Understanding the 95% Rule on Reverse Mortgages and Its Impact on Heirs

As home prices remain high across the country and more seniors seek ways to tap into their home equity, reverse mortgages are becoming a more common financial tool. Designed for homeowners aged 62 and older, these loans allow seniors to access their home's value without monthly payments or losing ownership. However, while they can provide much-needed financial support for retirees, they also come with complexities, such as the 95% rule.

Reverse mortgages, also known as Home Equity Conversion Mortgages (HECMs), are federally insured by the Federal Housing Administration (FHA). These loans accrue interest over time, and since no monthly payments are required, the loan balance can grow significantly. In some cases, the loan balance may even exceed the home's market value by the time the loan becomes due.

If the borrower passes away or moves out permanently, the heirs who wish to keep the property are required to either pay the full loan balance or 95% of the home's current appraised value, whichever is less. This is where the 95% rule comes into play. It ensures that heirs are not burdened with paying more than the home is worth, even if the loan has grown significantly due to interest.

For example, if a borrower owes $320,000 on their reverse mortgage and the home is now worth only $280,000, the heirs would only be required to pay $266,000—95% of the appraised value. The remaining $54,000 would be covered by the FHA's mortgage insurance. This rule provides a crucial safety net for families who may otherwise face the burden of paying a loan that exceeds the home's worth.

If the home is worth more than the loan balance, heirs must pay the full amount, just like with a traditional mortgage. However, they also have the option to sell the home, use the proceeds to repay the loan, and keep any remaining equity. It's important to note that the 95% rule only applies if the heirs want to retain the property. If they don't, they can allow the lender to foreclose or transfer the home through a deed-in-lieu of foreclosure.

For senior homeowners, the 95% rule offers peace of mind. It reassures them that their loved ones won't be left with an unfair debt burden or forced to sell a family home they might otherwise want to keep. It also provides a clear and predictable structure for what happens to the home after the borrower's death or departure.

However, heirs must act quickly. They typically have 30 days to express their intent to keep the home and up to six months (with possible extensions) to repay the loan or sell the property. They will also need to secure financing or have the cash available to buy the home.

While the 95% rule is a valuable protection for heirs, it's just one part of the equation. Seniors considering a reverse mortgage should carefully evaluate their financial goals and long-term plans with their families. It's essential to understand how the loan will impact their estate and what options will be available to their heirs in the future.

For those interested in learning more about reverse mortgages and how they might fit into their financial strategy, it's worth consulting with a financial advisor or a housing counselor who specializes in these types of loans.

Ultimately, the 95% rule plays a crucial role in protecting heirs and making the transition of a home after the borrower's death or departure more manageable. It ensures that loved ones have a fair chance of keeping the home, even if the loan balance has grown significantly over time.