By Harold Copher, Jr.
What is a reverse mortgage? A reverse mortgage is a special type of home loan that enables homeowners 62 and older to convert equity in their current residence into cash, a tenured payment or a line of credit that actually grows annually. However, many seniors don’t realize that a reverse mortgage can also be used to acquire a new property.
The only reverse mortgage insured by the U.S. Federal Government is called a Home Equity Conversion Mortgage (HECM), and is available exclusively through an FHA-approved lender. Unlike a traditional mortgage, HECM borrowers do not have to repay the reverse mortgage in monthly installments. Interest accrues on the mortgage over time and the balance is typically paid when the house is sold. Specifically, the loan becomes due when the borrowers no longer occupy the home as their principal residence.
As with a traditional mortgage, any equity remaining after paying the loan balance and settlement charges goes to the homeowner or their estate. When the last surviving spouse either passes away or no longer occupies the home as their principal residence, the borrower or their estate has several options. Most often, the heirs do not wish to keep the property so they have one year to sell the home, purchase it with conventional financing or cash, or simply put the keys in the mailbox and walk away with no obligation.
Note that all remaining equity goes to the borrower or their estate, not the lender! In the event that the property value is less than the accrued principal and interest on the loan, the heirs can choose to walk away. The FHA mortgage premium paid at closing ensures that the loan is non-recourse to all parties, including the heirs of the estate!
Although the first reverse mortgage was written in 1961, HUD issued the first HECM loan thru the FHA program in 1989. Since the program is managed by this government agency, the loan is federally insured. This is important since even if the HECM lender defaults, the loan is guaranteed.
Along with the minimum age and occupancy mandates, you must have sufficient income available to meet minimum residual income requirements. In Texas, the current residual income for a couple is $886 per month. FHA requires a financial assessment to determine the homeowners’ capability and willingness to remain current on obligations and ensure qualification. There must be a history of timely payments for property taxes, homeowner insurance premiums and HOA dues. These must also be kept current thoughout the life of the loan.
Counseling from a HUD-approved counseling agency is required for all reverse mortgages. The counselor will review other options available to the prospective borrower, including alternative housing, social service programs, property tax deferral programs, and the impact on the value of the estate to their heirs.
The equity available to the borrower is a function of their age and the market value of the property. In general, seniors can typically borrow between 50% and 60% of the value of the home up to FHA maximum loan limits.
Many seniors use the proceeds from the sale of their previous home and/or their investment assets to acquire the new home. By using a reverse mortgage for purchase, seniors can leverage their equity and purchase more home by bringing generally about 60% of the sales price to closing.
For example, if a senior sells their existing home and nets $200,000, they can use this as down payment on a new home selling for about $350,000. The result is they have no principal and interest payments moving forward! If the seniors are looking to downsize, they can use the HECM for purchase to pocket a large portion of their equity from their previous sale and eliminate any monthly P&I payments. This can be a great alternative to paying cash or using conventional financing.
So Harold, how do you use a HECM loan to purchase a new home? The answer is “very much like purchasing a home with a conventional mortgage.” The eligible homebuyer will provide the down payment, and then use the proceeds of the reverse mortgage to finance the remaining balance of the purchase price.