by James P. Gaines and Beth Thomas (posted in Tierra Grande, July 2010)
PROS
- A RM has no fixed due date and requires no repayment as long as the home remains the borrower’s principal residence. The loan becomes payable only if the borrower sells the home, ceases to live in the house for 12 consecutive months or more, dies, or fail to fulfill any of the other requirements of the loan. The borrower cannot be foreclosed on or forced out of the house for failing to make a payment.
- A RM is a nonrecourse loan. The amount owed can never exceed the net selling price of the home. If the loan balance is greater than the home’s net selling price, neither the borrower nor the borrower’s heirs are responsible for making up the difference.
- A RM is a lien on the property like any other mortgage. The borrower continues to hold title to the home. If the property is sold, the loan is paid off from the proceeds, and the borrower or the estate receives any excess between the net price and the amount owed.
- RMs provide flexible payout options. The borrower can receive funds either in a single lump sum, as a series of monthly advances, as a line of credit that can be drawn against any time in the future or any combination of these methods. The lender cannot unilaterally change the amount or timing of loan advances and cannot reduce the amount or number of advances because of an adjustment in the interest rate.
- RM loan proceeds are nontaxable. All RM advnaces represent principal loan amounts, not ordinary income.
- Loan underwriting and approval does not depend on the borrower’s current income, employment status, FICO score or anything other than the borrower’s age and the value of the property.
- Prospective RM borrowers are required to meeet with an independent financial counselor (HUD-approved in the case of HECMs) before signing a loan application or incurring any fees.
- The lender’s lien against the property is removed if the lender fails to make loan advances according to the terms of the agreement or does not correct any failure to fund upon receiving written notice by the borrower.
CONS
- RM loans are available only to homeowner-borrowers who are at least 62 years old and own their homes outright or have high levels of equity.
- Generally, RM loans provide around 65 percent of the value of the property based on the prinipal limiting factors (PLF) applied for different age and interest rate combinations. Home equity loans can be as high as 80 percent. The RM loan-to-value ratio is higher for older borrowers (even exceeding 80 percent), but highter closing costs and fees and shorter life expectancy offset some of this advantage.
- Upon the death of the borrower, the loan plus all accrued interest and costs becomes due and payable, typically necessitating the sale of the home. If the heirs want to keep the house, they have to repay the entire amount due, which could be greater than the value of the property at the time. Inheritance planning becomes trickier.
- With relatively high up-front costs, the borrower needs to stay in the home longer to make the loan more financially attractive. RM loans are significantly more costly than home equity loans if the borrower ells or moves just a few years after taking out the loan. The U.S Office of the Comptroller of the Currency found that it is most advantageous to remain in the home at least ten years. This disadvantage has been offset lately by some RM lenders eliminating origination fees, setting aside service fees or both.
- Although there are no monthly mortgage payments, the borrower is responsible for all other owenership costs. For older borrowers, estimating the length of time they can afford to pay utilities, property taxes, insurance, maintenance and repairs, or condominium fees, and how long they are physically able to keep living there may be difficult.
- A home subject to a RM can be foreclosed upon by court order if the borrower ceases to live in the property for 12 consecutive months without prior approval of the lender or if the borrower defaults on any obligation specified in the laon, such as maintenance, taxes, and insurance.
- RM borrowers may be the target of aggressive sales pitches for other expensive and potentially inappropriate products or sevices because of the large sum of money they receive from a reverse mortgage. Lenders providing RMs are generally prohibited from cross-selling other investment products such as annuities, long-term care insurance or services such as home repairs. The Housing and Economic Recovery Acct of 2008 (HERA) specifically prohibits cross selling to a RM borrower. HERA’s provisions are applicable to HECMs only.
- A RM is fundamentally different than a forward purchase mortgage or a home equity loan with generally more complicated terms and conditions. Borrowers often do not fully understand all the difference and nuances of RM loans, despite both Texas law and FHA requirements for full disclosure and counseling before obtaining the loan.