Seniors looking for a big cash payout from a reverse mortgage will have to look elsewhere for needed funds. A small but increasing number of defaults on the loan product has prompted a crackdown by the Federal Housing Administration (FHA) on the biggest payout loan to homeowners.
The basic theory behind reverse mortgages — you must be 62 or older to apply — and instead of making payments to a lender like in a traditional mortgage, the borrower receives non-taxable money from the lender, which does not have to be paid back for as long as the person lives in the home.
Borrowers are now restricted in how they get one type of reverse mortgage known as the standard fixed rate Home Equity Conversion Mortgage Loan, or HECM. The HECM has been the most popular with borrowers because it yields the greatest amount of money — often in the hundreds of thousands of dollars — in one lump sum. HECM loans are still available — but instead of having fixed mortgage rates, they are offered only with variable rates, which yield less immediate cash.
The FHA insures some 90 percent of reverse mortgages purchased from private lenders. It says about 58,000 loans — or nearly ten percent of its reverse mortgages — were in default in 2012. That’s up from 2 percent ten years ago. The FHA says it faces some $2.8 billion in losses from the defaults, which could force it to seek a bailout from the federal government next year.
By halting the fixed rate standard HECM, the FHA said in testimony before Congress late last year that it hopes to prevent more defaults in the future. “This does limit an option for people thinking about reverse mortgages, but you can understand why the FHA is doing this,” executives explained. “There’s some real concern about people spending their cash too soon and defaulting. “The amount of the loan is based on the equity or sale value of the house, as well as the type of interest associated with the loan. Payments to borrowers are monthly for a specific time or as long as the borrower lives in the house. The borrower retains title of the home, but the loan does have to be repaid when the person dies, sells the property or no longer uses the home as their primary residence. So basically, if you use all your equity and die, you leave a debt to your beneficiaries.
Borrowers still have to pay property taxes, home owners and mortgage insurance and any other home maintenance fees. Before applying, potential borrowers must meet with a government approved housing agency for counseling.
Critics of reverse mortgages say they come at too high of a price. Interest rates can be steeper than traditional loans — current rates are between 4 and 12 percent. There’s also closing costs and up-front fees, which can average anywhere between $2,000 and $10,000 depending on the lender and type of loan. For people who are cash poor and house rich and need the money to stay in their homes, the product may be helpful, but you really need to understand the products benefits and drawbacks.
Reverse mortgages are touted as a financial planning tool for seniors, however, one must be educated on the pro’s and con’s before signing on the dotted line. Not only are the transaction fees excessive, but they are usually a stopgap that leave seniors in a much worse financial position when they are exhausted of their funds from the loan.
As always, DO YOUR RESEARCH, be careful not to be too trusting, and speak to many sources before you decide to secure a Reverse Mortgage. For some, and used properly, it can be a good tool, for others, a financial disaster in the wake.
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