Reverse Mortgages: Myth vs Reality
Listed below are some common reverse mortgage myths along with a brief explanation of the reality.
M: You must own your home free and clear to qualify for a reverse mortgage.
Reality: A 62-year-old homeowner needs to have a minimum loan-to-value (LTV) ratio of approximately 45%, and a 95-year-old can be up to approximately 75% LTV (precise LTVs are calculated based on borrower’s actual birthdate).
M: Under the conditions of a reverse mortgage contract, the lender owns the property.
Reality: Just like a conventional mortgage, a reverse mortgage is a loan, and the borrower keeps the title to the property. Eventually, the property may be sold in order to repay the mortgage, but at no point while the reverse mortgage is outstanding does the lender own the property.
M: The lender can evict the borrower or spouse if one of them dies, or the home value decreases.
Reality: The only reason that a borrower can be evicted is if he doesn’t adhere to the rules of the loan — maintaining the home and paying obligatory insurance, interest and property tax payments.
M: A reverse mortgage must be repaid in monthly installments.
Reality: Unlike a conventional mortgage, a reverse mortgage is repaid only when the loan is due — typically when the borrower moves out or passes away. In addition, interest will continue to accumulate for as long as the loan remains outstanding. However, you can make payments if you choose to do so. There are no prepayment penalties — Make monthly interest payments, sell, or pay off at any time.
M: To qualify for a reverse mortgage, you need to meet certain credit and income requirements.
Reality: This is partially true, but needs some explanation. The lender will look at your credit but not your scores. They will also review the following:
- Income documents
- Property tax payment history (prior 24 months)
- Property insurance payment history (prior 24 months)
If you don’t have enough residual income the lender may require a “set aside” account to cover taxes and insurance.
M: Once a reverse mortgage is approved, all of the funds are dispensed to the borrower.
Reality: This is partially incorrect. The borrower only pays on what is drawn and the credit line grows if not used. The borrower only pays on what is drawn and the credit line grows if not used (funds grow at the rate of the credit line growth rate).
M: If the home is ever sold due to death or relocation, any equity remaining after the reverse mortgage has been repaid go to the lender.
Reality: When the home is sold, any difference between the sale price and the unpaid mortgage balance is distributed to the borrower, heirs, or estate.
M: If the home depreciates and the borrower owes more than the home is worth (underwater), the borrower is liable for the difference.
Reality: Reverse mortgages are non-recourse loans. Meaning the lender is legally prevented from seeking any deficiency judgment against the borrower regardless of what happens to the value of the property. The estate (immediate family) can purchase the home at 95% of the appraised value at loan maturity, regardless of what is owed.
M: Reverse mortgage loans are approved and serviced by the U.S. government.
Reality: Reverse mortgage loans are not a government benefit, nor are they processed by the government. The government’s role (via HUD and the FHA) is to insure reverse mortgages against default.
M: It is the responsibility of the lender to pay homeowners insurance and property taxes.
Reality: The lender does not pay these fees. In fact, the borrower’s ONLY financial responsibilities are to pay homeowners insurance and property taxes, and maintain the property in accordance with the law. Failure to fulfill these obligations could trigger a violation in the terms of the loan, and even lender foreclosure.
M: There are strict rules that specify how reverse mortgage funds can be used.
Reality: Proceeds from a reverse mortgage can be used freely by the borrower for any purpose. While foolish spending is never advisable, it’s technically the borrower’s right to do so.