require that the property is periodically revalued.[5][7]

Income from a reverse mortgage set up as an annuity or as a line of credit should not affect Government Income Support entitlements.[5][9] However, income from a reverse mortgage set up as a lump sum could be considered a financial investment and thus deemed under the Income Test; this category includes all sums over $40,000 and sums under $40,000 that are not spent within 90 days.[9]

When the loan comes due[edit]

The reverse mortgage comes due – the loan plus interest must be repaid – when the borrower dies, sells the property, moves out of the house, or breaches the contract in some way.[5]

Prepayment of the loan – when the borrower pays the loan back before it reaches term – may incur penalties, depending on the program.[5][8] An additional fee could also be imposed in the event of a redraw.[8]

"Some providers offer a 'no negative equity guarantee'. This means that if the balance of the loan exceeds the proceeds of sale of the property, no claim for this excess will be made against the estate or other beneficiaries of the borrower."[5][7]

Canada[edit]

Eligibility[edit]

Reverse mortgages are available through private corporations in Canada, although none of the programs are insured by the government.[10] Eligibility requirements vary depending on the lender. To qualify for a reverse mortgage in Canada,

Loan size and cost[edit]

Reverse mortgages in Canada are usually a maximum of 25[10] to 50%[12] of the property's value.[10] The exact amount of money available (loan size) is determined by several factors:[10]

The interest rate on the reverse mortgage varies by program. The length of loan also varies, with some programs offering no fixed term and some offering fixed terms ranging from 6 months to 5 years.[12]

The cost of getting a reverse mortgage from a private sector lender may exceed the costs of other types of mortgage or equity conversion loans. Exact costs depend on the particular reverse mortgage program the borrower acquires. Depending on the program, there may be the following types of costs:[13]

Proceeds from a reverse mortgage[edit]

The money from a reverse mortgage can be distributed in several different ways:[10]

Once the reverse mortgage is established, there are no restrictions on how the funds are used. "The money from the reverse mortgage can be used for any purpose: to repair a home, to pay for in-home care, to deal with an emergency, or simply to cover day-to-day expenses."[10]

The borrower retains title to the property, including unused equity,[12] and will never be forced to vacate the house.[10]

Taxes and insurance[edit]

The borrower remains entirely responsible for the property. This includes physical maintenance and payment of all taxes,[10] fire insurance and condominium or maintenance fees.[12]

Money received in a reverse mortgage is an advance and is not taxable income. It therefore does not affect government benefits from Old Age Security (OAS) or Guaranteed Income Supplement (GIS).[12][11] In addition, if reverse mortgage advances are used to purchase non-registered investments – such as Guaranteed Investment Certificates (GICs) and mutual funds – then interest charges for the reverse mortgage may be deductible from investment income earned.[12]

When the loan comes due[edit]

The reverse mortgage comes due – the loan plus interest must be repaid – when the borrower dies,[11] sells the property, or moves out of the house. Depending on the program, the reverse mortgage may be transferable to a different property if the owner moves.[11] Prepayment of the loan – when the borrower pays the loan back before it reaches term – may incur penalties, depending on the program.[13] In addition, if interest rates have dropped since the reverse mortgage was signed, the mortgage terms may include an "'interest-rate differential' penalty."[13]

If the borrower lived long enough that the principal and interest together exceed the fair market value when the mortgage is due, the borrower or heirs do not have to pay more than the house's value at the time.[10]

Origin of reverse mortgages in Canada[edit]

In 1986 William Turner, a Vancouver, BC based chartered accountant founded the Canadian Home Income Plan (CHIP) Corporation.[14] CHIP became Canada's first national provider of reverse mortgages.

United States[edit]

Eligibility[edit]

To qualify for a reverse mortgage in the United States, the borrower must be at least 62 years of age and must occupy the property as his or her principal residence.[15] In addition, any mortgage on the property must be low enough that it will be paid off with the reverse mortgage proceeds.[16] Reverse mortgages follow FHA eligibility standards for property types, meaning most 1–4 family dwellings, FHA approved condominiums, and PUD's qualify.[17] Manufactured housing qualifies based on standard FHA guidelines.

Before starting the loan process for an FHA/HUD-approved reverse mortgage, applicants must take an approved counseling course.[18] The counseling is meant to protect borrowers, although the quality of counseling has been criticized by groups such as the Consumer Financial Protection Bureau.[1]

In a 2010 survey in the United States, 48% of seniors cited financial difficulties as the primary reason for obtaining a reverse mortgage and 81% of seniors stated they would like to stay in the home in which they are currently living for the rest of their lives.[19]

On March 2nd 2015 FHA will implement its financial assessment for Reverse Mortgages. For those who are assigned a case number on or after March 2nd 2015 you will be subject to the financial assessment. A case number is assigned to a borrower by FHA so that lenders can identify them. The financial assessment means lenders will now be required by FHA to do a much more comprehensive credit, income and asset underwriting. Lenders will look at things like "late payments" on credit reports or unpaid property taxes etc and determine what they call a "willingness to pay." Borrowers who show that they have not in the past had a “willingness to pay” bills on time, for example, will see "set asides" for items like property taxes and homeowners insurance.[citation needed]

Loan size[edit]

The gross amount of money that a borrower can receive under a HECM reverse mortgage (i.e., a reverse mortgage insured by the federal government) is called the principal limit. The principal limit is based on the maximum claim amount, the age of the youngest borrower, and the expected average interest rate. The maximum claim amount is equal to the appraised value of the home or the maximum amount HUD will insure, whichever is less. At least through December 14, 2014, the maximum amount HUD will insure is $625,500.[20] The maximum claim amount is multiplied by a principal limit factor to determine the principal limit. Principal limit factors are determined by HUD and are based on the borrower's age and the expected average rate of interest.[21] The table below gives some examples of what the initial principal limit will be if a home is worth $250,000 and for borrowers of different ages and with different expected average rates of interest.

Borrower’s Age at OriginationExpected Mortgage Interest RatePrincipal Limit Factor (as of Aug. 4, 2014)[22]Initial Principal Limit Based on a MCA of $250,000
655.5%0.478$119,500
657.0%0.294$ 73,500
755.5%0.553$138,250
757.0%0.373$ 93,500
855.5%0.644$161,000
857.0%0.479$119,750

Loan costs and existing liens may be paid from the principal limit. Other amounts for items such as taxes and insurance may also be subtracted from the principal limit. The result after subtracting these amount is the net principal limit. This is the amount the borrower can actually convert to cash.

Interest Rate[edit]

Interest rates on reverse mortgages may be fixed or adjustable. Prior to 2007, all major reverse mortgage programs had adjustable interest rates. Adjustable rate reverse mortgages are typically adjusted on a monthly or annual rate up to a maximum rate. The note rate (or accrual) rate is used to calculate the interest added to the loan balance each month. The note rate may be different from the expected average interest rate used to determine the available loan proceeds.

Proceeds from a reverse mortgage[edit]

Cash from a reverse mortgage[edit]

The most common reverse mortgage is one in which the owner receives cash or a credit line from an existing home. The money from a reverse mortgage can be distributed in several different ways:[18][23]

Purchase of a new residence with "HECM for Purchase"[edit]

The Housing and Economic Recovery Act of 2008 provided HECM mortgagors with the opportunity to purchase a new principal residence with HECM loan proceeds — the so-called HECM for Purchase[24] program, effective January 2009. The "HECM for Purchase" applies if "the borrower is able to pay the difference between the HECM and the sales price and closing costs for the property.[18] The program was designed to allow seniors to purchase a new principal residence and obtain a reverse mortgage within a single transaction by eliminating the need for a second closing. Texas was the last state to allow for reverse mortgages for purchase.[25][26]

Total Annual Loan Cost[edit]

The Truth in Lending Act requires lenders to disclose the Total Annual Lending Cost (TALC) for reverse mortgages. The TALC calculation should allow borrowers to compare the costs of the reverse mortgage from one lender to another. The specific formulas to calculate the impact of the factors listed above can be found in Appendix 22 of the HUD Handbook 4235.1.[27]

Taxes and insurance[edit]

Unlike common practice in a standard mortgage, funds for taxes and insurance are not typically paid out of an escrow fund; they are paid directly by the homeowner.[28] A lapse in either taxes or insurance could result in a default on the reverse mortgage.

The American Bar Association guide[29] advises that generally,

The money received from a reverse mortgage is considered a loan advance. It therefore is not taxable and does not directly affect Social Security or Medicare benefits. However, an American Bar Association guide[29] to reverse mortgages explains that if borrowers receive Medicaid, SSI, or other public benefits, loan advances will be counted as "liquid assets" if the money is kept in an account (savings, checking, etc.) past the end of the calendar month in which it is received; the borrower could then lose eligibility for such public programs if total liquid assets (cash, generally) is then greater than those programs allow.[30]

When the loan comes due[edit]

The loan comes due when the borrower dies, sells the house, or moves out of the house for more than 12 consecutive months.[31] The loan may also be declared due and payable if the borrower fails to pay property taxes or fails to maintain hazard insurance on the property. Once the mortgage comes due, the borrower or heirs of the estate have an option to refinance the home and keep it, sell the home and cash out any remaining equity, or turn the home over to the lender. If the property is turned over to the lender, the borrower or the heirs have no more claim to the property or equity in the property.

The lender has recourse against the property, but not against the borrower personally and not against the borrower's heirs. Thus the mortgage is within the category known as "non-recourse limit".

Volume of loans[edit]

Home Equity Conversion Mortgages account for 90% of all reverse mortgages originated in the U.S. As of May 2010, there were 493,815 active HECM loans.[32] As of 2006, the number of HECM mortgages that HUD is authorized to insure under the reverse mortgage law was capped at 275,000.[33] However, through the annual appropriations acts, Congress has temporarily extended HUD's authority to insure HECM's notwithstanding the statutory limits.[34]

Program growth in recent years has been very rapid. In fiscal year 2001, 7,781 HECM loans were originated. By the fiscal year ending in September 2008, the annual volume of HECM loans topped 112,000 representing a 1,300% increase in six years. For the fiscal year ending September 2011, loan volume had contracted in the wake of the financial crisis, but remained at over 73,000 loans that were originated and insured through the HECM program.[35]

Loan volume is expected to grow further as the U.S. population ages. The U.S. senior population is expected to increase from 35 million in 2000 to 64 million in 2025, and seniors are expected to make up a larger share of the population.[36]

Criticism[edit]

Reverse mortgages have been criticized for several major shortcomings:

See also[edit]

References[edit]

  1. ^ a b c d e f "Reverse Mortgages: Report to Congress". Consumer Financial Protection Bureau. Retrieved 1 January 2014. 
  2. ^ "Reversing the Trend: The Recent Expansion of the Reverse Mortgage Market". Real Estate Economics. Retrieved 1 January 2014. 
  3. ^ Chen, Y-P. Unlocking home equity for the elderly (Ed. with K. Scholen). Cambridge, MA: Ballinger, 1980.
  4. ^ a b "Getting advice". National Information Centre on Retirement Investments Inc (NICRI). Retrieved 12 September 2012. 
  5. ^ a b c d e f g h i j k l m n o p q r "Reverse Mortgages". National Information Centre on Retirement Investments Inc (NICRI). Retrieved 12 September 2012. 
  6. ^ a b "Equity Unlock Loan for Seniors". Commonwealth Bank of Australia. Retrieved 13 September 2012. 
  7. ^ a b c "Features". Commonwealth Bank of Australia. Retrieved 13 September 2012. 
  8. ^ a b c d e "Rates & fees". Commonwealth Bank of Australia. Retrieved 13 September 2012. 
  9. ^ a b "Impacts on your pension". National Information Centre on Retirement Investments Inc (NICRI). Retrieved 12 September 2012. 
  10. ^ a b c d e f g h i j k l m n "Reverse Mortgages: How the Strategy Works". Canada Mortgage and Housing Corporation. Retrieved 11 September 2012. 
  11. ^ a b c d e f "Home Income Plan (Reverse Mortgage in Canada): How Does a Canadian Reverse Mortgage Work". Origin Mortgages DLC. Retrieved 12 September 2012. 
  12. ^ a b c d e f g h i j "ABCs of CHIP". CHIP Home Income Plan Provided by HomEquity Bank. Retrieved 12 September 2012. 
  13. ^ a b c d e Heinzl, John (31 October 2010). "The reverse mortgage quandary". The Globe and Mail. Retrieved 12 September 2012 
  14. ^ http://media.nrmlaonline.org/rma/RMAwinter99.pdf
  15. ^ 12 U.S.C. § 1715z-20(b)(1); 24 C.F.R. § 206.33.
  16. ^ 12 U.S.C. § 1715z-20(b)(4)
  17. ^ 12 U.S.C. 1715z-20(d)(3).
  18. ^ a b c "FHA's Home Equity Conversion Mortgage Program". United States Department of Housing and Urban Development. 14 October 2010. Retrieved 11 September 2012. 
  19. ^ a b "Interesting Reverse Mortgage Facts". Retrieved 2014-07-03. 
  20. ^ Pub. L. No. 111-88, § 168 (2009); HUD Mortgagee Letter 2013-43 (Dec. 6, 2013).
  21. ^ Principal limit factor tables are available at http://www.hud.gov/offices/hsg/sfh/hecm/hecmhomelenders.cfm
  22. ^ HUD Mortgagee Letter 2014-12 (June 27, 2014)
  23. ^ "How Reverse Mortgages Work". AARP.com. March 2010. Retrieved 11 September 2012. 
  24. ^ http://www.fhasecure.gov/offices/hsg/sfh/hecm/faqs_hecm.cfm
  25. ^ Ecker, Elizabeth (2013-11-06). "Texas Votes "Yes" to Allow Reverse Mortgage For Purchase Product". Retrieved 2014-01-10. 
  26. ^ Sheedy, Rachel L. (January 2013). "Buy a Home With a Reverse Mortgage". Kiplinger's Retirement Report. Retrieved 2014-01-10. 
  27. ^ Department of Housing and Urban Development. HUD Guide. Appendix 22. 
  28. ^ Coates, Tara (11 February 2011). "10 Things You Should Know About Reverse Mortgages: Before you sign, make sure you know about restrictions, fees". AARP.com. 
  29. ^ a b Reverse Mortgages: A Lawyer's Guide. American Bar Association. 1997. 
  30. ^ "Information on Reverse Mortgages". AARP. 
  31. ^ 12 U.S.C. § 1715z-20(j).
  32. ^ See Home Equity Conversion Mortgages Monthly Report (May 2010), http://www.hud.gov/offices/hsg/comp/rpts/hecm/hecmmenu.cfm
  33. ^ Pub. L. No. 109-289, s. 131 (2006).
  34. ^ See for example the Omnibus Appropriations Act, 2009, Pub. L. No. 111-8, s. 217 (Mar. 11, 2009).
  35. ^ For HUD's HECM Summary Reports, see http://www.hud.gov/pub/chums/f17fvc/hecm.cfm
  36. ^ U.S. National Population Projections (2008) at tables 2 and 3, http://www.census.gov/population/www/projections/summarytables.html
  37. ^ a b Santow, Simon (25 May 2011). "Reverse mortgages grow, but so do warnings". Australian Broadcasting Corporation (ABC). Retrieved 12 September 2012 
  38. ^ "Report to Congress on Reverse Mortgages". June 2012. Retrieved 12 September 2012 .
  39. ^ Hallman, Ben (27 June 2012). "Reverse Mortgage Foreclosures On The Rise, Seniors Targeted For Scams". Huffington Post. Retrieved 12 September 2012. 
  40. ^ "Reverse Mortgages Are Not the Next Sub-Prime". http://www.mtgprofessor.com. 

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