A reverse mortgage is a loan where the lender pays a homeowner (in a lump sum, a monthly advance, a line of credit, or a combination of all three) while he or she continues to live in the home. With a reverse mortgage, the homeowner retains title to the home.
Depending on the plan, a reverse mortgage becomes due with interest when the homeowner moves, sells the home, reaches the end of a pre-selected loan period, or dies. Because reverse mortgages are considered loan advances and not income, the amount received is not taxable. Any interest (including original issue discount) accrued on a reverse mortgage is not deductible until the loan is paid in full. The deduction may be limited because a reverse mortgage loan generally is subject to the limit on home equity debt. A lender commits itself to a principal amount, not to exceed 80 percent of the property’s appraised value.
Planning Point: Although available through the private sector the vast majority of reverse mortgage borrowers choose to use a Home Equity Conversion Mortgage (HECM), which are regulated by the Department of Housing and Urban Development (HUD) and only available through an approved Federal House Administration (FHA) lender.
1. How much money can a person expect to receive from a reverse mortgage?
Generally speaking, the higher the property value, the older the borrower(s), and the lower the current interest rates – the larger the loan. Although it is possible to find slight differences from lender to lender, most adhere to the four variables considered when calculating the maximum amount of a HECM Standard or HECM SAVER loan. These variables often include:
- The age of the borrower, or the youngest age of joint borrowers.
- The prevailing interest rates in the marketplace in which the loan is being written.
- The lesser of the appraised value or the maximum loan limit (presently set by HECM/FHA at $625,500) or the sales price of the home being purchased.
- The initial Mortgage Insurance Premium.
Unlike traditional mortgages where the loan to value (LTV) ratio is a significant feature, in a reverse mortgage there is no stated maximum. Unfortunately there is a general misunderstanding that the LTV ratio for a reverse mortgage is linked to the age of the borrower, leading many borrowers to believe that a 67-year-old would have an LTV ratio of 67 percent, a 70-year-old 70 percent, etc. In reality, the range for most LTV ratios is 50 to 65 percent of the home’s appraised value.
Planning Point: Another option available on reverse mortgages issued through the HECM/FHA for homeowners with appraised home values in excess of $625,500 is the private sector. Those who choose this route should keep in mind the private lenders are not required to follow the strict letter of the law as set by HUD and administered by the FHA. They should however insist that the general outlines of the HECM be followed as closely as possible.
2. How are the funds generated from a reverse mortgage distributed to the borrower?