This is part 2 of my article covering some of the basics about the HECM reverse mortgage. If you haven’t read part 1, you can find it here.
Reverse Mortgage Closing Costs
Like any mortgage product, there are closing costs that have to be paid to get the loan. Whether the fees are stiff or not, the good news is that most or all of them can be rolled into the new loan amount, so they don’t have to be paid out of pocket.
Reverse mortgage fees generally fall into three categories:
- 3rd party closing costs. These are the services the lender has to hire out to get the reverse mortgage done, including title insurance, escrow services, appraisal, etc. A lender is not allowed to mark up 3rd party closing costs; only the cost incurred can be passed on to the borrower.
- Origination. This is the lender’s fee for originating the reverse mortgage and it is often calculated based on home value. In other words, the higher the home value, the higher the fee, up to a maximum of $6,000 per FHA guidelines. Reverse mortgage borrowers often can negotiate this fee with the lender.
- IMIP. This is a fee charged by FHA to insure the HECM reverse mortgage and protect the lender and borrower if there’s not enough value in the home to pay back the reverse mortgage in the future. As with 3rd party closing costs, the lender cannot mark up this fee. Depending on how much is initially borrowed, this fee could be 0.5% or 2.5% of the appraised value (up to 2.50% of the FHA reverse mortgage lending limit).
If your home is worth a few hundred thousand or less and you owe little to nothing on it, the fees likely will be comparable or a little higher than what you would find on a traditional home loan. However, if your home value is worth more and you have a large mortgage balance, the fees could be pretty steep because you could fall under the higher IMIP rate of 2.50% of the appraised value.
As an example, let’s assume we’re working with a 75-year old single man who has a free and clear home in Texas worth $115,000. According to our reverse mortgage calculator, he would be able to access $64,735 in the form of cash or a line of credit (based on interest rates at time of publishing). His closing costs might look something like the following:
- IMIP: $575
- Origination: $2,500
- 3rd party costs: $2,800
For this kind of initial loan amount in Texas, these closing costs could be very comparable to a traditional forward mortgage.
As another example, let’s assume we’re working with a single 81-year old woman in Utah who has a home worth $375,000 and a mortgage balance of $175,000. The reverse mortgage calculator shows that she can completely eliminate her mortgage payment (which saves her around $1,000/month) and access an additional $58,450 in the form of a line or credit or lump sum in cash. Her closing costs might look something like the following:
- IMIP: $9,375
- Origination: $3,750
- 3rd party closing costs: $2,800
The biggest reason her total costs are so much higher is because she’s paying off a large mortgage balance and falls under the higher IMIP rate (2.50% of the home value). FHA charges much more for the IMIP because there’s a higher risk she could owe more on the home than it’s worth in the future, which means FHA could have to settle part of the loan balance out of the mortgage insurance fund.
As we’ve seen, yes, fees can be pretty stiff for a reverse mortgage depending on the scenario in question. However, they can be for forward mortgages as well. As of this writing, FHA charges a standard 1.75% of the loan amount for upfront mortgage insurance when you purchase a home using a traditional FHA loan. If you’re purchasing a $250,000 home, that’s $4,266 (assuming a minimum down payment of 3.50%) that has to be paid in addition to any other closing costs, such as title insurance, escrow, gov’t recording, prepaid interest, origination, etc.
Funding fees for VA mortgages can run as high as 3.30% of the loan amount for certain refinance scenarios (in addition to any other closing costs).
As with anything, it’s always important to look at cost versus benefit. If you’re retired and have 28 years to go on your mortgage, what’s really more expensive? An IMIP fee (that you typically don’t have to pay out of pocket) or having to limit your lifestyle because of a large mortgage payment that you’ll likely be making until you die?
As with any financial tool, it’s important to evaluate both costs and benefits. If the costs are high but the benefits much higher, it can still make a ton of sense to move forward.
Reverse Mortgage Interest Rates
If you’re worried about HECM reverse mortgage interest rates being sky high, don’t be. They’re usually pretty comparable or slightly higher than rates on a traditional home loan. This is possible because FHA insures the loan, which reduces risk for the lender. Therefore, lenders can offer very attractive interest rates on reverse mortgages.
There’s a lot of misconceptions and misinformation floating around out there about the reverse mortgage. The following are a few of the most common ones:
- Misconception #1: “I’m giving up ownership of my home.” Not at all. A reverse mortgage is fundamentally just a home loan, but one designed to give you access to your equity without having to sell the home or take on a monthly payment. Like a traditional forward mortgage, you always retain title ownership of the home. You are not selling your home to the bank when you get a reverse mortgage.
- Misconception #2: “The reverse mortgage will use up all of my equity.” A reverse mortgage is designed to convert equity into cash over time, yes, however, the goal is also to preserve equity. It is not a healthy program if it uses up your equity quickly.
- Misconception #3: “I’ll be passing on a big debt to my heirs.” The reverse mortgage is a non recourse loan, which means that a debt can never be passed on to your heirs. If there’s not enough value in the home to pay off the entire balance, you or your heirs are not responsible to cover the shortage. The program is insured against that.
- Misconception #4: “Reverse mortgage interest rates are sky high.” Not at all. In fact, HECM reverse mortgage rates are often comparable to traditional mortgage rates.
- Misconception #5: “Reverse mortgage closing costs are sky high.” There’s no question a reverse mortgage can be more expensive than a traditional home loan, but it doesn’t mean it will be. If you have a large initial loan amount (such as when you’re paying off a large mortgage balance), the lender may be able to cover all or a good chunk of the closing costs for you. If you have a small initial loan amount, expect that you’ll incur more of the fees. Whatever the fees are, however, it’s a good bet the vast majority can be rolled into the new loan, which means you don’t need to pay them out of pocket.
Is a Reverse Mortgage Right for You?
Whether or not the HECM reverse mortgage is the right option for you depends on your goals and plans for the future.
The following are some scenarios where the reverse mortgage may not make sense:
- You plan to move in the near future. Though there is no limitation on selling and moving when you have a reverse mortgage, the program is better suited to people who plan to stay in their homes for the foreseeable future.
- You desire to pass the maximum equity you can to your heirs. The reverse mortgage is designed to convert equity into cash over time, so if your goal is to preserve or build as much equity as you can, then it probably doesn’t make sense for you.
- You have young children or somebody with disabilities living with you and you want them to continue living in the home if you pass. The reverse mortgage becomes due and payable once the last borrower has passed away or permanently moved out of the house. If you have other people living with you who won’t be capable of paying off or refinancing the reverse mortgage, it could result in them having to move out of the home. Having said that, you may be able to protect against this with a life insurance policy or other assets that are adequate to pay off the reverse mortgage.
However, if you’re over 62, a homeowner, and you plan to live in your home for the foreseeable future, a HECM reverse mortgage could be a great option. As long as you have a good amount of equity in your home, it’s possible to convert it into cash that can substantially improve your lifestyle.