Buying with Reverse Mortgage
In this article, we explore options for seniors purchase a home without a monthly mortgage payment. Our focus will be on the FHA insured reverse mortgage known as a HECM – home equity conversion mortgage.
As a result of TV ads, you may familiar with reverse mortgages available as a refinance option for seniors. This article does not address the possibilities of refinancing your current home with a reverse mortgage.
A HECM is a ‘Reverse’ mortgage which means it does not require a monthly payment and has negative amortization (interest is added to the mortgage balance each month). Most people are unfamiliar with negative amortization and therefore do not understand the program.
For many seniors, 62 years or older, a reverse mortgage is a viable option to be explored. The HECM loan requires the youngest borrower to be at least 62, however, there are ‘private’ reverse mortgages available for borrowers 60 years old. In the remainder of this article, we are referring to the ‘HECM Purchase’ program. For non-reverse loans (normal loans), we will refer to them as ‘forward’ loans.
I. Why is purchasing a home with a reverse mortgage not very popular?
The program is seldom used due to three factors.
(1) Most real estate agents are not familiar with reverse mortgage and therefore do not explore the possibility with senior purchasers.
(2) Most mortgage lenders do not process HECM loans therefore the option is not explored with their senior borrowers.
(3) The calculations required are complicated. While there are several Internet sites that purport to be HECM purchase calculators, it has been our experience they do not work for a HECM purchase. The online ‘HECM calculators’ are most typically designed to be lead generators for Lenders active with reverse mortgages.
The AskChristee ‘Reverse Mortgage’ module is the most sophisticated reverse mortgage purchase program available.
II. HECM Terminology
To further complicates matters, the HECM loan has its own vocabulary. Below are several HECM definitions that may be confusing to most people.
1. The Maximum Claim Amount is $970,800 Nationwide. Claim Amount is the maximum loan amount.
2. The maximum claim amount will be the lessor of: 1) the appraised value (2) sale price (3) FHA HECM mortgage limit for a one family residence ($970,800).
3. Principal Limit Factor is the maximum loan-to-value based upon the youngest borrowers age and the interest rate for the loan. The principal limit factor is multiplied against the sales price to calculate the maximum loan amount available for that property – aka the ‘Principal Limit’ which cannot exceed the Maximum Claim Amount.
4. Expected Rate. Applicable to Adjustable-Rate Loans (ARMS), the expected rate is the index plus the margin. For fixed rate loans, the expected rate is the interest rate.
5. Principal Limit is the base loan amount before adding the Initial Mortgage Insurance Premium.
6. Total Loan Amount is the base loan amount plus Initial Mortgage Insurance Premium (IMIP). On forward (typical) FHA loans, this is referred to as the Up-Front Mortgage Insurance Premium (UFMIP).
7. IMIP. The Initial Mortgage Insurance Premium is 2% of the Maximum Claim Amount or Purchase Price whichever is less.
8. Annual Mortgage Insurance Premium (MIP) is ½ of 1% annually (.005).
III. Overview of the HECM Purchase Program
Below is a general outline of the HECM purchase program.
1. HECM is an acronym for Home Equity Conversion Mortgage.
2. A HECM loan is fully insured by FHA.
3. A HECM is a ‘Reverse’ mortgage which means it does not require a monthly payment and has negative amortization (interest is added to the mortgage balance each month).
4. A borrower is not personally liable for repayment of a HECM loan (non-recourse). Borrowers are personally liable for all forward mortgages such as Conventional, FHA, VA, and USDA.
5. A HECM purchase loan should not be confused with a HECM refinance loan. While there are some similarities, there are many distinct features of the HECM purchase loan.
IV. HECM Positive Features
1. No Monthly Payments
2. Little or No Qualifying. Lender may verify borrower’s ability to pay annual obligations such as property taxes and insurance premiums.
V. HECM Negative Features
1. Mortgage balance increases. Known as negative amortization.
2. Mortgage balance must be satisfied when the property is no longer the principal residence.
VI. Money Requirements for a HECM purchase
1. At closing, HECM mortgagors must provide a monetary investment which will be applied to satisfy the difference between the HECM principal limit (loan amount) and the sale price for the property, plus any HECM loan related fees that are not financed into the loan, minus the amount of the earnest deposit.
2. HECM mortgagors may choose to provide a larger investment amount in order to retain a portion of the available HECM proceeds for future draws.
3. HECM borrowers must use cash on hand or cash from the sale or liquidation of the mortgagor’s assets for the required monetary investment.
4. There are NO seller credits (concessions) allowed on a HECM loan.
5. HECM loans also prohibit the use of loan discount points, interest rate buydowns, closing cost down payment assistance, builder incentives, gifts or personal property given by the seller or any other party involved in the transaction. This includes customary charges that are normally paid on behalf of the borrower by the seller.
6. HECM borrower may pay a loan origination fee to the Lender based upon the following formula:
A lender can charge the greater of $2,500 or 2% of the first $200,000 of your home’s value plus 1% of the amount over $200,000. HECM origination fees are capped at $6,000.
7. HECM mortgagors may not obtain a bridge loan (also known as “gap financing”) or engage in other interim financing methods to meet the monetary investment requirement or payment of closing costs needed to complete the purchase transaction. This restriction includes subordinate liens, personal loans, cash withdrawals from credit cards, seller financing and any other lending commitment that cannot be satisfied at closing.
VII. Example of buying a home with a HECM loan
A senior husband and wife are downsizing and put their home on the market. The age of the youngest borrower is 72. They expect to net around $300,000 from the sale of their property. The purchase of a $300,000 will satisfy their new housing needs.
The available options are:
(1) Purchase a $300,000 house cash. Of course, should they purchase using all cash then they will lack the funds for maintenance, property taxes and insurance payments.
(2) Rent – keeping the $300,000 as a nest egg for future uncertainties.
(3) Purchase a $300,000 home with a $150,000 conventional mortgage and have a principal and interest payment of $869.93 based upon a 3.5% for 20-year term. The conventional loan will use about $158,000 of their cash leaving them $142,000. The conventional loan will have a zero-mortgage balance at the end of twenty years. Should they opt for the conventional loan, they will make total payments over 20-years of $208,783.
(4) Purchase a $300,000 house via a HECM purchase loan using about $146,000 cash. With this option, the senior couple could purchase a $300,000 home without a mortgage payment and have approximately $154,000 in the bank. Should they decide on the HECM option, after 20 years they will have a mortgage balance of approximately $309,468 which includes approximately $146.268 accrued interest. The loan balance is based upon an initial HECM total loan of $163,200 including the IMIP. Interest accrued monthly at the rate of 4.5% (4% interest rate plus ½ percent annual MIP). Of course, they will not have monthly payments during this period.
They now have the information to make an informed intelligent decision to exercise one of their four (4) options.
VIII. AskChristee Software
The AskChristee module ‘Reverse Mortgage’ software provides quick and detailed answers to the following questions.
1. What price home can be purchased with a HECM loan based upon age and interest rate?
2. How much HECM loan can be obtained for a specific property?
3. How much down payment will be required?
4. How much total cash will be required?
5. How much home can be purchased with a HECM purchase using a specific amount of cash?
6. An estimate of the closing cost.
7. An estimate of the annual property taxes and insurance.
IX. HECM Purchase Myths
There are many myths surrounding HECM loans. Below we address a few of them.
1. Myth. Property ownership reverts to Lender upon death of borrower.
Fact. When the last borrower dies, the property will become part of the deceased borrower’s estate. The heirs may either (1) sell the property or (2) payoff the HECM balance. Should the heirs elect to sell the property, then the HECM loan balance will be paid off at closing (like any other sale transactions). In the event the property is worth more than the HECM balance then heirs will benefit from the equity in the property.
Should the property be worth less than the HECM mortgage balance then the heirs may elect to have the property revert back to HUD and the heirs will not have any further responsibility for the property.
2. Myth. A homeowner does not have the right to sale property, which is subject to a HECM loan.
Fact. Homeowners may sell their property at any time. Of course, to convey clear title, the balance on the HECM loan must be satisfied as any other lien such as a ‘forward’ mortgage attached to the property.
3. Myth. Borrowers cannot make payments on a HECM loan.
Fact. Borrowers may make payments on the HECM loan. They simply are not obligated to make payments.
4. Myth. Borrower must borrower maximum principal limit. In other words, borrower must borrow maximum loan amount available.
Fact. Borrower may put down additional funds at time of closing thus reducing the loan amount. In this event, the borrower has additional HECM funds available to them at some later date.
5. Myth. Borrower cannot create an escrow account for future payments of annual fees such as taxes and insurance.
Fact. If borrower has borrowed the maximum amount available then this is true. However, if the borrower has borrowed a lessor amount then escrow like arrangements can be made with Lender.
X. Eligible Properties Guidelines
1. One to Four Unit properties.
2. Must be primary residence and must be occupied by the borrower.
3. Manufactured homes subject to certain guidelines.
4. Must be meet FHA minimum property standards.
5. For purchase transactions where major property flaws threaten the health and safety of the homeowner and/or jeopardize the soundness and security of the property, all repairs must be completed by the seller prior to closing.
6. In the event the borrower has an existing FHA loan on their current home, the existing FHA may be required to be paid off.
XI. Major Property Deficiency Examples
1. No running water.
2. Leaking roof.
3. No primary heating source.
4. Inadequate electrical systems (including lighting).
5. Inoperable doors and windows (inhibited ingress and egress).
6. State or local code violations.
XII. Properties Not Eligible
1. Cooperative units;
2. Newly constructed principal residences where a Certificate of Occupancy or its equivalent has not been issued by the appropriate local authority;
3. Boarding houses;
4. Bed and breakfast establishments;
5. Existing manufactured homes built before June 15, 1976; and
6. Existing manufactured homes built after June 15, 1976 that fail to conform to the Manufactured Home Construction Safety Standards, as evidenced by affixed certification labels (e.g. data plate and HUD certification label) and/or lack a permanent foundation as required in HUD’s Permanent Foundations for Manufactured Housing Guide or homes that are installed or occupied previously at another site or location.
The HECM (Home Equity Conversion Mortgage) calculates all the details for a reverse mortgage purchase. The software in NOT designed to be used for reverse mortgage refinances.
XIII. AskChristee HECM Module Input fields
The AskChristee module ‘Reverse Mortgage’ is extremely easy to use and will provide you with all the information needed to consider a possible HECM purchase.
Required Inputs for HECM Purchase. 4 Required Inputs
1. State. Select the State
2. County or City. Select the County or City. Closing cost are sensitive to the State and County or City.
3. Age of Youngest Borrower. Enter the age of the youngest borrower. Minimum age is 62.
Note: Husband is 78 and wife is 71. Enter 71.
4. Enter Interest Rate. Enter the interest rate currently available for reverse mortgages. This is the rate that will be used for HECM calculations also known as the ‘expected rate’. If you are uncertain about current fix rate for a HECM loan add ½ percent to the 30-year conventional rate. You can use the same approach for an adjustable rate; however, you will need to add 2% (ARM margin) to the rate.
Note. Current interest rate for a 30-year conventional are 3% percent, we suggest you enter 3.5% as the interest rate for the HECM calculations. Interest rates for the adjustable-rate HECM consist of an index (typically the 10 year swap rate) plus a margin that can be 1.50% to 2.50%, depending on the lender.
Optional Inputs for HECM Purchase. 6 Available
1. Cash. Enter the amount of total cash the borrower has available to purchase a home utilizing a HECM mortgage.
Note. If the cash entered is less than minimum required then AskChristee will resolve the purchase price based upon the cash entered.
Note. If the cash entered is greater than minimum required, then AskChristee will show amount of excess cash entered.
2. Sales Price. If you have a specific property or purchase price, then enter the Sales Price here.
Note. If the sales price is higher than the maximum claim amount, AskChristee will base the calculations on the maximum claim amount thus resulting in additional down payment.
Note. Think of the maximum claim amount (currently $765,600) as the maximum sales price which will result in the minimum down payment. For example. A sales price entered of $800,000 would require an additional $34,400 down payment.
3. Maximum LTV. Enter the maximum loan-to-value you wish the report to be based upon. If the LTV entered is less than the maximum LTV available then AskChristee will use the LTV as entered.
4. Mortgage Amount. Enter the maximum HECM loan the borrower would want. If the amount entered is less than the maximum mortgage amount available then AskChristee will use the maximum loan amount as entered.
5. Property taxes. If you have specific property information, you may want to enter the exact property taxes for that property.
Note. It is best practice not to enter property taxes unless you are considering a specific property. AskChristee will estimate the property taxes based upon the property tax rates for the county or city selected.
6. Age for HECM balance. Christee will estimate the HECM balance for the age entered.
Note. If this field is left blank then AskChristee will estimate the HECM balance for end of 10 years up to a maximum age of 100 years.
Note. If the age of youngest borrower is 75 and you would like an estimate in 7 years enter 82.
7. Include Origination Fee. If you enter ‘Yes’ then AskChristee will calculate the allowable Lender Origination fee on a HECM loan.