Reverse mortgages can be a much-needed financial lifeline for many retirees. But it’s important to remember that insuring your home is just as important if you have a reverse mortgage as it is with a traditional mortgage.
Reverse mortgages, also known as home equity conversion mortgages, are financial products that let homeowners who are older than 62 extract equity from their home without having to sell it or move out. Each month the homeowner receives a check from the mortgage company in exchange for a corresponding share of home equity.
The Federal Housing Administration insures most reverse mortgages and sets the rules that borrowers need to follow — which include maintaining sufficient homeowners insurance.
According to the Consumer Financial Protection Bureau, as long as the homeowner still lives in the home, maintains the home and pays all the taxes, insurance and other obligations, they don’t ever have to repay the loan. When the owner dies or moves to another home, the loan becomes due and the mortgage company must be paid back — typically from the proceeds of the sale of the home.
According to Steve Irwin, executive vice president of the National Reverse Mortgage Lenders Association, homeowners must secure and maintain a replacement cost homeowners policy that would cover 100 percent of the improvements to the property in the case of a loss.
If the property is a condominium, they need an HO6 policy, which covers everything from the walls of the condominium in.
“If the borrower so chooses to have additional coverage, that is fine, but that is the minimum,” Irwin says.
Seniors responsible for insurance with reverse mortgage
Under a traditional mortgage, homeowners would typically only be required to have an insurance policy that paid for the value of the remaining mortgage.
“But that is one of the difference we really should highlight here,” Irwin said.
With a regular forward mortgage, the loan is an ever decreasing balance, which means lenders will only look for coverage that equals the outstanding principle balance.
“Because a reverse mortgage is negatively amortizing, and the principle balance is increasing over time, the lender will require 100 percent replacement value for the entire life of the loan,” Irwin says.
If the home is in a flood plain designated by the Federal Emergency Management Agency, the homeowner must also secure a flood policy at least equal to the value of the homeowner’s policy, or for the $250,000 maximum allowed under the law.
Reverse mortgages are unique in that they are considered a “non-recourse loan,” Irwin says. That means that the only assets that must repay the borrowed funds come from the property.
“People can certainly repay out of other funds, but if something were to go awry, or ultimately the borrower passed away, the only thing the lender can look to is the property. Therefore, all collateral must be insured throughout the life of the loan,” Irwin says.
Many homeowners are used to their mortgage companies paying their homeowners insurance for them. This can also be an option with a reverse mortgage, but it is an arrangement that must be set up when the loan is originated.
With a forward mortgage, this is done through an escrow account. With a reverse mortgage, it is done with a lifetime expectancy set aside account.
While some people will chose to use a set aside account, in some cases the mortgage company will mandate it, especially in cases where the borrower has shown a history of not maintaining insurance or that shows other behavior the lender considers risky.
“Through the insurance monitoring process, the servicer would get billed directly and pay for the insurance through that lifetime set aside,” Irwin said.
When they create the set aside account, the mortgage company will calculate the borrower’s life expectancy, estimate how much insurance will cost over that timeframe, plus add an inflation estimate.
If a borrower outlives that expectation, it becomes the borrower’s responsibility to continue making those payments.
Falling behind on insurance could be costly
During the life of the reverse mortgage, if for some reason the borrower fails to maintain sufficient insurance, the mortgage company will begin to take action themselves to protect the property.
They will begin by sending the borrower letters explaining that the property is lacking insurance and explaining the requirements of a policy.
If the borrower doesn’t give the mortgage company proof of insurance, then the mortgage company will buy what is called a lender-placed policy and bill the homeowner for the cost. In general, those policies are more expensive than ones that the homeowner can secure through shopping around.
If the borrower fails to pay for that policy, then the mortgage company can legally begin foreclosure proceedings and force the sale of the house to repay the loan.
According to a Consumer Financial Protection Bureau report to Congress in 2012, a little under 10 percent of people are in danger of defaulting on their reverse mortgage because of a failure to pay property tax or homeowners insurance.