A reverse mortgage is a complex, somewhat controversial, financing vehicle. Perhaps that's why Home Equity Conversion Mortgages (HECMs), the most popular variety, are regulated by both the federal Department of Housing and Urban Development (HUD), whose purpose is “to create strong, sustainable, inclusive communities and quality affordable homes for all,” and the Consumer Financial Protection Bureau (CFPB). The CFPB, as a regulator of consumer financial products and services, accepts and investigates consumer complaints about reverse mortgages and conducts studies about how well reverse mortgages are serving consumers. The Federal Housing Administration (FHA), which insures HECMs, is part of HUD. State governments also impose regulations on reverse mortgage lenders and borrowers.
Let’s take a look at the key regulations that will affect you if you want to get an HECM.
Federal law limits the amount a homeowner can borrow through an HECM to $679,650 or the home’s appraised value, whichever is less. The size of the loan is also based on the age of the borrower(s) or his/her "eligible non-borrowing" spouse, whoever is younger, and on the loan’s interest rate. The total amount you can borrow immediately after closing is called the principal limit. The principal limit increases each month, after factoring in the mortgage interest rate and monthly mortgage insurance premium.
You can't borrow past your limit, obviously, but you can stay in your home until one of the events occurs that makes the reverse mortgage due and payable. A 75-year-old homeowner with a 7.75% expected interest rate and a home valued at $165,000 (though the local mortgage limit is $151,725) would have an initial principal affected by that $151,725 figure, and would thus have an initial principal limit of $84,055.65, according to HUD. The interest rate is “expected” since most reverse mortgages have adjustable rates, making it difficult to know in advance what the actual interest will amount to over time.
The lender then reduces the initial principal amount by any loan fees the borrower is paying with reverse mortgage proceeds, such as the origination fee and up-front mortgage insurance premium. If the loan is being used for immediate home repairs or requires a life-expectancy set aside (that is, funds earmarked to pay your property taxes and homeowners insurance, if your assets aren't enough to do so), the initial principal limit is reduced by these amounts as well. Homeowners can’t borrow more than 60% of the limit in the first year of the loan.
Borrowers can choose how to receive loan payments from the net initial principal limit. The only option with a fixed interest rate is a single disbursement lump sum, a large, one-time payment. This course can be risky if the borrower isn’t good at managing money, especially since it can also make him or her a target for scams (see Beware of These Reverse Mortgage Scams).
There are five payment plans with an adjustable interest rate:
- Tenure payment plans provide equal monthly payments for as long as at least one borrower lives in the property as a primary residence. The monthly payment calculation assumes that the borrower will live to be 100, but if the borrower lives longer, he or she will keep receiving the same monthly payments.
- Term payment plans also provide equal monthly payments, but they have a predetermined stop date. Borrowers are allowed to exceed the principal limit with a term plan if the loan’s actual interest rate ends up being higher than the expected rate that was calculated at closing.
- A line of credit grows over time and lets homeowners access reverse mortgage funds as needed, which also means they only pay interest on the sums they actually end up borrowing.
- Modified tenure combines smaller fixed monthly payments for life with a smaller line of credit.
- Modified term combines smaller monthly term payments with a smaller line of credit (smaller compared to getting either a term payment or a line of credit by itself).
You can change your payment plan during the life of the loan, as long as you stay within the principal limit. Note that if only one member of a couple is the borrower, a surviving spouse cannot receive any payments after the death of the borrower. This might be a reason to choose the lump-sum payment option (see Reverse Mortgage: Could Your Widow(er) Lose the House?).
Any lender that wants to offer HECM mortgages must receive FHA approval – and must obey federal regulations regarding loan fees.
The maximum origination fee, which is how lenders make money from mortgages, is based on a sliding scale for homes worth up to $400,000. The fee can be $2,500 or 2% of the first $200,000 of your property’s appraised value (whichever is greater) and 1% of the next $200,000. The fee cannot exceed $6,000, even for homes worth more than $400,000. So if your home’s appraised value is $300,000, you should pay no more than $5,000 in origination fees. If your home’s appraised value is $100,000, you should pay no more than $2,500.
The government does not limit what lenders can charge in settlement costs, also called closing costs, which include payments for the appraisal, title insurance and home inspection. Some lenders will offer to pay these costs for you, but then charge you a higher interest rate. In that situation, ask the lender to give you two quotes, one based on you paying closing costs and one based on the lender paying them.
The government also doesn’t limit third-party fees such as recording fees and mortgage taxes, but you can contact your local property tax assessor to make sure the lender is charging you the correct amount.
The government does limit the monthly servicing fees lenders can charge you to $30 or $35 a month, depending on your loan type. This fee is supposed to cover the lender’s costs for sending you account statements and loan proceeds, and making sure you’ve paid your homeowners insurance and property taxes as required. The lender adds this monthly fee to your loan balance each month; it’s also factored into how much you can borrow (the principal limit). If a lender doesn’t charge a servicing fee, it can charge a higher interest rate to cover its servicing costs.
Remedy for Cold Feet
Reverse mortgages have a three-business-day cooling-off period during which homeowners can cancel the transaction without penalty. This right is also called a “right to cancel” or “right of rescission.” If you exercise this right, the lender has to refund any amounts you’ve spent on financing the loan. Make sure to cancel in writing and send your notice by a method that lets you prove when you sent it and when the lender received it.
The Bottom Line
Reverse mortgages are a complex product, and the rules that govern them are complicated, too. (For more details, see Guidelines for FHA Reverse Mortgages.) Bear in mind that, if you get a proprietary or single-purpose reverse mortgage instead of the more common HECM mortgage discussed here, the regulations will be somewhat different.
A proprietary mortgage is for very expensive properties and doesn't have some of the government protections. A single-purpose is a reverse mortgage offered by governments or agencies for one of several very specific purposes, such as for home repair or paying property taxes.
Ask whether one of these reverse mortgages would be better for you than an HECM mortgage when you receive the counseling required before taking out this type of reverse mortgage. Find the Right Reverse Mortgage Counseling Agency explains more about this process.
Complete Guide to Reverse Mortgage
Comparing Reverse Mortgages vs. Forward Mortgages
Do You Qualify for a Reverse Mortgage?
Reverse Mortgage Types
Picking The Right Reverse Mortgage Lender
How to Choose a Reverse Mortgage Payment Plan
Reverse Mortgage or Home-Equity Loan?
A Guide to Taxes and Reverse Mortgages
5 Top Alternatives to a Reverse Mortgage
5 Signs a Reverse Mortgage Is a Good Idea
5 Signs a Reverse Mortgage Is a Bad Idea
How to Avoid Outliving Your Reverse Mortgage
Rules For Obtaining an FHA Reverse Mortgage
Find the Right Reverse Mortgage Counseling Agency
Find The Top Reverse Mortgage Companies
Reverse Mortgage: Could Your Widow(er) Lose the House?
Beware of These Reverse Mortgage Scams
Reverse Mortgage Pitfalls