Guidelines for FHA Reverse Mortgages
If you take out the most popular type of reverse mortgage, a Home Equity Conversion Mortgage (HECM), your loan and your home will have to meet Federal Housing Administration (FHA) requirements because the FHA insures these mortgages. Here’s an overview of the most important guidelines you should be aware of. (To learn more about borrower requirements, read Do You Qualify for a Reverse Mortgage?)
You can take out a reverse mortgage only on certain types of properties. The home must be a single-family home or a two- to four-unit home where you occupy one unit. HUD-approved condos are also eligible, as are manufactured homes that meet FHA requirements. The manufactured home’s floor area must be at least 400 square feet and must meet Federal Manufactured Home Construction and Safety Standards. The property to be reverse-mortgaged also must be classified and taxed as real estate. So while you might live in your recreational vehicle, you can’t reverse-mortgage it because it doesn't qualify as real estate. Also, to obtain and maintain a reverse mortgage on your property, you must live there as your primary residence.
Getting a reverse mortgage requires a professional home appraisal. Your home’s value will be based on its condition and the property values in the surrounding neighborhood. Lenders want to make sure the amount of reverse mortgage amount they extend to homeowners is in line with what they will get when the house is sold to repay the loan. An appraisal is typically valid for 120 days, which should be more than enough time to close your loan.
The home also must meet the FHA’s minimum property standards for safety, security and soundness. If the home doesn’t meet these standards, the lender might approve the reverse mortgage on the condition that part of the proceeds goes toward making the necessary repairs to bring the property up to those standards. A local HUD office will review a property that an appraiser thinks requires repairs costing 30% or more of what the home is worth. HUD may or may not allow such properties to be reverse-mortgaged. (Learn more in What You Should Know About Home Appraisals.)
Under a federal regulation that became effective earlier this year, lenders must conduct a financial assessment of borrowers before approving them for a reverse mortgage. The purpose of this assessment is to make sure the homeowner has the willingness and the capacity to keep up with required homeowners insurance and property tax payments. However, the main criteria to qualify for a reverse mortgage and to determine how much the homeowner can borrow are still the homeowner’s age, the loan’s interest rate and the property’s appraised value, not the homeowner’s income, credit and assets, as with a forward mortgage. (Learn about the differences in Comparing Reverse Mortgages vs. Forward Mortgages.)
If the financial assessment shows that you may not have the income or liquid assets you need to keep up with insurance and taxes, that doesn’t necessarily mean you won’t be able to get a reverse mortgage. Lenders can set aside part of your reverse mortgage proceeds to cover these expenses using a process similar to the escrow account you might have had with your forward mortgage. For reverse mortgages, this account is called a "life expectancy set-aside."
For the financial assessment, the lender will review the borrower’s credit reports, employment history, housing history over the previous year, property tax payment history, homeowners insurance status, flood insurance status (read Understanding Lender-Required Flood Insurance) and homeowners association fee payment history (if the property belongs to an association). Look at page 82 of this sample reverse mortgage financial assessment worksheet to see what information lenders will consider.
Mortgage Insurance Premiums
HECMs have two types of mortgage insurance premiums: upfront and ongoing. The up-front premium is charged when you take out the loan. It’s a percentage based on how much of the loan proceeds you decide to receive in the first year. The idea is that the more you take out in the first year, the riskier your loan is, so your mortgage insurance costs more as a result.
The calculation is simple: if you borrow less than 60% of your initial principal limit in year one, the up-front premium is 0.5% of your home’s appraised value. If you borrow more than 60%, it’s 2.5%. You can finance this premium if you don’t want to pay out of pocket, but that means you’ll be paying interest on it for as long as you have the loan. Since how much you can borrow is based in part on the amount of interest you’ll accrue over the life of the loan, financing the premium will reduce how much you can borrow by more than the amount of the premium.
You also have to pay annual mortgage insurance premiums (MIPs) for as long as you have the loan. This fee is 1.25% of the outstanding mortgage balance per year. MIPs also are added to your loan balance and reduce the amount you can borrow.
You Can't Owe More than the Home Is Worth
If you sell your home or move out while you’re alive, your reverse mortgage will be due and payable. The same is true if you die while you still live in the home. If the home sells for less than you owe on the reverse mortgage, you don’t have to make up the difference. And if your heirs want to buy the home after your death or move so they can keep it in the family, lenders can’t ask them to pay more than you owe, either.
An HECM is a non-recourse loan, and FHA mortgage insurance covers any shortfall. The one exception is that you can’t sell your home for less than 95% of what it’s worth and be off the hook. There has to be a restriction like this to prevent unscrupulous people from doing things like selling the home to a relative for less than market value and less than the reverse mortgage balance and then expecting the lender to take the financial hit.
The Bottom Line
The mortgage industry is heavily regulated, and the FHA has established many guidelines to protect borrowers from making major mistakes, to prevent lenders from taking advantage of borrowers and to encourage lenders to offer reverse mortgages. These regulations and their enforcement aren’t perfect, however, so you still need to be cautious when considering a reverse mortgage. (For further reading, see A Guide To Taxes And Reverse Mortgages and Find The Top Reverse Mortgage Companies.)