A common fear that prevents some people from even looking into a reverse mortgage is the persistent belief that all reverse mortgages result in the borrower unwillingly losing their home to foreclosure. The truth is more nuanced. Yes, a reverse mortgage can end in foreclosure. However, the situations that lead to a reverse mortgage foreclosure are typically much different than traditional mortgage foreclosures.
It’s also worth noting that a foreclosure is only one of several possible avenues for repaying the loan when it comes due. Sometimes it is the best course of action, but that does not mean that there aren’t other options available to borrowers and their heirs in most cases. The following is an explanation of how foreclosure works with a reverse mortgage and when it commonly occurs.
What Causes Most Reverse Mortgage Foreclosures?
When looking at foreclosures in reverse mortgages, it is important to understand that unlike with a traditional or forward loan, foreclosure can be a preferred method of ending the loan. A reverse mortgage foreclosure typically happens as the natural resolution of a reverse mortgage after the borrower passes away. This could be because the balance due exceeds the value of the home, because there is no next of kin to handle a sale of the home, or for some other reason.
When the loan matures, the loan balance sometimes exceeds any reasonable potential sale price of the home. In such cases, borrowers have no economic incentive to sell the home on their own. Fortunately for the borrower and their beneficiaries, all reverse mortgages are “non-recourse” loans. This offers them the opportunity to walk away despite a loan deficiency. And this should not impact their credit profile. Foreclosure is the mechanism that conveys title to HUD (or the lender), so they can sell the home and ultimately pay off at least a portion of the loan balance.
Reverse Mortgages Foreclosure Due to a Maturity Event
Often when traditional or forward loans end in foreclosure it is due to the borrower’s failure to make the required monthly mortgage payment. This can’t happen with a reverse mortgage, because it carries no monthly repayment obligation. Moreover, a reverse mortgage naturally allows the homeowner access to funds, which should reduce the likelihood that a borrower will default on their obligations.
However, though reverse mortgages don’t require a monthly principal and interest mortgage payment during the life of the loan, there are other borrower obligations contained in the reverse mortgage loan agreement. The borrower has agreed to occupy and maintain the home as well as pay all property-related charges. Failure to do these things will cause the loan to mature.
A “maturity event” is a term used to describe the life stage of the loan when:
- The borrower or a beneficiary sells the property.
- The last surviving borrower leaves the home for 12 consecutive months due to illness.
- The borrower does not maintain the property.
- The borrower fails to pay property taxes.
- The borrower passes away.
When one of these situations occurs, the borrower or one of their beneficiaries will often notify the lender of their intentions to sell the home. The lender will typically allow them six months to sell the home, and the Department of Housing and Urban Development (HUD) generally approves two- to three-month extensions for up to one year. If no action is taken to sell the home, the lender will need to foreclose on the home and handle the sale themselves so that the loan can be repaid.
Foreclosure Due to Failure to Pay Property Taxes
Failure to pay property taxes will almost always result in foreclosure. This is true whether the homeowner has a reverse mortgage, a traditional mortgage, or no mortgage at all. Lienholders on the home and are required by federal guidelines to foreclose on the property in these situations.
In 2013 and 2015, HUD implemented two requirements that have significantly reduced the number of foreclosures caused by property tax defaults and other maturity events that resulted from borrower’s inability to financially uphold the terms of their reverse mortgages.
- Initial disbursement limits. These limits were implemented in 2013 for all reverse mortgages insured by the Federal Housing Administration (FHA). For the first year of the loan, many borrowers are limited on withdraws from their calculated proceeds. Unless they have large mortgage payoffs that necessitate higher draws, the borrower may be initially limited to 60% of their funds. As a result, most borrowers keep a portion of their proceeds in a growing line of credit available for future emergencies.
- Financial assessment. Enacted in 2015, a financial assessment requires the lender to examine the credit history, property charge history, and residual income to determine whether the reverse mortgage is a sustainable solution for the borrower. Some borrowers are required to set aside a portion of the proceeds for the payment of property taxes. This has reduced the number of reverse mortgages nationwide but has also reduced the number of foreclosures.
It’s important to note that, while reverse mortgage foreclosures occur, they happen under a different set of circumstances than with a traditional mortgage. If you’re considering a reverse mortgage, these concepts will be covered in more depth during a mandatory reverse mortgage counseling session.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.