Home equity is the difference between what a mortgagee owes and the fair market value of the home. It's a potential asset that can improve retirement prospects or lifestyle, and many retirees have significant equity in their homes. A reverse mortgage can tap into that equity for cash, and a reverse mortgage for purchase can also be used to buy a home.
This option is known as a home equity conversion mortgage (HECM) for purchase.
A reverse mortgage can benefit retirees who don't necessarily want to stay put in the family home in their retirement years. They're looking for a cost-effective way to downsize their housing expenses, find a more suitable home for this season of life, or relocate to a more retirement-friendly location.
The Definition of a Reverse Mortgage (HECM)
An HECM allows senior homeowners to borrow against the equity in their primary residences. They must be at least age 62 to qualify, and no repayment of the mortgage is required until the property is sold or the borrower dies or moves out of the home.
The amount you can borrow depends on the age of the borrower and spouse, current interest rates, the home’s value based on an appraisal, and the initial mortgage insurance premium (IMIP)—a one-time loan closing fee.
Payments to the homeowner can be lump sum or periodic. They're essentially collecting the equity in their homes in cash. Unlike a traditional mortgage, no monthly payments are required, but interest does accumulate and must be repaid along with the original amount borrowed. The mortgage comes due when the house is sold, the borrower dies, or moves out for 12 months or more.
Reverse mortgages are only available through FHA-approved lenders.
Using a Reverse Mortgage to Purchase a Home
Reverse mortgages have commonly been used to strategically help retirees stay in their homes as they age and to improve their cash flow. The HECM for purchase provides the borrower with a fixed-rate, lump-sum loan that is applied to the purchase of a home. The reverse mortgage forms a lien against the property just as a traditional loan would.
The loan program is sponsored by the U.S. Department of Housing and Urban Development, Federal Housing Administration (HUD-FHA).
Borrowers must meet certain requirements to qualify for an HECM for purchase. In addition to age rules, these conditions must be met:
- The purchased home has to become your primary residence within 60 days of closing.
- You must be able to continue to pay for property taxes, insurance, HOA dues, or any other property maintenance costs.
- You must attend a counseling session approved by HUD.
- You must not have any federal debt obligations.
There are restrictions on properties that can be purchased as well. The home must be a single-family residence. A two- to four-unit dwelling is also acceptable as long as you occupy one of the units as your primary residence. FHA-approved manufactured homes homes and condos qualify as well.
Required Down Payment
A significant down payment is required, typically much more than you would pay on a traditional mortgage. You'll have to pay about half the home’s price using your own cash and savings—usually somewhere from 45% to 62%.
There will also be closing costs, and they can be more than those associated with other types of mortgages.
The down payment can come in the form of a gift from friends or family, however. You don’t have to own existing property or sell your existing home to qualify, as long as the home you're purchasing through a HECM becomes your primary residence.
How you repay the mortgage is up to you. You can make monthly payments if you want to, as much or as little as you like, or you can make no monthly payments and the loan will be repaid just as a traditional reverse mortgage would—the balance would come due at the time of your death, when you otherwise leave the home, or if you fail to abide by the mortgage terms.
Advantages of a Reverse Mortgage for Purchase
It's possible to purchase a house without draining retirement savings to make regular monthly payments because there no monthly payments are required. This allows retirees or pre-retirees to purchase homes that might be in a more desirable retirement location or better suited to their changing needs without losing the purchasing power of their entire retirement nest egg.
The Federal Housing Administration provides these loans with a non-recourse feature so you or your heirs will never owe more than the home's value when the HECM does come due.
Disadvantages of a Reverse Mortgage for Purchase
One of the biggest drawbacks of a reverse mortgage is the out-of-pocket costs. Retirees with cash flow concerns could eventually find that the property taxes, insurance, and other expenses become difficult to maintain.
Another potential risk is that the accruing interest will eventually eat away at your equity. The longer you live and stay in the property, the greater the chance becomes that your equity will be drastically reduced or even disappear.
One purpose of meeting with an approved counselor to qualify for the HECM program involves an assessment of your personal financial situation.
Another fear is that your family won't be able to take over the home after your death. They would have to refinance the property or otherwise pay off the reverse mortgage if they wanted to keep it.