How to Buy a Home with a Reverse Mortgage
Most people use a reverse mortgage to take cash out of a property they already own. In many cases borrowers have owned and lived in a property for many years and have paid off most or all of their loan balance. In these cases, borrowers use the program to access the significant equity they have in their homes.
Many people may not realize that you can also use a reverse mortgage to buy a home. Using the program to buy a home is different than using a regular forward mortgage to buy a home. With a regular mortgage, the borrower makes monthly payments and pays off the mortgage balance over a set period of time, usually 15 or 30 years. With a reverse mortgage, the borrower makes no monthly payments but the mortgage balance increases over time. Additionally, the loan has no set term and lasts as long as the borrower occupies the property. The principal loan balance is due in full when the borrower sells, vacates or refinances the property. So in short, you can use a the program to buy a home and make no monthly loan payments but the downside is that your loan balance grows over time.
Another importance difference between using a reverse mortgage to buy a home as compared to a regular mortgage is that you are required to make a much large down payment. For example, with a regular mortgage you can buy a home with a down payment of 20% or lower but a reverse mortgage usually requires a down payment of approximately 50% so you need to have significantly more equity in the property. In many cases, borrowers sell their existing home and then use the proceeds to pay for the down payment on another home.
Another important distinction is that regular mortgages are available to borrowers of all ages while at least one borrower is required to be 62 years old to qualify for the program.
Below, we outline how buy a home with a reverse mortgage and eliminate your monthly mortgage or rent payment. This financing option is especially well-suited for borrowers with fixed incomes or significant financial reserves but they are not without risk. When understood correctly and used properly, however, they can provide you with significant financial freedom. Review our comprehensive explanation of how to buy a home with a reverse mortgage to understand if using the program to buy a home makes financial sense for you.
Meet Borrower Eligibility Requirements
The borrower eligibility requirements for a reverse mortgage are different than for a regular mortgage. At least one borrower must be at least 62 years old. The older the borrower, the larger the larger the loan you can qualify for. Unlike a regular mortgage, there is no borrower employment requirement but borrowers must meet minimum credit score requirements. Borrowers are also required to complete a HUD-approved counseling class which typically costs $100 - $175.
Review our comprehensive Reverse Mortgage Guide to understand program eligibility requirements
Demonstrate the Ability to Pay Monthly Housing Expense
This is a really important point when it comes to qualifying for the program. Although a reverse mortgage does not have a standard debt-to-income ratio limit like a regular mortgage, the borrower must demonstrate the ability to pay for ongoing monthly housing expenses including homeowners insurance, property taxes, homeowners association (HOA) dues (if applicable) as well as property maintenance and upkeep.
Lenders should verify that borrowers have sufficient monthly income or savings in reserve to pay for these expenses. If the borrower fails to pay ongoing housing expenses the property could go into default or foreclosure and the borrower could lose the property. The lender will also review the borrower’s monthly debt to make sure the he or she can afford the housing expenses on top of the borrower’s other monthly bills. Borrowers with limited incomes or savings and high recurring monthly debt will likely find it challenging to qualify for the program.
The amount of ongoing housing expenses depends on several factors including the value and location of the property. For example, property taxes can range from .3% to over 3% of the property’s value depending on your city and state. Additionally, the higher the property value, the higher the homeowners insurance premium. Borrowers should be sure to understand the expenses involved in owning a property before using a reverse mortgage to buy a home.
Understand Total Monthly Housing Expense When You Own a Home
Understand Property Eligibility Requirements
Borrowers must live in the property they purchase so investment properties and second homes are not eligible. The property can be one-to-four units as long as the borrower occupies one of the units. Borrowers can use the program to purchase a home or condominium although the condominium must be located in a HUD-approved project. If you are considering buying a condominium make sure the project is HUD-approved before moving forward.
Determine Your Down Payment -- It May Be Higher Than You Think
Buying a home with a reverse mortgage requires a much larger down payment than buying a home with a regular mortgage. Whereas buying a home with a regular mortgage typically requires a down payment of 3% - 20% of the property purchase price, the program typically requires a down payment of approximately 50%, depending on the borrower's age and property value. The older you are the lower the down payment you are required to make, because you qualify for a larger mortgage amount. For example, a 62 year old borrower may be required to make a 53% down payment while a 70 year old borrower may only be required to make a 48% down payment.
For example, if you want to buy a $300,000 home you could be required to make a down payment of approximately $150,000, or 50% of the purchase price. The remaining $150,000 of the purchase price plus money for closing costs would come from the loan proceeds.
Understand the Pros and Cons of a Reverse Mortgage
The down payment which can come from your personal savings or by selling your current home and using the proceeds for the down payment on your new home. In many cases borrowers sell their existing home, pay off their current mortgage and use the remaining money for the down payment on the home they purchase. Under this scenario, the borrower replaces a regular mortgage on their old home with a reverse mortgage on their new home which also eliminates their mortgage payment.
Determine How Much Home You Can Afford
What price home you can afford to buy with a reverse mortgage depends on the size of your down payment and how much you can afford to spend on monthly housing expenses. The higher your down payment, the higher the price home you can afford. For example, if you make a $100,000 down payment you can afford an approximately $200,000 home and if you make a down payment of $150,000 you can afford an approximately $300,000 home (assuming the down payment represents 50% of the purchase price in both cases). The higher the price of the home, the higher the monthly housing expenses so borrowers need to demonstrate that they have sufficient income or assets to afford the more expensive home.
There is also a limit to the size of mortgage you can obtain. Your loan amount cannot exceed the FHA reverse mortgage loan limit of $1,089,300. This is also known as the FHA HECM limit (Home Equity Conversion Mortgage). Limiting the size of mortgage you can obtain serves to restrict how much home you can buy with the program.
Finally, borrowers should also consider closing costs such as lender origination, appraisal, title and settlement agent fees in determining how much home they can afford. Closing costs vary depending on property value, location, interest rate and mortgage program but typically run between 0.5% and 2.5% of the property value. Borrowers are also required to pay an upfront FHA mortgage insurance premium (MIP) which is 2.0% of the property value and an ongoing FHA MIP, which is 0.5% of the loan balance, calculated on a monthly basis. The borrower typically does not pay for either of these fees out of pocket as the upfront MIP is included in the closing costs which are financed as part of the loan and the ongoing FHA MIP fee is added to the mortgage balance.
Lender, settlement agent, title and up-front FHA MIP costs are typically financed which means they are included in the loan amount and paid for with the proceeds from the mortgage, although this means borrowers receive less proceeds that can be used to pay for the home they are buying. Borrowers should work closely with their lender and consider their down payment, monthly housing expenses and closing costs to determine how much home they can afford to buy with a reverse mortgage.
Shop Reverse Mortgage Lenders
Borrowers should shop and compare lenders like they would for a regular mortgage. Just like with a regular mortgage, the lower interest rate and fees, the more money the borrower saves. There is typically less variation in interest rates across lenders but more variation in fees and closing costs. Borrowers can also elect to pay discount points to lower their interest rate.
Reverse mortgages are relatively lucrative for lenders and borrowers can use this information to their advantage by negotiating lower up-front fees. Borrowers may also be able to negotiate that lenders pay for certain closing costs such as the appraisal fee. Borrowers should compare proposals from multiple lenders and be prepared to negotiate to find the loan with most attractive terms.
You can apply for the program with any HUD-approved lender. Mortgage banks are the most common type of lender and there are multiple mortgage banks that specialize in purchase loan programs. Mortgage brokers are another lender option for borrowers. Mortgage brokers act as personal shoppers for borrowers and compare mortgage terms across a network of lenders to find the best loan terms. FREEandCLEAR recommends contacting at least one mortgage bank and mortgage broker before selecting a lender for your lender. When shopping lenders borrowers should also understand the lender’s qualification requirements and the transaction timetable so that there are no surprises as the process progresses.
Use the FREEandCLEAR Lender Directory to find lenders that offer reverse mortgages
Select a Lender and Buy Your Home
After you have determined what size mortgage and home you can afford and compared multiple lenders you are set to select a lender and purchase your home. In addition to comparing key terms such as mortgage rates and closing costs, make sure that the lender you select has extensive experience with reverse mortgage home purchase transactions and ask for client references. Working with a capable and experienced lender is the best way to ensure a successful transaction so that you can buy the home you want.
Review Tips for Saving Money on Your Reverse Mortgage
Sources
"How the HECM Program Works." Federal Housing Administration. U.S. Department of Housing and Urban Development, 2020. Web.