A reverse mortgage is a loan option that allows seniors 62 years or older to live comfortably in their retirement. Borrowers can cash off their equity and pay for their mortgages or other expenses this way. This type of mortgage is most popular with seniors who've run out of sources of income and savings.
In this article, we look at what exactly reverse mortgages are, how they work, and how they can benefit borrowers. Read on to find out more:
What Is A Reverse Mortgage?
A reverse mortgage is an inverse mortgage where roles are switched. In traditional mortgage plans, a person takes out a loan to purchase a home, then repays the loan over time.
With reverse mortgages, a borrower with significant home equity takes a loan against the value of the home. The borrower already owns a home. They then receive the amount borrowed in a single deposit, fixed monthly instalments or by a line of credit.
Additionally, the borrower in an inverse mortgage isn’t necessarily required to repay the lender. Instead, once the borrower has moved to another property or dies, their heirs are responsible for paying off the loan. In case the profits from the sale exceed the loan amount, the borrower or their estate gets the difference.
The loan amount isn't supposed to exceed the home's value. If this happens, the borrower and their heirs won't be responsible for the difference. Some events that may lead to such a situation are if the market value of the home drops or the borrower lives for a long time.
Most reverse mortgage lenders are government-regulated. This means that they follow strict guidelines and lending measures. Some private lenders who operate away from banks, but these have the risk of being conned.
Who Qualifies For A Reverse Mortgage?
The primary qualification to be eligible for a reverse mortgage is being 62 years or older. However, you can also qualify if your partner is 62 years or older, and you meet other qualifications, which include:
You must own the property outright or have at least 50% equity with a primary lien.
Your home must be a single-family home, a condominium, a multi-unit house with a maximum of four units, manufactured after June 1976 or a townhouse.
If you don't own the property outright, you must complete existing mortgage payments, using money from the reverse mortgage.
You must live within the property as your main residence.
Your home must remain in pristine condition.
You must be updated on property taxes, homeowners' insurance, and any other compulsory legal requirements.
If the lender is government-regulated, you'll be required to attend a consumer information session with a HUD-approved reverse mortgage counsellor.
Private reverse mortgage lenders have their criteria that differ from lender to lender and also loan program.
How Does It Work?
In conventional mortgages, a financial institution — usually banks — lend the borrower money to buy a home. The borrower then pays back the money within a certain period in fixed instalments.
Reverse mortgages are the inverse of traditional mortgages. The lender pays the borrower a fixed amount. How these payments are made solely depends on what the borrower chooses. Also, interest is only paid on the money received.
The interest is forwarded to the loan balance. This means that the borrower doesn't have to pay anything upfront. The borrower also stays with the house's title. During the loan's lifetime, the borrower's debt grows, while home equity reduces.
The process of taking a reverse mortgage is pretty straightforward. As mentioned before, the borrower needs to own a home outright or have at least 50% equity. Owning a home gives the homeowner liquidity by taking away equity. Once a borrower decides that this is what they want, they see a reverse mortgage counsellor. This counsellor helps them find the most suitable lender and package for them.
The next step after finding the best lender is the application process, where the lender has to check the borrower's credit score. If they're eligible, they review the borrower's property, its title, and estimated value.
Once approved, the lender funds the loan depending on the plan chosen by the borrower. It could be in a lump sum, line of credit, or structured instalments (monthly, quarterly, or yearly). You can choose to receive the money in one of the following ways:
Lump-sum: You can choose to get the entire amount all at once. This option comes with a fixed interest rate.
Monthly Payments: This option provides equal monthly payments to the borrower as long as they live in their home as the primary residence.
Period Payments: This option lets the lender give the borrower equal payments for terms chosen by the borrower, such as five years.
Line Of Credit: Here, the money is available to the borrower when they need it. Interest is paid for the amount the borrower only borrowed on their line of credit.
Monthly Payments Plus A Line Of Credit: In this option, the lender provides equal monthly payments as long as the borrower lives in the home as the primary residence. The borrower can also access money on their line of credit when they need to.
Period Payments Plus A Line Of Credit: In this plan, the borrower receives money on set periods, such as five years. If they need cash at any time, they can access it on their line of credit.
When the borrower receives the money, they can use it for the purpose provided in the loan agreement. Some reverse mortgages have restrictions on how you can use the money. For example, you can only use the proceeds for house renovations in some reverse mortgages, while other services don't have any form of restriction.
Reverse mortgages last until the borrower dies or moves houses. The borrower or their heirs then pay the loan. Alternatively, the property can be sold for the lender to recoup the money. In case there's excess money after the house has been sold, the borrower benefits from the difference.
Types Of Reverse Mortgages
There are three major types of reverse mortgages. Each of them depends on the borrower's needs. They are:
Single-Purpose Reverse Mortgage: Government agencies offer this type of reverse mortgage at federal and state levels. Non-profit organizations also offer it. This type of reverse mortgage has rules and restrictions on how you can use the proceeds. In most cases, single-purpose reverse mortgages can only be used for home repairs or pay for property tax. They’re most suitable if you need to make urgent home repairs or you're late on home insurance and property taxes. Basically, the lender has to approve of how the money will be spent.
Home Equity Conversion Mortgage (HECM): This is the most popular type of reverse mortgage and can be more costly than traditional mortgages. If you qualify for a HECM loan, you can use the money for any purpose. For example, you can use the loan to buy another home. Whichever way you choose to spend the money, be careful and mind the consequences. You also have to pay heavy insurance fees that protect the lender, not you, in case of losses.
Proprietary Reverse Mortgage: These are private loans that are usually not federally regulated like the HECM. Because they aren't government-regulated, they can use crafty terms, such as higher loan amounts, to attract borrowers. However, they can have much higher interest rates than federally regulated loans. Because they’re the easiest to access and fund, you should be careful with them as they sometimes attract fraudulent lenders.
What Are the Benefits Of Reverse Mortgage?
Reverse mortgages have their advantages. Some are listed below:
You continue to live in your home. As an adult of 62 years and older, you don't want the trouble that comes with moving to a new house in another neighborhood. At this age, you want to grow old in your community, near your lifelong friends and family. This is why reverse mortgages are suitable. They don't require you to move. Moving houses may also result in less equity because of the costs involved.
It boosts income. Upon retirement, many older people experience a reduction or loss of cash flow. It especially becomes difficult if you have monthly mortgage payments. With a reverse mortgage, however, a senior can get cash to pay off any existing mortgages and for other uses.
Costs are lower. While there are costs involved with reverse mortgages, they’re lower compared to moving houses. Moving involves expenses such as costs associated with selling the home, moving your belongings, and buying or renting another place. These aren’t issues when it comes to reverse mortgages.
No unwanted heir claims. Reverse mortgages grow in size. Because of this, the reverse mortgage owed can surpass the value of the home over time. Regardless of such an event, your heirs' responsibility to pay the reverse mortgage can never go beyond the property's value. The lenders can never lay claim on the heirs' property or other assets.
Reverse mortgage isn’t taxed. Reverse mortgage proceeds are regarded as loans and not income. As the borrower, you choose whether to receive the money in a lump sum, line of credit, or monthly instalments. You can also choose to receive the funds in a combination of all three plans. Also, the reverse mortgage loan interest isn't deductible until you've paid off the loan in full. However, make sure you consult with a tax professional as tax laws can sometimes be complicated.
No monthly payments. So long as you continue to live in your home, it's not required that you make monthly payments. There's a catch though: you have to continue meeting your property tax obligations and homeowners' insurance. You also have to keep your home maintained.
Key Takeaways
Reverse mortgages allow seniors 62 years or older with significant home equity to cash off from their homes' value and spend the funds to pay mortgages or other living expenses. Before applying for a reverse mortgage, speak to an expert to know if you're eligible. They’ll also be able to inform you of things you'll need to know. Reverse mortgages last until the borrower dies or moves. In such cases, the borrower or their heirs will still have to pay off the loan.
