Traditional Mortgages vs. Reverse Mortgages: Are They Really That Different?

Every year, millions of people across the nation turn to traditional (forward) mortgage loans in order to finance their home purchases.  The typical requirements of these mortgage loans are well known, and many have become comfortable fulfilling them.

Reverse mortgage loans, on the other hand, are far less common. Since their specialized features are not yet fully understood by mainstream media, misconceptions have arisen that lead consumers to believe that they are drastically different from the traditional mortgage loans they are familiar with.  In reality, traditional mortgages and reverse mortgages have more in common than you might think, with reverse mortgage loans having a few distinct features for seniors looking to improve their financial situation.

Common Requirements for Traditional and Reverse Mortgage Loans

Due to lack of education about how reverse mortgages work and how they differ from other home equity loans, many have described some of the requirements as reverse mortgage drawbacks or pitfalls.  The truth is that these requirements are often the same as those that are expected, as well as accepted, of traditional mortgage loans.  Such requirements include the following:

Borrowers must continue to pay:

  • Property taxes
  • Homeowners insurance
  • Basic home maintenance and repairs.

With homeownership and a mortgage comes the responsibility of continuing to pay the home’s annual property taxes, and the appropriate homeowner’s insurance.  If these obligations are not fulfilled as agreed upon under the loan terms, foreclosure may occur under any kind of home loan.

One difference is that, under a traditional mortgage, home repairs throughout the life of the loan are not a requirement, while reverse mortgage lenders may foreclose if they are not upheld. However, if traditional mortgage borrowers do not keep the home in good condition, they assume the diminished value that occurs on a home that is in disrepair, so it may be in their best interest to do so.

Borrowers pay a Mortgage Insurance Premium (MIP).

Mortgage insurance is another requirement for any mortgage loan that is insured by the Federal Housing Administration (FHA).  The reverse mortgage called the Home Equity Conversion Mortgage (HECM) and traditional FHA loans are both federally insured, and require that borrowers pay a mortgage insurance premium in order to decrease risk to lenders if the homeowner defaults on the loan.

In exchange, the benefits of insurance are plentiful for the borrowers of both types of loans.  Insurance for HECM reverse mortgages includes guarantee of funds to the borrower if their lender goes out of business and also provide them protection that they will never owe more than the value of the home when sold.

And for traditional loans, federal insurance may allow lenders to offer competitive interest rates and low down payments to qualifying borrowers.  This allows the borrower to purchase a more expensive home with the smaller required down payment.

An assessment of a borrower’s finances must be conducted before approval.

With any mortgage loan, lenders must ensure that borrowers have the resources to afford the financial obligations of the loan. To do this, lenders require additional documents from the borrower, which may include the following:

  • Credit history documentation
  • Income verification
  • Asset verification
  • Property charge verification
  • Residual Income Analysis
  • Documentation of extenuating circumstances or compensating factors
  • Calculations for life expectancy set asides
  • Residual Income shortfall set asides

Though financial assessments are conducted for both types of loans, there are slight differences between how the result of the assessment affects the borrowers.  With reverse mortgages, if it is determined from the documentation that a qualifying borrower does not have the capacity to cover the financial responsibilities of the loan, they are required to set aside part of their loan funds to cover these obligations, but they are not automatically denied the reverse mortgage loan.

However, with traditional forward mortgages, if a borrower’s documentation reveals they lack the resources to cover loan costs, they may be denied the loan completely.

Costs are comparable and include similar fees.

Traditional mortgage loans are known to have mandatory closing costs and fees, and reverse mortgages are no different.  Both loans require expenses such as loan origination fees, lender servicing fees, and closing costs.  And because typical reverse and traditional mortgage closing costs include many of the same types of fees, the overall expenses are often comparable.  Typical fees on both loan types may include:

  • Appraisals
  • Credit Report
  • Flood Certification
  • Courier Fees
  • Escrow/Settlement/Closing
  • Title Search
  • Title Exam
  • Document Preparation
  • Title Insurance
  • Endorsements
  • Recording Fees
  • County/Mortgage Registration Tax
  • Name Search
  • Special Assessment Search
  • Counseling Fee
  • Survey Fees
  • Pest Inspection

Traditional Mortgages vs. Reverse Mortgages:  Are They Really That Different? - AAG Reverse Mortgage

The Advantages of a Reverse Mortgage Loan

Although traditional mortgages are more common, reverse mortgage loans have advantages that can help senior borrowers in ways that traditional loans cannot.  Reverse mortgage loans are unique, with features designed specifically to cater to the special demographic of seniors ages 62 years and older.  The following are a few advantages that reverse mortgage loans offer over traditional mortgage loans:

Repayment is deferred

One of the greatest advantages that a reverse mortgage has over a traditional mortgage is that repayment of the loan is deferred.  This means that while traditional loans require borrowers to make a payment every month for a number of years, with a reverse mortgage there are no monthly mortgage payments. Borrowers are responsible for paying property taxes, homeowner’s insurance, and for home maintenance.

This is beneficial for senior homeowners because deferring repayment allows borrowers on a fixed income to have more control over their finances.  Instead of paying for a monthly mortgage, those funds are freed up to use on almost anything the borrower wishes, such as paying for daily expenses.  Borrowers may continue to defer repayment for the life of the loan, and the loan only becomes due and payable if the borrower moves away, passes away, sells the home or defaults under loan terms.  These terms include the payment of taxes, insurance and home maintenance as described above.

Added Federal Insurance Protections

The FHA mortgage insurance that protects a lender from borrower default is the same insurance that will protect a borrower as well.  The reverse mortgage insurance guarantees the following safeguards:

  • Even if the lender were to go out of business, the government will cover continued access to the funds for which the borrower signed up.
  • Reverse mortgages are non-recourse loans, which means that lenders do not have access to any assets other than the home to repay the loan, thus there is no personal liability to the borrower or their heirs.
  • Borrowers are also guaranteed never to owe more than the value of the house when sold.
  • In addition, if heirs prefer to keep the home as an inheritance, they only have to repay 95% of loan.

Traditional mortgages do not have these safeguards. They are typically recourse loans, meaning you are personally liable for the loan, and you are not protected if the loan balance is higher than your home value.

As a Non-Recourse Loan, Heirs are Protected

After a borrower passes, heirs take over the responsibility of repaying the remaining reverse mortgage loan balance.  Typically, heirs will simply sell the home and use the proceeds to repay the entire loan.  Proceeds from the sale of the home will always cover the entire repayment amount, whether or not the loan balance has exceeded it. As a non-recourse loan, no other assets of heirs can be taken by lenders to repay the reverse mortgage.

Line of Credit Growth

When choosing the line of credit disbursement option, a reverse mortgage loan offers a feature that a traditional mortgage loan does not.  The line of credit has an increasing growth rate, making more funds available for the borrower to access as time progresses.  With a reverse mortgage, the unused line of credit grows at the same rate the borrower is paying on the used credit, whereas with a traditional home equity line of credit, the credit line stays the same amount as what a borrower had originally signed up with.

Rolled-In Closing Costs and Fees

Another attractive feature of a reverse mortgage is being able to finance many of the costs into the loan amount.  Some traditional mortgage loans may offer to finance fees as well, but reverse mortgage loans have the advantage of combining the feature of deferred repayment with this feature of rolled-in costs.

For homeowners concerned with immediate costs, this could minimize the amount of out-of-pocket and up-front cash needed from the borrower, both before and after loan closing. Fees that may be rolled into the reverse mortgage loan balance may include the loan origination fee, servicing fee, and other closing costs.

To learn about how a reverse mortgage could help to eliminate your current traditional mortgage, call American Advisors Group and speak with an experienced reverse mortgage professional at 1-888-998-3147.  For some seniors, it may be a surprise to realize that a reverse mortgage loan may not be as daunting as it first seemed.  Learning the details about this loan can help you determine whether it may be the solution you are looking for when seeking to maximize your income in retirement.

Source Links:

“Most Frequently Asked Questions: MIP.”  ReverseMortgage.org.  NRMLA.  ND.  Web.  19 November 2015. http://www.reversemortgage.org/gethelp/mostfrequentlyaskedquestions.aspx#mip

“PMI and MIP: Understanding Mortgage Insurance.”  Quickenloans.com.  Zing!.  27 January 2011.  Web.  19 November 2015.  http://www.quickenloans.com/blog/pmi-mip-understanding-mortgage-insurance

Postins, M.C.  “What Does FHA Insurance Cover?”  SFGate.com.  SFGate.  ND.  Web.  4 December 2015.  http://homeguides.sfgate.com/fha-insurance-cover-9461.html

“Reverse Mortgage Costs Explained.”  HomeFinder.com.  NP. ND.  Web. 19 November 2015.  http://www.homefinder.com/research/reverse-mortgage-costs-67id

“How Mortgage Insurance Works for You.”  MGIC.com.  NP.  ND.  Web.  4 December 2015.  https://www.mgic.com/pdfs/71-42265howmiworks_csmr.pdf

“The Reverse Mortgage Assessment: What You Need to Know.”  NewRetirement.com.  NP.  28 January 2015.  http://www.newretirement.com/blog/2015/01/28/the-reverse-mortgage-financial-assessment-what-you-need-to-know/?nabe=4954149098618880:0&utm_referrer=https%3A%2F%2Fwww.google.com%2F

Elmer, Vickie. “Inherited a Home, and a Loan.” NYtimes.com. 17 November 2011. Web. 11 December 2015. http://www.nytimes.com/2011/11/20/realestate/mortgages-inheriting-a-home-and-a-loan.html?_r=0

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