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Why Age Requirement Reverse Mortgage?

HECM Reverse Mortgage

Sep 10

Why is there an age requirement for reverse mortgages?

People who are familiar with reverse mortgages know that a homeowner must be at least age 62 to qualify. In cases where two homeowners are obtaining a reverse mortgage loan, both must be age 62 to be considered borrowers.

Why is there an age requirement to obtain a reverse mortgage? Why can’t younger homeowners who owe little to nothing on their homes take advantage of this type of loan?

The primary reason is that reverse mortgages do not have a specified term; they can stay active for as long as the homeowner lives in the property.

Most other loans and mortgages have a defined end date, be it five years, 15 years or 30 years. That makes it easier for a lender to determine an interest rate and repayment amount to ensure the loan is financially beneficial.

No defined end date
A reverse mortgage, on the other hand, does not have a defined end date. Instead, this type of loan typically ends either when the homeowner passes away or permanently moves out of the home. The borrower can also default on the loan by failing to pay property taxes and insurance, or by not maintaining the property.

Therefore, if reverse mortgages were granted to homeowners who are, say, 55 years old, the loan could be on the lender’s books for 40 or 50 years or more.

Like Social Security and annuity payments, reverse mortgage proceeds are based in part on the borrower’s life expectancy. The older the borrower(s), the more funds that are available because, actuarily speaking, the borrower will not be receiving loan payments as long as a younger borrower. If people younger than age 62 could receive a reverse mortgage, the payments or credit line would have to be set at a much lower amount.

Designed specifically for retirees
Another reason for the age requirement is that reverse mortgages were created to help retirees who have little income but significant equity in their homes. The design of a reverse mortgage helps these individuals turn their home equity into cash without the burden of making monthly loan payments.

Younger homeowners who want or need to tap their home equity have options such as home equity loans, home equity lines of credit, or mortgage refinancing. Plus, they typically still are earning income and can, therefore, make monthly payments on those loans.

The risk to lenders
Another reason for the age requirement is that lenders do not get paid back any funds until the loan closes. The longer the reverse mortgage stays active, the greater the risk the lender will not recoup the full amount owed.

With traditional mortgages and other types of loan, the borrower makes monthly payments that include some of the original principal as well as interest.

In fact, in a traditional mortgage, you will pay the most amount of interest in the first years of the loan. The longer you make payments, the less the amount of interest is required with each payment.

For example, if you borrowed $300,000 on a 5-percent, 30-year mortgage, your monthly principal and interest payment would be just over $1,600.

In the first year of the loan, you would pay almost $15,000 in interest while paying down only $4,400 in principal. In year 15, your monthly payments would reduce your principal by $8,900, while accounting for $10,425 in interest. In year 30, your interest payments would only amount to a little over $500.

In a reverse mortgage, your interest obligation will compound each year and become larger, thus adding to the total amount you will repay at the end of the loan.

For example, if you took a lump sum $100,000 reverse mortgage at a fixed 5 percent interest rate, the loan would accrue $5,000 in interest the first year. That would result in you owing the lender $105,000 after the first year.

Another 5 percent interest would be tacked on to that amount during the second year, resulting in a second-year interest amount of $5,250 ($105,000 x 5%). Added to the first-year balance, your loan repayment amount would be $110,250.

In year 25 of this hypothetical example, the annual interest accrued would be $16,125, and your reverse mortgage loan repayment would total $338,635.

Using the example of a hypothetical 55-year-old getting a reverse mortgage, after 40 years, you would owe $740,000. That’s money the lender would have to wait 40 years to collect, and even then it would have to sell the property for that amount or be reimbursed by the government if the loan was federally insured.

Now imagine you receive your reverse mortgage proceeds as monthly income.

If you completely own a home valued at $300,000, you can borrow about $162,000, minus fees and closing costs. If you don’t receive any of the money upfront, the reverse mortgage will pay about $785 a month as long as you live in the home.

According to a reverse mortgage amortization schedule, assuming an average annual interest rate of 3.5 percent, after ten years your reverse mortgage will have paid you a total of $94,200 while generating interest of $18,722. That means if the loan ended after ten years, you would owe $112,922.

After 20 years, the loan balance would be just over $273,000 ($188,400 in principal and $84,600 in interest). If the reverse mortgage lasted 40 years, the loan balance would be more than $822,000 with the interest payment for just that year equal to $28,000.

Because of how much interest compounds over time, it’s in the lender’s and borrower’s best interests, as well as the federal government insuring reverse mortgages, to minimize the length of reverse mortgage contracts by setting a minimum age requirement.