Reverse mortgage demand is spiking due to COVID-19

Thinking about a reverse mortgage? You’re not alone. Demand is soaring.

In 2019, there were only 2,600 reverse mortgages opened per month, according to the National Reverse Mortgage Lenders Association (NRMLA).

Recently, that number has nearly doubled.

Reverse Market Insight reports 5,000 reverse mortgage originations in May 2020 alone.

For some affected by the COVID-19 economy, who need quick cash and lower monthly costs, a reverse mortgage may be appealing.

But there are serious drawbacks to consider, too. Here’s what to know before using a reverse mortgage to tap your home equity.

In this article (Skip to…)

• Why the new interest in reverse mortgages?
• How a reverse mortgage works
• Reverse mortgages: Benefits
• Reverse mortgages: Drawbacks
• Who qualifies for a reverse mortgage?
• How do you pay off a reverse mortgage?
• Reverse mortgage alternatives
• Who to talk to about a reverse mortgage

Given their age, location, and property value, the Smiths qualify for $222,400 in financing according to the MyHECM reverse mortgage calculator. The loan results look like this:

• The $50,000 remaining loan balance is paid off. The Smiths save $492 a month in mortgage payments
• They also receive a $615 monthly payment for life
• They are now ahead by $1,107 per month ($492 plus $615)
• Instead of lifetime payments, they might elect to get a $1,512 monthly check for ten years

That sounds like a sweet deal. But there are inherent drawbacks to the reverse mortgage model that need to be considered.

There are also costs to originate a reverse loan.

For example, the Smiths might pay $8,000 for the up-front mortgage insurance premium, a $4,000 origination fee, and $2,800 in closing costs.

That’s a total of $14,800 in up-front expenses. They also have a 0.5% ongoing mortgage insurance fee calculated monthly. Those are big fees to stomach for someone on a tight budget.

And, a reverse mortgage can be foreclosed. This may seem odd for a loan with no required payments for principal and interest, but other obligations continue. Borrowers must keep paying taxes, insurance, and HOA fees. Stop paying those, and a reverse mortgage can be foreclosed.

Perhaps most importantly, seen over the long run, reverse mortgage benefits may decline in value because of inflation.

Think of the $615 fixed monthly payment received by the Smiths. It will buy a lot less over time as inflation eats away at buying power.

According to the Consumer Financial Protection Bureau, “your borrowing limit is called the ‘principal limit.’ It takes into account your age, the interest rate on your loan, and the value of your home.

“In general, loans with older borrowers, higher-priced homes, and lower interest rates will have higher principal limits than loans with younger borrowers, lower-priced homes, and higher interest rates.

“If you are married or co-borrowing with another person, the principal limit is based on the age of the youngest co-borrower or Eligible Non-Borrowing Spouse.”

A home equity line of credit (HELOC) can be an attractive option because such loans generally have small up-front costs. To get a HELOC you need equity plus a lender willing to offer such financing.

Here’s another example: The Smiths have a $400,000 property and $50,000 in mortgage debt. They have roughly $350,000 in equity, though some lenders might calculate a lower value.

If lenders will finance 80% of the property’s value, that’s $320,000. Subtract the $50,000 in outstanding mortgage debt, and the Smiths can get as much as $270,000 in HELOC financing.

The catch is that with a HELOC, the borrower has to make monthly payments. The Smiths have a limited monthly income. While a HELOC may be attractive, it does not solve the Smiths’ need for more monthly cash or lower monthly costs.

Lender practices can be another problem. Lenders may no longer offer HELOCs. The reason is that a HELOC is a second lien. Lenders worry that in the COVID-19 economy, home values might fall. That concern makes HELOCs too risky for some lenders.

Cash-out refinancing

Instead of a HELOC why not a cash-out refinance? The Smiths have plenty of equity, so a cash-out refinance might work.

Lenders might also prefer a cash-out refinance because, unlike the typical HELOC, it is a first-lien loan. If home values go down, that’s the loan lenders want. It gives them the most protection in case of a foreclosure.

But, just like a HELOC, a cash-out refinance creates a new and additional monthly cost. That’s something the Smiths are trying to avoid.

The option to move

The Smiths may elect to downsize and move. They have substantial equity. What if they sell the property and buy a smaller or less expensive home for cash?

Sellers can sometimes wind up with a mortgage-free property plus cash in the bank. Also, if they move to a jurisdiction with no state income tax, the Smiths can save even more.

The urge to move has increased not only as a result of the coronavirus but also because of changing work opportunities.

“During the first month of the pandemic, interest in rural areas skyrocketed while interest in cities fell, with many urbanites dreaming of packing up and heading for the hills,” said Redfin lead economist Taylor Marr.

“Some of that boost in rural areas proved to be temporary, but it appears to be more sustainable in small towns, which may be a more realistic option for those looking to work from home primarily or commute into the office once or twice a week.”

If you’re considering a reverse mortgage, your first step will be to speak with a professional. HUD maintains a nationwide network of reverse mortgage consultants who can help counsel you on whether or not a reverse mortgage is the right decision for you.

If you’re more interested in a cash-out refinance or home equity line of credit, your next course of action is to check rates and speak with a lender to see which option best suits your needs.