REVERSE MORTGAGE LOANS

What is a Reverse Mortgage Loan?

One way for you to potentially improve your cash flow during retirement is to use a home equity conversion mortgage (also known as a “HECM” or “reverse mortgage”).

The HECM is a mortgage loan made by a private lending institution such as a bank, credit union or mortgage company.  The loan is insured by the Federal Housing Administration (FHA), which is a division of the US government.  You are not required to make monthly mortgage payments, and any interest that you owe is simply added to your loan amount.  Here’s how it works:

  • Assume you are 62 years old and your home is worth $500,000. You would likely qualify for a loan in the $250,000 range. So you’d still have about $250,000 of equity remaining in the home (see illustration above). The $250,000 can be used to pay off other debts and eliminate the payments associated with those debts. Or you could use the funds for any other reason.

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  • Your home would continue to go up or down in value, taking your equity position right along with it. However, the HECM balance would also be growing over time. So in this example, if the home goes up in value to $600,000, and the HECM balance grows to $350,000, your equity in the home would remain constant at $250,000. If you use the line of credit version of the HECM, the credit limit on your line of credit would increase every year. This would give you immediate access to your home equity at any time that you need it (see illustration below).

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  • In the worst case scenario, let’s assume the home doesn’t go up in value at all, and the HECM balance continues to grow throughout your lifetime. By the time you sell the home, assume the HECM balance is greater than the value of the property. In this example, the home would only be worth $500,000 and the HECM balance is $600,000, which is $100,000 more than the value of the home. The FHA would eat the loss. That’s the entire reason why the FHA charges mortgage insurance on the loan. The FHA mortgage insurance basically covers you and your estate from a potential negative equity scenario in the future (see illustration below).

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  • Before delving into four reasons a reverse mortgage might be appealing now, here are a few things to keep in mind: With a HECM, the total amount you can borrow will depend on your home’s appraised value (calculated on the value up to $625,000 but no higher), the youngest borrower’s age (one borrower must be 62 years old but a spouse may be younger), the lender’s margin (a fixed rate) and prevailing interest rates.

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The bottom line is that a HECM can be used to improve your cash flow and give you more financial options than you previously thought were available.