This is the question that I am most often asked when I tell someone that I am a reverse mortgage specialist, (I actually manage the reverse mortgage department for a North Denver mortgage company). I'm asked this by everyone from the lady that cuts my hair, to family members, to real estate agents, to other mortgage professionals.
In a nutshell, a reverse mortgage is an FHA insured loan that is specifically designed for homeowners, age 62 and above, that allows you to convert a portion of the value of your home into tax-free money*, without ever having to sell your home, give up title or obligate yourself to a monthly mortgage payment.
"OK, that's what a reverse mortgage is," you say, "but how does it actuallywork? How is it that someone can actually get a loan that they never have to pay back?"
Great question. I'm so glad you asked!;-)
As I said above, with a reverse mortgage, you never "obligate yourself to a monthly payment".
Please do not misunderstand me here - A reverse mortgage is not free money. You are still charged interest, it's just that you are not actuallypaying it out of your pocket. As long as you, or anyone else who is signed on the reverse mortgage loan, are
you will never, ever have to have to repay the loan or be forced to move. The reverse mortgage loan only becomes due and payable when the last person who is signed on the loan can no longer live in the home, or when the youngest borrower turns 150 years old.
In fact, there is a form that you sign at the closing called a "Limited Liability Notice" that states:
"Your liability under the Plan is limited to the net sale proceeds from the sale of the property. You will have no personal liability for the payment of the note. No deficiency judgment may be taken against you or the estate."
That should explain clearly enough for you that you're never held responsible to repay the loan. "But", you ask, "what happens to the interest you're being charged?"
Another great question! ;-)
That interest does in fact have to be repaid at some point. What happens is that you are charged interest for as long as you keep the loan.
But instead of having to pay it every month like a regular mortgage, the interest is added to the loan balance. So your loan balance on the reverse mortgage loan gets larger instead of smaller. This is why we typically only loan between 50% - 75% of the value of the home.
So the longer you keep the reverse mortgage, the larger the balance gets. Depending upon how quickly your home appreciates, your loan balance could very possibly eclipse the value of the home. But that's OK!
"So what happens if the balance does get larger than the value of my home?", you ask. YOU WIN! (Boy, you do have a lot of questions, -of course they are all good ones- but you should check out my FAQ page for answers to the most common "What is a reverse mortgage?" type of questions).
Actually, all FHA reverse mortgages have something called "mortgage insurance" on them. This is not insurance against fire or if you die. It's actually to protect the lender in the case that your loan balance does grow larger than the value of your home.
As long as you or your spouse (or whomever is on the loan with you) is living in the home and paying the property taxes, homeowner's insurance and maintaining the home, which I'm sure you do anyway, it really makes no difference at all how much is owed on the reverse mortgage. You could owe $100,000 more than the home is worth, but the lender can never kick you out because this is a 100% non-recourse loan.
That's what the mortgage insurance is for. It pays the difference to the lender once the last borrower permanently leaves the home. So since the lender is getting their money from the mortgage insurance, they can never come after you, your heirs or the estate for any deficiency.
I know that this page is getting quite lengthy, but I feel that I have to explain two more brief topics that I have never seen on any other reverse mortgage web-site.
Sometimes my wife reminds me that this is a very dry (i.e. boring) subject for a web-site, and I am probably going into too much detail, and worse, possibly confusing you, so feel free to quit any time and just pick up the phone to call and talk to me.
Compounding Interest - This is a great thing for savings accounts and investments, but it can actually work against you when you borrow money. What this means is
that you are charged interest on the interest that you have already been charged. With reverse mortgages, you are only charged interest on the money that you actually use, but the next month, you are charged interest on the new balance, which includes the interest that you were charged the month before.
I think an example is in order:
So let's say that you take out a reverse mortgage loan that has an initial balance of $100,000. Let's also say the interest rate is 5.06%. The amount of interest that you would be charged in the first month is $466.67. This amount is added to the original loan balance to bring your new balance up to $100,466.67. This new amount is what you're charged interest the following month. So in the second month of the loan, your interest charge would be $468.84, (notice it is slightly higher). This amount is added to the balance of $100,466.67 to bring your balance up to $100,935.51.
Even though the interest rate in the above example is fixed, the actual amount of money you are charged each month increases because you are being charged interest on top of interest.
Please understand that I am not telling you this to try to talk you out of getting a reverse mortgage. My goal is simply to make sure that you are making an informed decision.
I would much rather you learn this now, before you get a reverse mortgage, than after it's too late. I am very proud of the fact that I have never had a customer (or an heir for that matter), come back to me after they closed the loan and tell me that they regretted their decision, and I've closed close to 500 reverse mortgage loans since 2003.
I think the reason is that they knew everything they needed before hand to make an educated, informed decision. That is what I want for you.
Two Notes and Two Deeds of Trust - I really do wish that the reverse mortgage counselors would get on board with explaining to the people they counsel that there are actually two notes and two deeds of trusts on reverse mortgage loans. This can be very confusing for people and cause them to take a step back, wondering if they are being ripped off.
Here's how it works: Every FHA reverse mortgage loan closed in the United States has two notes and two deeds of trust.
A note is something that you sign at the closing that says that you intend to pay the loan back at some point in the future, when you no longer occupy the home as your primary residence. Remember, only the amount up to the value of the home needs to be repaid.
On a normal (forward) loan, the note says that you will repay the mortgage company so much every month at a certain interest rate until the loan is paid in full.
On a reverse mortgage note, there is no repayment schedule, but it still says that the mortgage company will be paid back at some point in the future and it states the interest rate as well. But there is also a second note that says that the "The Secretary of Housing and Urban Development" will be paid back at some point in the future. Everything else on the note is exactly the same.
A deed of trust is what gets recorded at the county that proves that there is a lien against the property. In some states they use mortgages, but in Colorado we use deeds of trust. Each is a little different, but they serve the same function so a lot of people use the terms interchangeably.
The deed of trust says essentially the same stuff that the note does but has a lot more details that explain the rights of the homeowner and the rights of the lender. Just like the reverse mortgage notes, there are two deeds of trust - one for the lender and the other for the Secretary of Housing and Urban Development.
Let me be perfectly clear here - there is only one loan on the home. Once that one loan is paid off, both liens get released. Now I don't know why HUD requires their own lien on the home with reverse mortgages, (they didn't consult me when they made the decision in 1988), but here is my best, slightly educated guess:
I think that HUD looks at reverse mortgages as a liability to the lender. On a normal loan, the borrower is obligated to pay the lender, so the loan is an asset to the lender and a liability to the borrower. With a reverse mortgage, a lot of the time, the bank is the one obligated to pay the borrower - so the roles are switched.
Since FHA, which is a division of HUD, is guaranteeing to the borrower that the money will be available, they look at this loan as a liability to the lender and they want their own lien on the property securing the loan.
That's my story and I'm sticking to it...until proven wrong.
Lastly, both the notes and deeds of trust have a loan amount on them. If you are not prepared for it, the amount that you see will freak you out and send you screaming into the night. Well, maybe not that bad, but it will be a shock.
The loan amount on these two documents is equal to one and a half times the value of your home (up to the maximum FHA lending limit of $625,500). So if you have a $300,000 home, the amount that you see on the note and deed will be $450,000.
As I mentioned above, the amount that you can receive from a reverse mortgage is typically 50% - 75% of the value of the home. So if you qualify to receive 60% of the value of your $300,000 home, that means that you are only getting $180,000, but the note and deed say you owe $450,000! What's up with that!?
Here's the scoop - You might keep this loan for 20 years or you might get hit by a bus the next day, but let's hope not. The lender doesn't know how long you might keep the reverse mortgage.
Since this is a negative amortization loan, (the balance gets bigger over time), the lender doesn't know how much might eventually be owed, but they have to put a number on the form, so they decided to use the formula of V x 150% = amount of loan.
But the amount that needs to be repaid is only the amount owed, if that makes sense. This of a normal "forward" loan. If you take out a $200,000 mortgage and pay on it for the next 20 years you might only owe $60,000, but if you were to look up the deed on public records, the deed would still say $200,000. How can that be when you only owe $60,000? The deed was recorded when you actually did owe $200,000, however the lender can only collect on the amount that is actually owed.
The same is true with the reverse mortgage. Even though the deed says one possible figure at some unknown time in the future, you only owe what the actual balance is at the time that you no longer live in the home.
Whew! Hopefully that didn't make your head explode.
But if you still need more information, check out my reverse mortgage newsletters to stay up to date on the continual changes in the reverse mortgage industry that might affect whether or not you choose to get a reverse mortgage.
You can receive the monthly newsletters by standard postal delivery or as an e-mail.
As always, please feel free to contact me directly with any questions:
Bruce E. Simmons
Direct: (303) 467-7821
Toll Free: 1-877-564-7350
American Liberty Mortgage, Inc.
Bruce E. Simmons, CRMP
Reverse Mortgage Manager
1932 W 33rd Ave
Denver, CO 80211
Direct: (303) 467-7821
Cell: (303) 513-2748
Toll Free: 1-877-467-7801
Fax: (303) 600-7871