How does a reverse mortgage work in California?
Sometimes, life throws a financial curveball at you. And when that happens, you might need extra cash.
Fortunately, cash-strapped homeowners in California can tap into their home equity using a financial instrument called a "reverse mortgage."
If you're feeling like cashing out, read on. Although a reverse mortgage can offer a valuable lifeline in the right circumstances, it comes with a hefty cost.
In this article, you'll learn how a reverse mortgage works in California, the benefits, drawbacks, and potential implications to make an informed decision.
What is a reverse mortgage?
A reverse mortgage is a loan that allows a homeowner to convert a portion of their home equity into cash. Instead of you, the borrower, making payments to the lender, the lender makes payments to you.
With reverse mortgages, loan repayment is not due until the home is sold or vacated.
Typical use cases
There are several reasons someone might convert a portion of their home equity into cash.
- Supplemental income: Most retired Americans live on a fixed income. As a result, a reverse mortgage can offer additional monthly income to help cover living expenses.
- Pay off existing mortgage: It might seem counterintuitive, but a reverse mortgage can be used to pay off remaining conventional mortgage debt.
- Cover health expenses: Health care costs can be significant, especially as we age. Reverse mortgages can help seniors cover out-of-pocket healthcare costs or long-term care needs.
- Home improvements: Reverse mortgages can provide funds to complete costly home renovations.
- Delay social security: Some seniors opt to delay collecting their social security benefits so their payments will be higher when they do. They use a reverse mortgage to provide monthly income.
- Estate planning: Sometimes, individuals leverage a reverse mortgage as part of a comprehensive estate planning strategy.
- Investment opportunities: Some people believe they can invest the proceeds of a reverse mortgage and earn a return higher than the cost of servicing the loan.
- Travel: People often use reverse mortgages to pay for cruises or other travel and leisure activities.
Requirements and limitations for reverse mortgages
- Eligibility: In California, and in the rest of the country, the youngest homeowner must be at least 62 years old and live in the home as their primary residence. They also require sufficient home equity that can be tapped for cash.
- Loan amount: How much can be borrowed depends on the age of the youngest borrower, current interest rates, any lending limits, and the current appraised home value. Higher loan amounts are typically given to older borrowers and more valuable homes.
- Payment options: Borrowers can decide how they will receive their funds. You can choose from a lump sum payment, monthly deposits, or a line of credit.
- Interest: As with your mortgage, interest on the borrowed amount accrues and grows over time.
- Fees: While each institution differs, reverse mortgages usually entail additional costs, like origination fees, mortgage insurance premiums, and closing costs.
- Loan repayment: When a “maturity event” occurs, the loan becomes due and must be repaid. For example, a maturity event might be when the last surviving borrower sells the home or passes away.
- Non-recourse loan: One fundamental characteristic of reverse mortgages is that they are considered “non-recourse” loans. If the home is sold to repay the loan, the owner or their heirs will never owe more than the loan or the property value, whichever is less. In other words, you would not be required to pay the difference if the house sale doesn't cover what you owe the lender.
- Federal insurance: Most reverse mortgages are Home Equity Conversion Mortgages (HECMs). These are federally insured loans backed by the U.S. government through the Federal Housing Administration (FHA). This insurance protects both lenders and borrowers.
How does a reverse mortgage work in California?
Because reverse mortgages are more complex than conventional loans, you are required to consult a counselor approved by the U.S. Department of Housing and Urban Development (HUD).
In fact, under California state law, lenders must provide borrowers with a list of 10 nonprofit counseling agencies.
Consultation with these agencies is mandatory to ensure borrowers fully grasp any risks associated with the loan. Not only that, loan applications cannot be submitted until consultation has been completed.
Additionally, before accepting your application, lenders must deliver a detailed summary of the topics you and your counselor need to discuss.
The importance of this worksheet prompted its codification into Civil Code § 1923.5 by the California state legislature.
As a borrower, you have seven days to cancel your reverse mortgage agreement under California law. The seven-day period begins from the date you receive counseling from a HUD-approved representative.
- If you’re considering a reverse mortgage, connect with a HUD-approved counselor in your area. You can find a list of counseling agencies based in California on the HUD website.
- If you and your counselor decide a reverse mortgage is suitable, work with them to prepare and submit an application to the lender. This may or may not be the same lender for your existing mortgage.
- Following the application, the lender will tell you the loan size you’re eligible to borrow.
- Decide how you want to receive the loan proceeds (i.e., lump sum or otherwise).
- Review the term details and sign the contract to formally initiate the loan.
While reverse mortgages can offer a valuable lifeline to the right person, there are some factors you need to consider.
- Costs: Reverse mortgages can often include steep fees and interest rates. Typically, these costs are higher than other loans, like a conventional mortgage.
- Decreasing equity: When you pay a traditional mortgage, you build equity each month. With a reverse mortgage, you lose equity with each loan payment you receive.
- Potential impact on public assistance: Proceeds from a reverse mortgage can affect your public assistance program eligibility. Ask your HUD-authorized counselor to explain any impact the loan might have.
While they can be complex, reverse mortgages are a unique product that can help eligible homeowners when money is tight.
Whether it’s supplemental income to cover living expenses, cash for hospital bills, or funding for a once-in-a-lifetime trip to Europe, reverse mortgages offer a unique source of financing.
Nevertheless, as with any significant financial decision, be cautious and informed. Before applying, consult with a HUD-authorized counselor.
Not only is it a requirement in California, but it’s also a valuable step to help ensure you’re making the right decision.