When I was a young boy, my parents took my brother and I on a vacation. I was pretty little, so I don’t remember much about the trip. I know we traveled on an airplane, but I have no recollection of where we went, what we did, or who we saw. What I do remember, however, is a passing moment on the trip home.
It’s funny how the mind works, right? It often remembers insignificant things and forgets the more important details. I remember my mom telling me as we boarded the plane that we were “flying home.” I still remember all these years later how the idea of flying home puzzled me.
When we drove home, we always pulled up in front of our house, got out of the car, and went inside through the garage. I assumed flying home would work the same way. I still vividly remember imagining our street after dark (we were flying at night) and the airplane pulling up in front of our house and dropping us off.
Like usual, we would get out and go inside through the garage. I wasn’t sure how an airplane could land on our street, but surely my mom knew what she was talking about, right?
Obviously, I had some misconceptions about what it meant to “fly home.” Children often have misconceptions because they have limited life experience and tend to take things literally. I see this with my own children.
However, adults commonly have misconceptions as well.
We often believe certain “truths” because we’ve always heard them and have never had reason to believe otherwise. This is true of reverse mortgages, too!
Many accepted “truths” about reverse mortgages are, in fact, misconceptions. Even reputable pundits, bloggers, and journalists constantly get it wrong about reverse mortgages.
I’ve been in the reverse mortgage industry for a number of years, and I’ve heard it all. I’d like to set the record straight on some of the most common misconceptions you may have heard. Some of you may have avoided a reverse mortgage because of the rumors you’ve heard. Frankly, if half the rumors were true, I would avoid a reverse mortgage too!
Now, before we dig in, let me first point out that the reverse mortgage I’ll be discussing here is the FHA-insured and regulated Home Equity Conversion Mortgage, or HECM (often pronounced heck-um by industry insiders).
The HECM is the most common reverse mortgage in the United States today. If a friend, relative, or neighbor got a reverse mortgage, it’s very likely they got a HECM.
Despite decades of educational efforts by housing counselors, reverse mortgage lenders, and industry groups, the reverse mortgage still carries a stigma. Many people think it should only be pursued as a last resort.
In reality, broke and desperate people often don’t qualify because they have limited income and/or severely damaged credit.
The reverse mortgage is best used as a safety net, not a lifeboat. The idea is to add home equity to the retirement funding picture so you can live a more enjoyable and financially secure retirement. If you’re in need of a financial lifeboat, your circumstances may already be too dire to qualify.
The best candidates are seniors who are at least reasonably financially stable. And the best time to apply for a reverse mortgage is before you desperately need it. After all, it’s pretty hard to get insurance on a house that’s already burning down, right?
Contrary to the stigma, many wealthy seniors take advantage of a reverse mortgage. I did a reverse mortgage a few years ago for a gentleman who had a $5 million net worth. He didn’t need the reverse mortgage, but it offered him additional cash management options he wouldn’t otherwise have.
The HECM is simply a home loan. You always remain the owner of your home, and you’re free to leave it to your heirs. Your heirs will inherit any equity remaining in the home whether they choose to keep it (they’ll have to pay off or refinance the loan balance), sell it, or let the lender sell it.
There is no purchase contract or sales agreement in the closing paperwork. Like a traditional “forward” mortgage, the closing paperwork contains a Note (the “promise to pay”) and a Deed of Trust or Mortgage, depending on your state.
The Note is the “IOU” and the Deed of Trust or Mortgage secures the debt to the home. This is how it works for both traditional “forward” mortgages and reverse mortgages.
A key requirement of the HECM is to live in the home and pay the property taxes and insurance. If the bank owned your home, it would be paying the property taxes instead of you, right?
The HECM is a home loan so, naturally, it comes with an interest rate. However, HECM interest rates are usually comparable to traditional 30-year fixed mortgage rates.
The reverse mortgage is a non-recourse loan. The most that will ever have to be repaid is the value of the home. If the home isn’t worth enough to pay off the entire loan balance, FHA will cover the shortage.
If your heirs wish to keep the home, they’ll need to pay off or refinance the loan balance. If they prefer to sell, they can hire a real estate agent or sell the home on their own. Once the sale is complete, the reverse mortgage is paid off through closing, and your heirs keep the remaining equity.
If your heirs don’t want to keep the home or mess with selling it, they can let the lender sell it. Any remaining equity will go in their pocket once the sale is complete.
Reverse mortgage closing costs can be high, but not always. There’s a little more nuance to this topic than the rumors would imply.
First of all, it’s important to understand that all mortgages have closing costs that can add up to thousands of dollars. The key question is this: Who pays the closing costs?Does the lender pay them? The borrower? Or is it a combination of both?
You’ve probably heard of so-called “zero cost” or “no cost” traditional “forward” mortgages. Lenders offer such loans by charging a slightly higher interest rate and paying closing costs for you with a lender credit.
Lenders can only do this when the starting loan amount generates enough interest to justify offering a lender credit.
For example, a $250,000 traditional “forward” mortgage at 4% generates almost $10,000 worth of interest in just the first year. It’s relatively easy for a lender to pay all or most of your costs when they’re earning that kind of interest on the loan balance.
A reverse mortgage, on the other hand, tends to start with a relatively small loan balance, as it is only workable when you owe relatively little (or nothing at all) on your home.
For example, a reverse mortgage with a $25,000 starting loan balance will generate less than $1,000 worth of interest in the first year. When closing costs add up to thousands of dollars, it’s no wonder reverse mortgage lenders can’t absorb them.
They have to pass the closing costs on to the borrower, which means the costs are typically rolled into the starting loan amount. This contributes to the perception that reverse mortgages have high fees.
Now, having said that, there are some situations where reverse mortgage lenders can pay all or part of your closing costs. I’ve done plenty of “no cost” reverse mortgages over the years.
For example, if you’re using the reverse mortgage to pay off a large existing mortgage balance, the lender may be able to cover all or part of your closing costs. Again, a larger loan balance generates more interest, which makes it easier for reverse mortgage lenders to cover closing costs.
It’s true that the reverse mortgage is best suited for people who don’t plan to sell anytime soon. However, there is no prepayment penalty or limitation on selling.
Selling works just like it would for any other mortgage: you hire a real estate agent, sell the home, and the loan balance is paid off through closing. Any remaining equity goes to you.
I hope this cleared up some concerns you may have had about reverse mortgages. Perhaps you even feel a little less apprehensive about them now. That’s my goal!
I’ll be the first to acknowledge that a reverse mortgage is not perfect for everybody, but it’s a fantastic product for the right candidate. In the weeks and months ahead, I’ll be writing more about how reverse mortgages really work, who should and shouldn’t get one, pitfalls to avoid, etc.
What do you know about reverse mortgages? Have you applied for one? Are there any negative rumors you’ve heard about reverse mortgages that I didn’t address here? If so, please leave them in the comments!