What’s in it for the Bank?
Many reverse mortgage applicants express that the reverse mortgage just sounds too good to be true. The old adage is that if it sounds too good to be true, it probably is, right? Well, believe it or not, I love hearing people say this because it shows that they get it. They see the benefit that a reverse mortgage can offer them.
What is a Reverse Mortgage?
A reverse mortgage is a type of home loan designed to give homeowners aged 62 and older access to a large portion of the value of their homes without having to give up home ownership or take on a mortgage payment. As long as at least one borrower is living in the home and keeps up with required property charges (property taxes, homeowners insurance, HOA dues, etc.), no mortgage payment has to be made and the money doesn’t have to be paid back.
Reverse mortgage proceeds can be received as a lump sum, line of credit, monthly payments, or some combination of all of these.
When I buy a car I know that the dealer is in it to make a profit and I don’t begrudge that. After all, they’re a business, right? They don’t stay in business unless they make money. I want them to make some money on me, I just don't want them to take advantage of me. I want to make sure that the deal is fair so I do my homework so I can feel confident about what I’m getting into.
I’m very upfront about the fact that lenders make money off reverse mortgages. They have to, or there’s no point doing them, right? As long as you know how a bank makes their money, you can then decide if the deal is worth it to you. So where does the bank’s profit come from? The short answer is: your home equity.
The banks make their money on a reverse mortgage just like they do on any mortgage: they get interest on the money borrowed. What’s different about the reverse mortgage is that the bank might have to wait a number of years –potentially even decades - before collecting even a dollar’s worth of interest. With a forward mortgage, the bank collects interest every single month with each mortgage payment. Because no payments are required on a reverse mortgage, the interest accrues onto the loan balance over time and the bank collects the money lent plus any interest at the time the last borrower permanently leaves the home.
The reason banks are willing to lend money without asking for a monthly payment is because it’s profitable to do so. It might sound crazy to the average person to do something like that, but the program works – as it has for nearly 30 years now.
Though a person can have a reverse mortgage for potentially decades, the average payoff for a reverse mortgage happens at the 9 ½ year mark. This is just a handful of years longer than the average payoff of a typical forward mortgage, which is usually around 5 ½ to 6 ½ years when the homeowner either refinances or sells.
Reverse mortgages have about the same interest rate as the typical forward 30-year fixed, but they’re usually adjustable. If rates creep up in the future, there’s less risk for the bank because they’re not locked into a fixed rate that is lower than the prevailing market rate.
The reverse mortgage lender also doesn’t have to worry about a borrower losing their job, missing monthly payments, and defaulting on the loan as with a forward mortgage. If a borrower defaults on a forward mortgage, the bank is out the missed payments and has go through an often expensive foreclosure process to recoup their money. This isn’t such a concern with a reverse mortgage; the borrower only needs to keep up with their taxes, insurance, and any HOA dues and a majority of borrowers are on a stable income source such as Social Security or pensions.
It’s also worth noting that reverse mortgages are insured by FHA, which means that the FHA mortgage insurance fund makes the lender whole if there’s not enough value in the home to settle the entire loan balance. This is a key component of the program, and it’s the prime reason why it makes sense for lenders to do reverse mortgages.
The bottom line is that the HECM reverse mortgage is a great plan for both borrower and bank. Though it may sound too good to be true at times, it’s a 100% legitimate program and lenders are more than happy to offer them.