Reverse Mortgage Part #1: The Basics
Posted on May 2, 2016 by bob in MoneyWise
No doubt you have heard of reverse mortgages, perhaps courtesy of celebrity advertising on TV. The reason these 
instruments get so much attention is that many older Americans have significant home equity but insufficient other resources to meet their needs in retirement. Reverse mortgages are a way to access home equity while still living in the house. This month we’ll examine the basic provisions of FHA-insured reverse mortgages, formally known as Home Equity Conversion Mortgages (HECMs).
An HECM is a non-recourse loan—the only collateral available to the lender is the house that has been mortgaged. Many older individuals and couples who own a home may use an HECM.
An HECM may be used when:
1. The homeowner has no existing mortgage;
2. The homeowner has an existing mortgage that will be replaced by the HECM;
3. The borrower buys a house for his primary residence.
HECM Requirements
1. The collateral property must be:
a. A single-family home, including a manufactured home meeting FHA requirements;
b. A HUD-approved condominium;
c. A multi-family structure consisting of no more than four units, with one unit occupied by the owner.
2. The collateral must be the primary residence of the borrower(s) at the time of the application and they must be living there. In the case of an HECM for Purchase, borrowers must take occupancy within 60 days of closing.
3. The HECM must be the only mortgage on the home.
4. All borrowers must be 62 or older at the time of loan approval. If a married couple owns the property and only one is 62 or older, that spouse may apply for an HECM singly.
5. The borrower must pay the property taxes, keep adequate insurance on the property, maintain the home, and pay ancillary costs such as condominium or homeowner association fees.
6. Borrowers must complete HUD-approved counseling and undergo a financial assessment before HECM approval.
How an HECM Works
An HECM borrower will incur the usual closing costs associated with a new mortgage. Most of these can be paid as a draw against the HECM. Not all lenders have the same charges, so it pays to shop around.
HECM borrowers must pay for FHA Mortgage Insurance to protect the lender from losses if the value of the home is less
than the mortgage balance when the mortgage is finally paid off. The initial mortgage insurance premium (MIP) is part of the closing costs and is calculated as a percentage of the Maximum Claim Amount (MCA). The MCA is the lesser of the home value at closing or the FHA maximum of $625,500. If the borrower takes more than 60% of the maximum available loan in the first year, the initial MIP will be 2.5% of the MCA. Otherwise the initial MIP is 0.5% of the MCA. The interest rate on the loan will also include a 1.25% annual MIP charge on the loan balance.
The maximum available loan, which depends on the MCA, the age of the youngest borrower, and the loan interest rate, is usually about half of the MCA.
The amount actually disbursed during year one, however, is generally limited to the greater of 60% of the maximum available loan, or the sum of the “mandatory obligations” (e.g., closing costs, initial MIP, funds to pay off existing mortgage or make required repairs, etc.) plus 10% of the maximum available loan.
With fixed rate HECMs, the loan is limited to the amount advanced at closing. With variable rate HECMs the borrower can usually withdraw in future years the portion of the maximum available loan not accessed in year one (similar to a line of credit).
The maximum available loan will increase annually by the rate charged on the outstanding balance, including the MIP. No loan payments are required during the borrowers’ lives, so the loan balance will typically grow each month by the interest rate plus the MIP plus any additional funds distributed to the borrower.
Next month we will look at some problems that have affected people who have used reverse mortgages or inherited homes encumbered by one.
Alan Wallace
Alan Wallace, CFA, ChFC, CLU, is a Senior Private Wealth Advisor for Ronald Blue & Co.’s Montgomery office, www.ronblue.com/location-al. He can be reached at 334-270-5960, or by e-mail at alan.wallace@ronblue.com.
