How Does A Reverse Mortgage Actually Work?

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Why rates dropped

Welcome to Mortgage Mom Radio. I'm Debbie Marcoux, I'm the Mortgage Mom, and today we're covering two subjects: interest rates, because they definitely came down and we got a nice little rally, and reverse mortgages, because lately quite a few people have been asking about them. I think it's a very special product with a bad name attached to it that isn't at all what people believe.

So: why did rates come down, and how much? We've seen about a sixty basis point improvement. That might sound like a foreign language, but it equates to about six tenths of a percent.

Last Thursday the inflation report came out and told us things are looking better than they were. Everybody got very excited — the stock market was up a thousand points, crypto had a little rally. The report was that inflation numbers were actually starting to come down. Not staying the same, not inching up a little — actually coming down. That threw the market into a rally, and when we get a rally, rates improve.

I talk about this often on the show: it depends on what they're talking about. Somebody makes an announcement or a report gets published, and it can throw mortgage-backed securities, the stock market, the bonds — everything — into a tizzy, for good or for bad.

I can't put an exact number on it because rates change every day, but from our highest to where we dropped, it was about 0.60 of improvement. So if you've been hearing seven and a half percent, which is roughly where we've been for the last couple of weeks, now you're in the high sixes. On government loans, FHA and VA, we came down into the low sixes, which is very nice. And if you're a buyer who can get the seller to pay some closing costs and buy your rate down a couple of points, you could very well be into the high fives.

Now — my personal opinion, the Mortgage Mom, not a financial advisor. I don't think rates are going to keep dropping. We got one really big drop on Thursday and it's held pretty steady since: Monday, Tuesday, Wednesday. I think we got our dip, we've plateaued, and the next move is the upward escalator.

Why? Because after that great report, another one came out this week saying the Federal Reserve understands inflation got better but it is not fixed, we've still got a long way to go, and they do not plan to let up. We're rolling into a holiday week, and the next Fed meeting is at the beginning of December. They told us last time, when they raised in November, that they were planning to raise again at the next meeting. So we'll start to see anticipation build, and I believe rates climb back up.

So if you've been thinking about refinancing, or consolidating a first and a second into one loan, or doing a renovation — now is the time. I've never steered you wrong in all the years I've done this show: lock in a rate right now. Over the next week to a week and a half they are going to start anticipating the next hike. That's my two cents of the day.

Q&A: refinancing, renovation loans, and where the money sits

Cindy asks: “Would we be able to refinance at the moment?”

Great question. You can always refinance — refinances aren't gone whatsoever. It's a matter of where your interest rate is today and whether it makes sense based on your personal scenario. If you'd rather not put your situation into the feed for me to read aloud, that's completely fine. Call the office and get me or one of the team on the phone, and we'll talk it through privately.

Another listener asks: “What kind of loan do I need to do an addition to the house? I need more cash than the equity I have available.”

Really great question. There are plenty of loans where, if you have the equity, you can pull cash out — either in a first mortgage or a home equity line of credit. But you're saying you don't have enough equity for a standard refinance or an equity line. In that case you're a very good candidate for a renovation loan.

Renovation loans come a couple of ways: a conventional renovation through Fannie Mae, and an FHA renovation loan. We determine the work you're going to do, we get your contractor's bids for that work, and we provide the bid to the appraiser. The appraiser then appraises your home and adds the work you plan to do — the bedroom, the bathroom, the larger family room. They appraise the property based on the future value once those improvements have been made. That's what allows us to close the refinance and get you the cash, and then you start the work with your contractor.

Follow-up from the same listener: “Does the money stay in escrow during the build?”

It doesn't actually stay in escrow — it remains with the lender. The bank holds the money, and as you start the project they disburse funds to the contractor as you go. The contractor gets a disbursement and starts to build. They send an inspector out to see what point in the project the contractor is at. The contractor requests additional funds, they release another set of funds, the contractor keeps building, and it continues that way as you roll through the project.

Maria asks: “I have a five-acre lot and I want to put a modular home there. Can you help me with the loan?”

It really depends, and I'm going to be honest with you — probably not. What it sounds like you need is financing to purchase that home, and we don't do new construction loans. If you're getting a loan for the manufactured home itself, that's mobile home lending, which is its own thing.

What I'd actually advise: you can call the office and talk to us, and if it isn't something that works for our group, I have a fantastic mobile home lender I can refer you to. But you may want to start with the company you're buying the home from. Manufacturers generally have a lender they refer you to if you're looking at one of their units. That's the very best place to start. And if that doesn't help in any way, call my office — we'll get you a name, we'll get you a number, we'll tell you who to call and how to find the answer you need.

Q&A: equity line or new first mortgage?

A listener asks: “Do you feel getting a home equity loan or a refinance is better right now if I need to pull out money?”

A very good question, and one I've answered quite a few times, because we get it daily from people calling the office. It really depends on the person, what their current rate is on the first mortgage, whether they even have a mortgage right now, and how much cash they're trying to pull out.

A quick example. If your mortgage balance is $200,000 and your rate is 3%, and you call us and we say we're going to give you 7% on a new loan, you might think that doesn't make sense at all. But if you owe $200,000 and you're looking for another $200,000, and the rate on a home equity line of credit is 10% or more, then it probably does make sense to put all four hundred thousand at 7%.

And the good news is we just got that nice dip. So right now there's a very good chance that if you called us looking to do a cash-out, or a debt consolidation, or to combine your first mortgage and your equity line into one loan, we could get you locked into something under seven — in the six percent range. We can also talk about paying points to buy that rate down further if it's something you want to hold for a long time. All of your options, and the math behind them, is what we give you so you can make the decision.

My own lean: if you owe $200,000 and you want to pull out a hundred or a hundred and fifty thousand, you're probably better off doing one brand new mortgage at a fixed rate for the long term. When rates come down in the future you can always refinance again. Equity lines of credit are adjustable, their rates are significantly higher than what you'd lock on a first mortgage, and because they're adjustable they can keep going up — and as I said, the Fed is meeting again in December and is expected to raise. Could they change their mind? They could. But I'm reading them saying the CPI numbers are better and they plan to stay the course.

But we've got to talk to you. We've got to know how much you're looking to take out, what you owe on the first, and what your current rate is, before anyone can tell you what's actually best.

Q&A: first-time buyer, four-unit property

Nora asks: “I want to begin the process. I'm a first-time home buyer and I'd like to know where to begin — a four-unit property preferably.”

Fantastic. We're here to help first-time buyers get the education they need — that's why I do the home buyer workshops. They're on the YouTube channel under a playlist called Home Buyer Workshop. It's a three-hour workshop, so you might have to take me in pieces. But everything you need to know about getting started is in there: the process from beginning to end, what the words mean, what pre-approved means, how to find the right real estate agent, what happens when you're getting ready to close. That's step one if you're not quite ready to make the phone call.

Step two — and you sound ready — is to call us and let us start your application, get your documentation, and see what you qualify for. Then you have your numbers and your price range.

Step three: because you're talking about a four-unit building, we want to make sure you're working with a real estate agent who understands units and can give us a good indication of what the additional units would rent for. We can use that rental income to help you qualify for the purchase. And depending on the program: if you're looking at a conventional loan, you'd need at least 25% down for a four-unit building. If you're doing FHA, there are some additional guidelines you need to be aware of as you're out looking at properties.

So there's a lot to discuss, and I just threw all of it at you very quickly — which is exactly what we don't want the process to feel like. We take you step by step: learn the process, get pre-approved, then talk about properties and an agent, then get out there looking.

Another listener asks: “What are the current rates for VA loans?”

VA loans are going to be lower than conventional — they have some of the best rates of any product we carry. They depend on your credit score, your loan-to-value, and all the same factors as any other mortgage, so I have to give you a range: anywhere from the high fives to the mid sixes depending on you. A lower credit score puts you at the higher end of that. But significantly better than where we were previously.

What a reverse mortgage actually is

A reverse mortgage does exactly what the name says: it goes in reverse. Instead of making a payment every month and watching your balance drop, you don't make a payment — or you make a very small one, depending on how you set it up — and your balance gets bigger. It keeps increasing for as long as you have the loan, and that loan stays open for as long as you live there.

Who is it good for? Somebody whose home is the bulk of their assets at retirement. Maybe they worked a long time for a company but don't have a pension. All they have is Social Security. They have a 401(k) but the balance isn't very big. They never really got the chance to do a lot of investing or saving — but they have this house, it's worth a good amount, and they don't owe very much on it, if anything at all.

They could sell and take the lump sum — but where are they going to go? They want to stay where they are. They want to live in the home they've always lived in. Their property taxes are low because they've been there a long time. When real estate is genuinely your retirement vehicle, that's where a reverse mortgage comes in.

Now, if you have a fantastic monthly pension, Social Security, some self-employed income on the side, and more than enough budget to make a mortgage payment — then a reverse mortgage isn't for you. Keep the home free and clear, or keep making the payment to pay the debt off, so that when you pass you leave the home to your heirs with a good amount of equity in it. A reverse mortgage does eat away at your equity. But that's really no different from selling the home, taking the cash, and living on it.

What your family inherits

This is what I get from families who are upset when they find out a parent has looked into a reverse mortgage. They feel like the home they thought they were going to inherit is going to be lost. It isn't.

Number one: title does not change. You are still the owner of the property.

So what does that mean for sons and daughters? When you pass, the loan on the home has to be paid off. They get six months from the time of your passing to do that. They can refinance the property or they can sell it — so they do have the option to keep the home in the family. It does not automatically go to the bank. It is not taken away from them. They inherit the property exactly as they would in any other situation. If you pass and you have an ordinary mortgage, it's the same thing: they take over the mortgage, or they refinance it, or they sell. It really is no different.

Second thing people misunderstand. The reverse mortgage stays on the home for as long as you live. Let's say you took it at 62. They cannot at any point say sorry, your house isn't worth what it was, you owe more than it's worth, we're cutting you off and you have to pay us back. That doesn't happen. If they put you in the reverse mortgage, the terms you agreed to are yours for your lifespan. That doesn't change.

And if property values drop, or you live substantially longer than the bank anticipated, and you now owe more on the house than it's worth — your heirs are not required to pay that back. If the house is worth less than what you owe, they can choose to let the bank take it. If it's worth more, they can refinance or sell.

What the lender checks

A lot of the misconceptions people carry come from before the Dodd-Frank Act and the mortgage reform legislation. Things were done differently in those days. Since then everything has been rewritten to protect the consumer, so it is much different today than it used to be.

We are going to check your debt-to-income ratio. We need to make sure you have the means to stay in the home — to cover your property taxes and your homeowners insurance, and to cover your other monthly expenses. It's qualified significantly differently from a normal mortgage, it is not at all the same, but we do check that you have the funds to take care of yourself.

We are also going to check your credit. Way back in the day it didn't matter what your credit looked like. Today it does. You can have a low credit score, but you won't be able to get as much financing — we won't go to as high a loan-to-value as we would for somebody with a better rating, no tax liens, nothing else negative on the report, and no recently missed mortgage payments. Creating protections for the consumer also brought in additional guidelines the lender has to follow when qualifying you.

How age sets the maximum loan

Who can get a reverse mortgage? It starts at age 62 — you have to be at least 62. And the younger you are, the lower the loan-to-value they will allow.

I've got my cheat sheet right here so I'm reading this accurately. At 62 years old the maximum loan-to-value is about 0.424 — call it 42%. So if your home is worth a hundred thousand dollars, the maximum loan that can be offered is forty-two thousand. That's what your loan can start at. If you own the house free and clear and it's worth a hundred thousand, at 62 you could take a forty-two thousand dollar loan, cash in hand — minus closing costs, obviously.

Then every month that you don't make a payment, your balance increases. So they're leaving the other 58% as equity in the property, because your life expectancy has so many years left that they assume the balance will grow across all those years.

Say you're 80 years old, you owe nothing, and the house is worth a hundred thousand. You'd be able to take about 0.546 — call it 55%. So the forty-two thousand becomes about fifty-four or fifty-five thousand, and you're not making a payment for your complete life expectancy. At 90 we could go as high as 0.66 — 66% of your home's value.

Here's how that plays out. If you have a mortgage today and you owe $50,000 on a $100,000 property, you would not be a candidate at 62. But at 75, we'd be able to pay off the mortgage you have, set you up with the new reverse mortgage, and you're not making payments going forward.

The five things we need to quote you

It's very easy for us to get you a quote — there isn't much we need. Here's the list, so you're prepared when you call.

Names and dates of birth for everyone who will be on the loan. If it's just Mom, or just Dad, or both — and note that if they live together in the home, they both have to be on the loan, and both have to be at least 62. Then: the property address. Your best guess at what the property is worth, just so we have a place to start. How much you owe on the current mortgage. How much your property taxes are per year. And how much your homeowners insurance is per year.

That's pretty much it. If there's an amount of cash you'd like to have in hand, know that too, so we can factor it into the quote.

Whether it's for you, a friend, a family member, or a parent who's been thinking about it — we can get you the numbers very simply, and you can take them back to them. Call the office at 844-935-3634, that's 844-WE-LEND-4.

Wrap-up

Back to where we started: we saw a really great rate drop. My personal opinion — the Mortgage Mom, not a financial advisor, just somebody who's been in the industry approaching thirty years — is that the lower rates are very short-lived. So if you've been thinking about any kind of lending, taking out cash, debt consolidation, consolidating a first and an equity line into one loan, or purchasing a home, you need to reach out and do it now. Talk to us about lock-and-shop programs, anything we can do to get you locked in. We had a big rate drop nobody anticipated, and I do not expect it to stick around much longer.

I always forget to do this, so: happy holidays, everybody. I will not be on next week, because next Wednesday is the day before Thanksgiving, and that's the day I roll up my sleeves and start cooking — from scratch, starting Wednesday morning, and we eat Thursday at three. So we'll be dark next week and I'll be back the Wednesday after. Happy Thanksgiving. You'll see me after the bird is done. Talk to y'all real soon.