You have begun the process of buying a new home and are hearing about using a reverse mortgage for purchase loan. You like the idea of being able to put 40 to 55%¹ down, depending on your age, and not having a principal and interest payment for your life in the home. Once you begin the process of speaking with a lender and getting a quote, however, you are put off by the high closing costs. Sound familiar?
The lion’s share of the closing costs, in most states, is the 2.5% upfront FHA mortgage insurance premium (MIP). On a $400,000 purchase price, the fee is $10,000. That’s not a small sum of money, but you have another option. What some loan officers don’t know (or aren’t telling you) is that there is a way to lower your reverse mortgage closing costs.
The Largest Reverse Mortgage Purchase Fee – The Upfront MIP
FHA charges the mortgage insurance at a rate cost of 2.5% of the purchase price or appraised value, whichever is lower. The maximum charge caps out at $15,637.50 for homes at the top of the lending limit of $625,500.
The reason they have the fee is because a fully drawn reverse mortgage loan has a greater chance of exceeding the home value after 15 to 20 years of you occupying the property. Since the loan is non-recourse, and you or your heirs will never owe more than the home is sold for, FHA is on the hook for any losses that occur. Due to the volatility of real estate prices, there is sufficient risk there.
How To Reduce The Upfront MIP
What you might not have been told is that there is another option. When you only take 60% of the reverse mortgage loan amount at closing, the upfront mortgage insurance premium drops to 0.5% of the purchase price or appraised value, whichever is lower. On the same $400,000 purchase, the fee drops to $2,000, an $8,000 savings.
What happens to the other 40% of the loan amount that you are not drawing at closing? That depends on whether you are taking a fixed rate, closed-end loan or an adjustable rate, open-ended loan. If you go with the variable rate option, the remaining funds are left on a line of credit for a the period of twelve months before you are free to draw them in full.
Reverse Mortgage for Purchase Fees: A Real Life Example
John and Jane Thompson, both 65 years old, are selling their large home in Seattle for $500,000 and owe $150,000 against it. After a 6% real estate commission and 4% selling costs, they expect to net approximately $300,000. They are looking to downsize and buy a low maintenance $400,000 condo in San Diego, California, that is FHA-approved. Let’s take a look at their two options using a reverse mortgage purchase loan –
|Option One – full MIP||Option Two – reduced MIP|
|$216,800 principal limit[i]||$216,800 principal limit|
|No upfront draw limitation||X 60% draw limitation|
|= $216,800 initial loan amount||= $130,080 initial loan amount|
|– $10,000 FHA MIP (2.5% of price)||– $2,000 FHA MIP (0.5% of price)|
|– $0 origination fee||– $0 origination fee|
|– $3,500 third party costs[ii]||– $3,500 third party costs|
|= $203,300 net loan amount||= $124,580 net loan amount|
|– $400,000 purchase price||– $400,000 purchase price|
|= $196,700 down-payment||= $275,420 down-payment|
|$0 line of credit||$86,720 line of credit (40% of principal limit)|
So which option is best for the Thompsons? Since they have $300,000 on hand from the sale of their Seattle home, why not go with option two and save $8,000 in closing costs? Assuming their monthly income is sufficient, and they are comfortable with having the $86,720 in a line of credit that is frozen for twelve months, it will be worth it to them. If their interest rate is 4.00% in year one, the line of credit will grow to $91,384 after just twelve months4. By keeping the excess funds in a line of credit, they are reducing their reverse mortgage loan balance and increasing their borrowing power.
Rate – Fixed vs. Adjustable Reverse Mortgage
One of the most common concerns we hear about when offering reverse mortgages is regarding the variable interest rate. Generally speaking, people prefer a fixed rate, even if the starting interest rate is 2 to 3% higher on the fixed. Unfortunately, when offering the reduced MIP option above with the line of credit, a variable rate is required.
Fixed rate loans are closed-end, so after you purchase the home, the loan would not allow for you to access any further funds. You could pursue option two above with a fixed rate, but you would forfeit the line of credit.
Variable rate reverse mortgages should carry less concern than a variable rate conventional loan, due to the lack of a required monthly principal and interest payment.
Much of the apprehension about variable rate loans stemmed from the subprime era many years ago when customers had serious payment shock after their first rate adjustments. With the fairly new annual, adjustable reverse mortgage-that has a 2% annual cap and a 5% lifetime cap-you have some solid protection in place. The variable rates are based on the LIBOR index plus a lender margin in the 2% to 3.5% range. Take a look at where the LIBOR index has been historically.
Why Were We Not Told About This?
Just like with most types of businesses, there are those who are looking out for their customers and those who are just looking out for themselves. In the reverse mortgage industry, most loan officers and companies are compensated based on the loan amount that is drawn at closing. That is particularly the case with purchase loans, where you will typically see a $0 origination fee. When you compare options one and two above, you can see that option one would create more revenue for the lender due to the higher loan amount being disbursed at closing.
There is also the possibility that you are speaking with a loan officer that originates reverse mortgages part-time and just is not up to speed on all the intricacies of the program.
How To Get Started
Before you list your home and begin shopping for a new one, you will want to call us at (800) 996-5361 or email us to get prequalified for the purchase loan
It is easier to do the prequalification by phone, partly because of the number of questions we need to ask and partly due to the sensitivity of the information we need from you, including date of birth and SSN. We will also want to discuss with you how the reverse mortgage loan is unique from other loans, so you structure the contract in a way that is acceptable to HUD and that best benefits you.
¹The principal limit (gross loan amount) is determined by the youngest spouse’s age and expected interest rates. For this example, we are using an expected interest rate at or below 5.06%. The actual range of loan amounts is from 52.4% for a 62 year old to 75% for a 90 year old. The 40%-55% downpayment range given is a rough estimate for those 62-76 years old, which are the ages of the buyers we see most often.
²A 65 year old can borrow 54.2% of the purchase price or appraised value, whichever is lower. We are assuming for this example that the home appraises for $400,000 or more.
³The $3,500 in third party costs is specific to a $400,000 purchase in CA. It does not include property taxes, association fees, homeowner’s insurance, the property inspection, or any transfer taxes. It does include the closing fee, title insurance, appraisal, recording fees, credit report, flood cert, document preparation, and a few other small charges.
4Reverse mortgage lines of credit grow at an annual rate that is calculated by adding the current interest rate and the mortgage insurance rate of 1.25%. For this example that growth rate is 5.25%. It is compounded monthly. The funds in a line of credit can be withdrawn in full after twelve months or never used at all. They only begin accruing interest, and have to be repaid in the future, if the funds are withdrawn.