Reverse Mortgage

A reverse mortgage is a loan secured by a home that pays the homeowner rather than the reverse, and that requires no repayment of principal or interest for as long as the borrower occupies the property as a principal residence. Interest and charges accrue and are added to the balance, so the debt rises over time while the equity behind it falls. The loan becomes due and payable when the last surviving borrower dies, sells the home, or ceases to occupy it, and it can also become due if the borrower fails to meet the continuing obligations described below.

Most consumer discussion of reverse mortgages is really about one product. A home equity conversion mortgage is the version insured by the Federal Housing Administration under a program Congress authorized in 12 U.S.C. 1715z-20, and it accounts for the great majority of reverse mortgages made. It is the most common type of reverse mortgage rather than another name for one. The other two types are proprietary reverse mortgages, offered by private lenders without federal insurance and generally aimed at homes worth more than the insured program's limit, and single-purpose reverse mortgages, offered by some state and local government agencies and nonprofit organizations for a stated purpose such as home repairs or property taxes.

Eligibility, as the statute actually writes it. For the insured program, 12 U.S.C. 1715z-20(b)(1) defines an elderly homeowner as any homeowner who is, or whose spouse is, "at least 62 years of age or such higher age as the Secretary may prescribe." That trailing clause is not decoration: the threshold is a floor that the Department of Housing and Urban Development is authorized to raise, so it should be checked rather than assumed. Beyond age, the mortgage must be a first lien on a one-to-four-family dwelling in which the borrower occupies one unit, the borrower must complete counseling, and the lender must be approved. Lenders also run a financial assessment of the borrower's capacity and willingness to keep the property charges current, and can require a set aside from the proceeds to cover them, which is described below.

The counseling requirement is stronger than it sounds. Section 1715z-20(d)(2)(B) makes the mortgage ineligible for insurance unless the borrower has received adequate counseling from an independent third party who is not, directly or indirectly, associated with or compensated by anyone involved in originating or servicing the mortgage, funding the loan, or the sale of annuities, investments, long-term care insurance, or any other type of financial or insurance product. That last clause exists because reverse mortgage proceeds have historically been used to fund purchases of exactly those products, and Congress separated the adviser from the seller by statute. The counselor is also required to discuss options other than a reverse mortgage, including other housing, social service, health and financial options.

How much is available, and why it is less than the equity. The amount a borrower can draw is not the home's value. It is a principal limit derived from three inputs: the age of the youngest borrower or eligible non-borrowing spouse, an expected average mortgage interest rate, and the maximum claim amount, which is the lesser of the appraised value, the sale price, and the ceiling HUD will insure. The older the borrower and the lower the rate, the larger the proportion available, because the calculation is projecting how long interest will compound before the loan is repaid. Closing costs, an initial mortgage insurance premium and any required set aside come out of the same figure, and any existing mortgage must be paid off first, so a borrower with a remaining mortgage may find that most of the proceeds are consumed by it.

The costs are front-loaded and ongoing. The insured program charges an up-front mortgage insurance premium capped by regulation at a percentage of the maximum claim amount rather than of the home's value, and a periodic premium that accrues on the outstanding balance, both set by HUD, alongside origination charges, third-party closing costs and a servicing charge. The distinction matters for an expensive home: because the maximum claim amount is capped at the HUD ceiling, the premium is computed on that ceiling rather than on what the house would fetch. Because interest and the ongoing premium are added to the balance rather than paid, the cost compounds. The mirror image of that is what makes the product work for a household that stays: the same compounding is what allows the lender to wait, and the borrower never writes a check.

Four protections written into the statute. The loan is non-recourse: section 1715z-20(d)(7) requires that the homeowner not be liable for any difference between the remaining indebtedness and what the lender recovers from the net sale proceeds or from the insurance. Prepayment in whole or in part must be permitted without penalty at any time under (d)(4). The borrower chooses among a statutory menu of payment methods under (d)(9), which includes a line of credit, monthly payments for a term the borrower specifies, monthly payments for as long as the borrower occupies the home, and combinations of a line of credit with either, and may convert from one method to another during the loan. And the lender must give a series of disclosures: a list of approved counseling sources at application, a statement of the borrower's limited liability and their rights and obligations at least ten days before closing, a projection of the total cost expressed as an annual rate at more than one assumed appreciation rate and more than one assumed loan term, and an annual statement of principal advanced, deferred interest added, and the outstanding balance.

The obligations that remain are what cause most trouble. The borrower keeps title and therefore keeps the duties that go with it: property taxes, hazard insurance, any association dues or special assessments, keeping the property in repair, and occupying it as a principal residence. An extended absence, including a long stay in a care facility, can end the occupancy that the loan depends on. Failing any of these can make the loan due and payable while the borrower is still living, which is the scenario the product is usually assumed to prevent.

Two things soften and complicate that, and both are worth settling before signing. Based on a financial assessment of the borrower's capacity and willingness to keep the charges current, the lender may require a life expectancy set aside, a reserve carved out of the proceeds from which the lender pays property taxes and hazard and flood insurance. Note what it does not reach: ground rents, condominium fees, planned unit development fees and homeowners association dues stay the borrower's own obligation to pay directly, so a set aside does not insulate a borrower in a community with assessments. And where one spouse is not a borrower, the program defines an eligible non-borrowing spouse, being one who meets stated qualifying attributes, and a deferral period following the death of the last surviving borrower during which the loan does not become due while those conditions continue to be satisfied. Whether a particular spouse falls inside that definition turns on those attributes and on when the loan was made, so it is a question to settle in writing rather than afterward.

The sequence is: complete independent counseling, apply through an approved lender, have the home appraised, pay off any existing mortgage from the proceeds, choose a payment method, and then draw. Nothing is repaid until the loan becomes due, at which point the home is sold or the balance is paid from other funds, and any remaining equity belongs to the borrower or their estate.

A hypothetical example of how the balance behaves. Suppose a borrower draws $100,000 and the all-in cost of the loan, meaning interest plus the ongoing insurance premium and servicing charges, comes to a hypothetical 7 percent a year compounded annually. Nothing is repaid, so the balance grows by the same mechanism that an investment does. After ten years it is $100,000 multiplied by 1.07 raised to the tenth power, which is about $196,700, so the debt has very nearly doubled while the borrower has paid nothing. If the home appreciates more slowly than that rate, the equity behind the loan shrinks each year; if it appreciates faster, the equity grows despite the rising balance.

That single comparison is the whole trade. A household that stays in the home for many years is buying an income stream it never has to service, and the non-recourse feature caps the downside at the house. A household that moves after three or four years has paid substantial up-front costs to borrow money for a short period, and would almost always have done better selling or borrowing another way. Neither outcome is a defect in the product; the difference between them is the expected length of stay, which is the question worth settling first.

Pros

• No monthly payment is required while the borrower lives in the home, which converts an illiquid asset into cash flow without a sale and without a move.
• The insured loan is non-recourse, so neither the borrower nor the estate owes a shortfall beyond what the property is worth.
• The borrower keeps title, keeps any appreciation above the balance, and can prepay in whole or in part at any time without a penalty.
• The payment method is chosen from a statutory menu and can be changed later, so a line of credit can become monthly payments if circumstances change.
• Independent counseling is a condition of the insured product, and the counselor may not be paid by anyone selling the loan or a financial product.

Cons

• The balance compounds and the equity behind it generally falls, which reduces what is left for heirs or for a later move into assisted living.
• Up-front costs are substantial, so the effective cost per year is high for anyone who does not stay long.
• The continuing obligations are unchanged: taxes, insurance, dues and repairs are still the borrower's, and failing them can make the loan due while the borrower is still living there.
• An extended absence from the home, including a long stay in a care facility, can end the occupancy the loan depends on.
• A spouse who is not a borrower may be in a materially different position from one who is, and the rules governing that have changed over time.
• Proceeds are sometimes marketed alongside annuities and insurance products, which is precisely the pairing the counseling statute was written to separate.