What are the 3 types of reverse mortgages?
Learn how each of the three types of reverse mortgages works, and what makes each option unique.
Most seniors experience income reduction when they retire, and they may struggle to keep up with the increasing cost of living. A reverse mortgage can help you supplement your retirement income. You can also use the reverse mortgage to pay off your mortgage, pay healthcare costs, and other ongoing expenses.
The three types of reverse mortgages include Home Equity Conversion Mortgage (HECM), Proprietary Reverse Mortgage, and Single-Purpose Reverse Mortgage. HECMs are federally-insured and are regulated by the Department of Housing and Urban Development (HUD), while Proprietary reverse mortgages are offered by private lenders, and they are available to homeowners who want more money than the HECM limit. Single-purpose reverse mortgages attract the lowest fees, and they are offered by state, local, and non-profit agencies.
What is a reverse mortgage?
A reverse mortgage is a type of mortgage that allows homeowners to tap into their home equity without selling the home. The reverse mortgage lender pays the homeowners in lump-sum payments or multiple payments spread over time, and you will not need to pay back the loan as long as you live in the home and pay the required financial obligations like property taxes and homeowner insurance.
However, you will be required to pay the reverse mortgage in full, including the loan principal, interest, and other fees, when you move out or die. If you or the deceased’s estate sell the property, they must pay the mortgage in full from the sale proceeds. If the deceased’s estate wants to retain the property, they must pay the full reverse mortgage amount from other sources. They can also turn the property over to the lender to pay the debt.
Types of reverse mortgages
The three types of reverse mortgages available to homeowners include Home Equity Conversion Mortgage, proprietary reverse mortgage, and single-purpose reverse mortgage.
These mortgages are explained in detail below:
Home Equity Conversion Mortgages
Home Equity Conversion Mortgages (HECM) are insured by the federal government, meaning they are backed by the HUD. They are the most common type of reverse mortgages, and they are preferred because they do not have income limitations or medical requirements. HECMs are available to homeowners who are 62 or older, and they must either fully own their home, or have paid a big portion of their mortgage.
HECMs are ideal for homeowners on a fixed retirement income who need to access the equity in their homes to pay ongoing expenses. For example, if you solely rely on Social Security or state pension, and you don’t have other retirement assets, you can use a HECM to convert the accumulated home equity into cash, and use the money for any purpose.
However, before you apply for a HECM, you must undergo counseling with HUD. The counseling session helps ensure that the homeowner is fully aware of the mortgage costs, payment options, and responsibilities during the loan term. They are also briefed on alternative mortgage options if they are eligible. After undergoing counseling, you can find out how much you can borrow; the amount you receive may be determined by your age, home value, and current interest rates.
Proprietary Reverse Mortgages
Proprietary reverse mortgages are backed by private lenders, and they are not regulated by the HUD or the Federal Housing Administration. This reverse mortgage does not require borrowers to undergo counseling before applying for a reverse mortgage, but some lenders may require it.
A proprietary reverse mortgage is preferred by homeowners who want more money than the HECM limit, and whose homes have higher appraised values. For 2022, you may qualify for a proprietary reverse mortgage if the value of the property is greater than the lending limit of $970,800 for HECMs.
Since this type of reverse mortgage is not federally insured, you won’t be required to pay monthly mortgage insurance premiums. However, you should still consider the lender’s interest rate and how much you are eligible to borrow, compared to the reverse mortgage terms you will get from HECM lenders.
When compared to HECMs, proprietary reverse mortgages have higher fees and interest rates, to compensate for the lack of government insurance, which HECM provides.
Single-Purpose Reverse Mortgages
A single-purpose reverse mortgage is offered by state and local governments, as well as non-profit agencies. It is the least expensive reverse mortgage option.
You can borrow a single-purpose reverse mortgage if you need to pay a one-time expense such as a home renovation or property taxes. If another expense arises, you will have to originate a new loan or restructure the reverse mortgage. Since only a small amount of home equity is used, this type of reverse mortgage is ideal for homeowners with low to moderate incomes.
Drawbacks of getting a reverse mortgage
When you take a reverse mortgage, you will be required to pay various costs, or you can choose to wrap these costs into your loan balance. Some of the associated costs include loan origination fees, interest, servicing fees, counseling fees, and insurance fees. If you add these fees to your loan balance, it means you will have an even bigger debt to pay and less equity.
No interest deduction
If you have a traditional mortgage loan, the mortgage interest you pay is tax deductible up to a certain limit. However, with a reverse mortgage, you won’t be able to deduct the mortgage interest until you have paid off the loan.
If you fail to keep the property taxes and homeowner insurance current or fail to keep the property in good repair with routine maintenance, your home can be foreclosed. Foreclosure may also occur if you move out of your home involuntarily (such as when you move to a nursing home), and the reverse mortgage becomes due.