Complete Guide to Reverse Mortgage Protections
By: Courtney Jorstad
September 11, 2023 • 7 minute read
A reverse mortgage is one of many financial products that allows homeowners to access their home equity, but it’s the only financial product exclusively available to older homeowners that doesn’t require monthly payments to pay it back.
For that reason, it makes it a very attractive way to tap into additional cash in retirement, whether the goal is to supplement monthly retirement income, do much-needed home renovations, or use it for unplanned expenses.
However, you may have also heard negative stories from previous years about reverse mortgages and are wondering how safe this product is.
In response to some of the risks associated with reverse mortgages in the early years, the federal government has passed new laws and established better protections for reverse mortgage borrowers in recent years so that homeowners can feel more confident about pursuing this type of loan.
How Reverse Mortgages Work
The Home Equity Conversion Mortgage (HECM), commonly known as a reverse mortgage, is a federally-backed home loan that allows homeowners who are 62 years old or older to withdraw money from their home’s equity.
If homeowners still have a traditional mortgage on their home when they take out a reverse mortgage loan, the loan proceeds will pay off that mortgage first. For the remaining loan balance, the reverse mortgage borrower will then choose to receive money as a lump sum, a line of credit, and/or monthly installments.
A reverse mortgage loan can only be obtained on a homeowner’s principal residence, which means that a secondary home does not qualify.
Homeowners are still required to pay property taxes, homeowner’s insurance, and maintain the home.
A reverse mortgage loan is paid back when the homeowners sell the home, the home is no longer the primary residence of the homeowners, or when the last remaining borrower passes away.
Where Do the Reverse Mortgage Protections Come From?
HECM reverse mortgages are the most common type of reverse mortgage and the only reverse mortgage that is backed by the federal government.
Reverse mortgages are insured by the Federal Housing Administration (FHA) and regulated by the U.S. Department of Housing and Urban Development (HUD).
The reverse mortgage protections that are in place typically stem from one of these federal agencies.
Some states have created additional protections beyond the federal government. However, this guide to reverse mortgage protections focuses on those established by the federal government.
Reverse Mortgage Protection #1: Mandatory Counseling
In order to officially file an application for a reverse mortgage, all potential borrowers must first complete a counseling session with a third-party HUD-approved counselor.
The purpose of the counseling session is to educate homeowners on how reverse mortgages work, to discuss how appropriate a reverse mortgage is for their personal situation, and to go over alternatives to a reverse mortgage.
Homeowners are encouraged to include others in the counseling session such as a family member or a financial adviser.
According to HUD, one of the reasons for the counseling requirement is to ensure that the homeowner’s decision to get a reverse mortgage is solely the homeowners, and that he or she isn’t being pressured by someone who may have a financial interest.
Once the counseling session is completed, the counselor will give the homeowners a certificate that will need to be presented to the lender before moving forward.
Reverse Mortgage Protection #2: Financial Assessment
The Federal Housing Administration (FHA) requires lenders to perform a financial assessment of each prospective borrower.
The purpose of the assessment is to make sure that the homeowners are going to be able to continue to cover the costs associated with the home such as the property taxes, homeowner’s insurance, HOA fees (if applicable), and maintenance.
To perform a thorough assessment, the lender will likely ask for the following information: current income, debts, tax returns, bank statements, and a credit report. While a good credit score is not a requirement for obtaining a reverse mortgage, a credit report will show if there’s a history of missed payments or any other similar issues.
The purpose of the assessment is to prevent foreclosure. Reverse mortgage borrowers can face foreclosure if they fall behind on property taxes, home insurance, and home maintenance.
Reverse Mortgage Protection #3: Right to Cancel (Right of Rescission)
The reverse mortgage right to cancel or right of recission means that reverse mortgage applicants can cancel the loan at any time during the application process including three business days after the loan closes.
If an applicant decides to cancel, it must be done so in writing. The Consumer Financial Protection Bureau (CFPB) recommends sending the cancellation request by certified mail and to request a return receipt so that the sending and receiving of the cancellation request is documented. It is also recommended that all communication between the applicant and lender is documented.
Once the cancellation request is received, the lender will have 20 days to return any money provided toward financing the loan.
Reverse Mortgage Protection #4: Non-Recourse Loan
Reverse mortgages are not paid back in the form of monthly mortgage payments. They are paid back when the homeowners sell the home, they no longer live in the home as their primary residence, or when the homeowner passes away.
One common concern about paying back a reverse mortgage is what happens if the final loan amount is more than the value of the home. Will they, or their heirs, have to pay the difference out of pocket?
Fortunately, a reverse mortgage is a “non-recourse loan.” According to HUD, this means that the borrowers “will never owe more than the loan balance or the value of the property, whichever is less.”
In addition, the lender is not allowed to take or use any other assets besides the home to pay off the loan.
The mortgage insurance premiums that reverse mortgage borrowers pay goes toward ensuring this protection.
Reverse Mortgage Protection #5: Non-Borrowing Spouse Protections
There are cases in which a spouse is not named as a borrower in a reverse mortgage. One of the reasons is that the amount homeowners are able to borrow is based on the age of the youngest borrower. The younger the borrower, the less they are able to borrow. The older the borrower, the more they are able to borrow.
A couple may decide to leave a spouse off the reverse mortgage if he or she is significantly younger than the other spouse so that they are able to borrow more.
In previous years, if the older spouse passed away while they still lived in the home, the younger spouse would either be asked to pay off the reverse mortgage loan or the home would go into foreclosure.
HUD changed the rules in 2014, as the result of a court battle, allowing eligible non-borrowing spouses to remain in the home as long as the following requirements and loan obligations are met:
- The name of the non-borrowing spouse has to be included on the loan documents as the non-borrowing spouse.
- Both the borrower and the spouse have to be legally married when the reverse mortgage loan is obtained OR in a committed relationship similar to marriage but were unable to marry before the reverse mortgage loan closed due to the gender of either the borrower or non-borrower.
- The nonborrowing spouse must live in the house as his or her primary residence and needs to be living in the home when the reverse mortgage loan closes.
- After the borrowing spouse passes away, the non-borrowing surviving spouse needs to continue to pay the property taxes, homeowners’ insurance, and maintain the home.
- When the borrowing spouse passes away, the reverse mortgage loan needs to be in good standing, meaning that the homeowners aren’t behind on property taxes or homeowner’s insurance.
The time that an eligible nonborrowing spouse is allowed to remain in the home is called the deferral period.
If these requirements are not met, then the loan will become due and payable.
An ineligible non-borrowing spouse is defined as a spouse who is no longer living in the home, the home is no longer his or her primary residence, or they weren’t married to the borrower when the loan closed.
Reverse Mortgage Protection #6: Cross-Selling Ban
In 2021, those who are 60 years old and older lost $1.7 billion as the result of elder fraud, according to the Federal Bureau of Investigation (FBI).
Since reverse mortgages are a product that is offered to older homeowners who are at least 62 years old, the federal government has placed a ban on cross selling a reverse mortgage with other financial products.
The goal is to prevent would-be scammers from convincing older homeowners to get a reverse mortgage so they can invest their proceeds into another financial or insurance product.
There are no rules about how reverse mortgage proceeds may be used, but if someone is trying to get you to take out a reverse mortgage so you can buy something else from him or her, know that this is illegal.
[Source: Justice Department]
The safeguards that have been established by the federal government signify a conscientious effort to create a balanced environment for those considering a reverse mortgage.
By mitigating potential risks, these protections ultimately bolster reverse mortgages as a viable option for older homeowners seeking financial flexibility in their retirement years.
This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.