Guide To Lenders
July 29, 2014

New FHA Reverse Mortgage Competes With Home Equity Loans

Gina Pogol

One of the biggest drawbacks with FHA's Home Equity Conversion Mortgage (HECM) is its upfront mortgage insurance premium. That premium makes HECMs a poor option for borrowing smaller amounts. But a new product is changing that.

New FHA Reverse Mortgage Competes With Home Equity Loans

It's a sad but true joke that it's only easy to borrow money when you don't need it. If you're a senior on a retirement-sized income, you may not easily qualify for a home equity line of credit or a second mortgage.

Reverse mortgages were designed as solutions for this problem, allowing seniors to cash out some home equity without worrying about making monthly payments or qualifying. But if you only need a smaller amount, reverse mortgage fees make borrowing this way extremely expensive.

Traditional FHA reverse mortgages costly for smaller loan amounts

Upfront mortgage insurance for Home Equity Conversion Mortgages (HECMs) -- the name for reverse mortgages backed by the Federal Housing Administration -- is based on the property value, not the loan amount as in a regular FHA mortgage.

If you have a $400,000 home, the premium is 2 percent of $400,000, or $8,000. That's the fee incurred whether you take a $200,000 lump sum or a line of credit and only use $20,000. So if you only need to borrow $20,000, that $8,000 ends up being a whopping 40 percent of your loan amount!

Many would-be reverse mortgage borrowers decided they'd be better off at their friendly neighborhood loan shark or pawn shop, and HECM popularity declined.

HECM Saver Requires Far Lower Mortgage Insurance Premiums

HECM Saver is a new program that will be available October 4, 2010. HECM Saver lets seniors take out something very close to a traditional home equity line of credit (HELOC).

Like a HELOC, the upfront costs of HECM Saver are minimal, making it a fine choice for smaller projects or as a buffer for emergencies. The amount of home equity that can be tapped is lower -- but in exchange for agreeing to a less risky loan, the borrower pays a much lower upfront mortgage insurance premium.

In fact, at 0.01 percent (no, that isn't a typo), the upfront mortgage insurance premium is nearly nothing. In the previous example, instead of paying $8,000, a homeowner with a $400,000 home would pay $40. Then, he or she would pay 1.25 percent of the loan's balance each year for mortgage insurance. Borrowers who hit a credit line for $20,000 would pay just $250 that year for the mortgage insurance. (This increases as the balance of the loan grows.)

Other Costs in Tapping Home Equity

HECM Saver, like other reverse mortgage products, come with other costs and fees -- there may be an origination charge, appraisal fees and monthly service charges. Interest is usually variable. Given the variety of fees, it pays to compare reverse mortgage rates and shop with several lenders before committing to a deal.

Reverse mortgage counseling from a HUD-approved practitioner (required before you can get one of these loans) can help you decipher reverse mortgage-specific forms called TALC disclosures and choose the best loan.

Mortgage Program Allows Flexibility in How You Take Loan Proceeds

You can choose a line of credit like a HELOC, which is the lowest-cost option because you only pay for money that you use. This form of taking proceeds is ideal for:

  • funding home improvement projects
  • providing cash flow for a business
  • just having available in case you need emergency cash

You also have the option of choosing a lump-sum distribution, which is good for consolidating high-interest debt or paying off medical bills. Or you can get monthly payments for a specific tenure or for life, to supplement your other sources of income.

Reverse mortgage borrowers can tap their home equity to enhance their lifestyle and security, and with this new HECM Saver program, far less of the home equity will be eaten up by high insurance costs. Any remaining home equity stays with the estate after the loan is repaid. So heirs should welcome this new home equity product as well.

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