The reverse mortgage is more carefully regulated by the government than other forms of loans – and for good reason: It has its own perils and pitfalls. If you are an older homeowner who is having trouble making ends meet, it still might be your best alternative. But to answer that question, you need to know the rules.

Rule No. 1: The most popular type of reverse mortgage is the Home Equity Conversion Mortgage (HECM), backed by the Federal Housing Administration (FHA). This is not just the usual awkward federal acronym. The HECM comes with rules that protect the consumer. 

And, a blunt definition: A reverse mortgage is a home-equity loan that is usually not repaid until you and your spouse leave your home forever, or die. (Note that you may have to pay it back earlier if you no longer use the home as your principal residence, or if you fail to make necessary repairs or pay taxes or insurance.) Most official sources of information on reverse mortgages delicately avoid the “d” word, but that’s what it’s about, after all. Except for a mortgage insurance premium (MIP) of 2% that is due when you close on the reverse mortgage, all of the money you spend from your line of credit, and all of the interest and fees charged by the financial institution, will be payable by you when you sell your home, or by your heirs after they inherit it. The point of getting a reverse mortgage is to make it affordable for you to live in your home for the rest of your life.

Rules for Borrowers

In order to qualify for a government-approved reverse mortgage, you must be at least 62 years old (your spouse must also be 62 to either co-sign the reverse mortgage or inherit it after your death). You must own your home outright, or at least have substantially paid down the mortgage. And, as with any mortgage application, you need to prove that you can afford to live in this home, if the reverse mortgage is approved.

That last rule forces you to complete a useful budgeting exercise. You need to figure out whether a reverse mortgage would free up your monthly income, or increase your monthly income, to a level that allows you to stay in your home.

Remember, a reverse mortgage can be taken in a lump sum, or it can be drawn in monthly payments that add to your regular income, for the rest of your life or for some set period of time. Or, you can opt for some combination of both. The purpose of a lump sum withdrawal should be to pay off other debts. There’s no rule that prevents you from blowing it all on a Ferrari, but that would be a very dumb move.

You can read the rules in full at the government site. If you go through with the application, you’ll hear all the rules at a personal meeting with a counselor approved by the Department of Housing and Urban Development (HUD). That counseling session is another requirement for obtaining a reverse mortgage (see Find the Right Reverse Mortgage Counseling Agency).

Rules for Lenders

Like any mortgage, a reverse mortgage contains upfront fees and ongoing servicing costs. It also includes a federal mortgage insurance premium.

In a reverse mortgage, many of these costs are folded into the loan agreement, along with the accrued interest, so they are collected only when the loan is paid off. The federal rules limit the amount a lender can charge for each of these fees.

At the risk of bringing up the “d” word again, the reverse mortgage contains an “origination fee” that ensures that the lender gets something out of this deal, even if you die right after signing the agreement. This fee is capped, too, at $6,000.

Crucially, reverse mortgage rules forbid a lender from charging more than the value of the home, when it comes time to pay off the loan. In fact, even if the borrower eventually withdraws an amount exceeding the value of the home, the repayment cannot exceed the home’s value. (Any shortfall is covered by that federal mortgage insurance program.)

That means you can live forever, and you still won’t owe more than your home is worth. Or, you or your heirs can’t be stuck with paying off an “underwater” mortgage if the housing market crashes again and your home is worth less than the loan.

In fact, the rules include a requirement that the lender must offer to settle for a lower amount than the full debt, generally 95% of the total borrowed. The rules also require the lender to give heirs some time to decide what to do with the home before settling the debt, generally six months with at least one possible extension.

These are good rules to know. Some lenders do not bring up the subject of settlement until forced to do so, according to a report in The New York Times. Some have even rushed into foreclosure proceedings against property heirs.

Why All the Rules?

All of these federal rules are designed to protect borrowers from the kind of predatory lenders who prey on senior citizens. The federally regulated reverse mortgage known as a HECM may be the only kind of reverse mortgage that you should ever consider, simply because it imposes layers of regulations on both you and the lender. 
In short, if it isn’t FHA-approved, it could be a scam (see 5 Reverse Mortgage Scams). The FBI offers a laundry list of crimes that target senior citizens, including bogus reverse mortgage scams. 

The Bottom Line

If you’re considering going for a reverse mortgage, make sure you know the rules in advance. If you’re contacting a financial institution that offers a reverse mortgage, make sure it is a legitimate company that is selling a “HUD-approved” or HECM mortgage. These days, it may be the only kind of reverse mortgage that can protect you and your family.

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