Jeff Cooper, NMLS #18242 | Phone: 301-529-8289 | E-mail: Jeff@JeffreyCooper.com
The largest source of wealth for most retirees is their home. At the same time, low rates on savings and longer life expectancies have sent retirees scrambling for new sources of income. Enter the new reverse mortgage!
The newly restructured Reverse Mortgage (HECM) allows homeowners to convert their home equity into cash. The Federal Housing Administration, which insures home equity conversion mortgages (or HECMs), as reverse mortgages are formally known, has made rule changes that have reduced the cost of these products and the risk to borrowers.
One of the new rules requires a financial assessment to ensure that borrowers have enough money to pay ongoing costs (taxes, insurance, and HOA or Condo fees). The amount of equity immediately available has also been limited, but so has the up-front cost of mortgage insurance that borrowers are required to pay.
Reverse mortgages offer flexibility to help make other retirement resources last longer. You can continue living in your home or buy your next one (Reverse For Purchase) without a monthly mortgage payment. You could take monthly payments to supplement your income and defer taking Social Security until age 70, when you’ll qualify for the maximum payout, or substitute those payments for an annuity.
One of the biggest risks in retirement is that a market downturn could force you to sell investments at a loss to maintain income. With a HECM line of credit, you could make withdrawals when the market is down and, when your portfolio has regained value, sell investments to replenish the line.
The Basics of a Reverse Mortgage:
A reverse mortgage lets you convert your home’s equity into a lump sum or a line of credit. You don’t make principal and interest payments to repay the loan; withdrawals accumulate and interest on them accrues until the loan is due – usually after you or your heirs sell the home.
To be eligible for a HECM, borrowers must be at least 62 years old. The maximum payout, or principal limit, for which you’ll qualify depends on your age (or that of a younger co-borrower or a nonborrowing spouse), the current interest rate, and the appraised value of your home, up to a maximum of $625,500. The older you are, the lower the interest rate and the higher your home’s value, the greater the initial maximum payout.
You can withdraw up to 60% of your principal limit in the first year, unless you need more to pay off a mortgage or make repairs required by the lender. At closing, you’ll pay an initial mortgage insurance premium equal to 0.5% of the appraised value of the home if you take 60% or less in the first year, or a 2.5% premium if you take more than 60%.
Interest charges and annual mortgage premiums (at a rate of 1.25% of the amount you borrow) will accrue on any outstanding balance—though no principal or interest payments are due until the home is sold. The interest rate on lump-sum payouts is fixed — a typical rate is 5.06%. Monthly payouts or draws from a line of credit will have variable rates (recently ranging from 3.1% to 4.1%).
You may also pay a lender’s origination fee and fees for third-party services (such as an appraisal or inspection), plus closing costs, which can run $1,000 to $2,500 or more. You can pay up-front costs out of pocket or from the loan proceeds.
Lump sum or line of credit? You can take the money up front in a single payment and lock in a fixed rate, but if you do, that’s all you get. Some borrowers choose this option to eliminate debt or buy their next home, and it preserves a chunk of home equity for heirs. Or you can take a series of monthly payments or a line of credit, or some combination.
A line of credit offers the most flexibility, allowing you to tap 100% of your principal limit within the first two years. And right now, interest rates remain low; the lower your rate, the more you can borrow.
If you don’t need the money immediately, consider the reverse mortgage with a stand-by line of credit as soon as you’re eligible. That’s because the amount of credit available to you will grow over time, and you can take advantage of the higher credit line if you need money later to pay long-term-care bills or wait out another market downturn.
This is where reverse mortgages get counterintuitive. Your untapped credit line increases as though interest and mortgage insurance premiums were being applied to the balance, even though you don’t pay interest or insurance on money you don’t tap. Plus, if the variable interest rate increases over time, so does the rate of growth of your available credit.
For example, say that you had $400,000 in equity in a $500,000 home and you qualified for an initial credit line of $165,014 at 4.1% interest. Over 10 years, if you took no withdrawals and the interest rate never rose, your available credit would grow to $279,938. If you plan to preserve your available credit for as long as possible to maximize its growth — rather than tap your equity immediately — look for the highest interest rate you can get for the lowest up-front cost.
Although you’ll no longer make a monthly mortgage payment, you must maintain your home and pay property taxes, hazard insurance premiums and homeowners association or condo dues, or you’ll risk defaulting on the loan. If the lender determines that you can’t handle those costs, it will set aside funds from your payout in an escrow account and pay those bills.
The money you receive will be tax-free. It won’t affect what you pay for Medicare, how your Social Security benefits are taxed or your eligibility for Medicaid. You or your heirs can deduct interest on the first $100,000 of indebtedness when the loan is repaid.
The loan becomes due and payable when the last surviving borrower sells the home, leaves for more than 12 months due to illness, or dies. Lenders must allow a nonborrowing spouse or committed partner to stay after the borrower dies.
You’ll never owe more than the value of your home when you or your heirs sell it to repay the reverse mortgage, and you can keep any leftover equity. If your heirs want to keep the home, they can refinance the reverse mortgage, or they can pay the outstanding debt or 95% of the home’s appraised value, whichever is less.
For more information or to set up an appointment, call Jeff Cooper at 301-529-8289