NEW YORK (BankingMyWay) -- Many older homeowners want to move but dread a hefty mortgage payment. There are various ways to remedy this problem, including one that has too often been overlooked: using a reverse mortgage for a home purchase. Usually, these loans are for taking cash out of a home one has had for many years.
The so-called HECM for Purchase has been available since 2008, but is rarely discussed. It allows a homeowner -- or even a renter -- to use a reverse mortgage to buy a home. It can be a good option for those who want to relocate while avoiding mortgage payments.
A reverse mortgage is a government-backed loan that allows a homeowner aged 62 or older to borrow against the equity in the home -- the difference between the property’s value and the remaining debt on any mortgage or home equity loan.
The borrower makes no payments. Instead, the principal and gradually accumulating interest charges are paid off after the homeowner dies, moves or sells the property. The debt can never exceed the proceeds from the property’s eventual sale, so the borrower’s other assets are safe. Because there are no payments, the borrower does not need an income to qualify for a reverse mortgage.
Typically, a reverse mortgages is used by a homeowner who wants to stay in the home he or she has had for many years. The loan can convert a portion of the property owner’s equity to cash, either a lump sum or monthly income.
But there are several ways to use one of these loans to purchase another property, says Jack M. Guttentag, professor of finance emeritus at the Wharton School of the University of Pennsylvania.
On his website, The Mortgage Professor, Guttentag says the simplest way is to buy the new home with cash, then take out a reverse mortgage to convert some of that equity back into cash. This is especially useful for those who want to build a new home, since reverse mortgages cannot be used for construction. But this approach requires a large cash outlay, from sale of another home or some other source.
The second approach is to take out an ordinary mortgage to buy the new home, then take out a reverse mortgage to pay off the original loan. This way the homeowner reduces or eliminates the monthly payments on the ordinary mortgage. The drawback: the homeowner must have enough income to qualify for the initial loan, and many retirees do not.
That leaves the third option, the HECM for Purchase program, which allows purchase of an existing home, including one that is newly constructed.
“Seniors using this program must have the means to pay the difference between the sale price of the property plus settlement costs, and the maximum amount they can draw on the HECM,” Guttentag says. “The maximum draw is based on the lower of the sale price, appraised value and FHA’s maximum loan amount.”
With a reverse mortgage the homeowner cannot borrow the full value of the home because the accumulating interest charges would then create a debt exceeding the home’s value, causing a loss for the lender after the home is eventually sold. Older homeowners can borrow more than younger ones, because there is less time for the debt to grow too large.
The HECM for Purchase program is a good option for people who want to move and convert equity to cash, but do not want to downsize to buy a cheaper home than the one they are selling. As with all loans, it’s important to read the fine print, as charges on reverse mortgages can be steep.
More on mortgage issues for existing homeowners:
Time to trade down your home
Using home equity in retirement
Reverse mortgage misuse too common
--By Jeff Brown
—For more ways to save, spend, invest and borrow, visit MainStreet.com.