Reverse Mortgage Basics
A reverse mortgage is a special type of loan used by older Americans to convert the equity in their homes into cash. There are three common payment methods: You can be paid all at once, by means of a regular monthly advance, or at times and in amounts that you choose. You pay the money back plus interest when you pass away, sell your home, or permanently move out of your home.
To better understand how a Reverse Mortgage works, let's compare it to a regular mortgage. Both types of mortgages create debt against your home and both affect how much equity or ownership value you have in your home. They do so in opposite ways.
Debt is the amount of money you owe a lender. It includes cash advances made to you or for your benefit, plus interest. Home equity means the value of your home (what it would sell for), minus any debt against it.
Falling Debt/Rising Equity, Rising Debt/Falling Equity
When you purchased your home, you probably made a small down payment and borrowed the rest of the money you needed. You then paid back your mortgage loan every month over many years. As you made each monthly repayment, the amount you owed (your debt or loan balance) grew smaller, but your ownership value (your equity) grew larger.
Reverse mortgages have a different purpose than regular mortgages. With a mortgage, you use your income to repay debt and this builds up equity in your home. But, with a reverse mortgage, you are taking the equity out in cash advances and this creates debt against your home. With a reverse mortgage, your debt increases and your home equity decreases. It is just the opposite or reverse of what happens in a regular mortgage. If you have a reverse mortgage, the lender sends you cash and you make no repayments, which can be a good way for you to increase your income in retirement.
In a reverse mortgage, the amount you owe (your debt) gets larger as you receive more cash and more interest is added to your loan balance. As your debt grows, your equity shrinks, unless your home's value is growing at a high rate. When a reverse mortgage becomes due and payable, you may owe a lot of money and your equity may be very small.
Qualifying for a Reverse Mortgage
* The borrower must be 62 years old or older.
* The home must be your principal residence. In other words, it is where you live most of the time.
* You must own the home outright or have a small mortgage balance left.
* Single-family homes are eligible.
* Some condominiums and duplexes qualify, depending on lender policies.
* Mobile homes and cooperatives do not usually qualify.
If you meet these conditions, you will probably qualify for a reverse mortgage. Once approved by the lender, you can choose to have the money paid to you in a lump sum, in installments, or as a line of credit that you can use when you need it. There are no monthly payments required, which is a huge advantage for somebody on a fixed income. The homeowner retains the title to the property and is still responsible for property taxes and property maintenance.
You may be wondering how the loan is paid back if you never make any monthly payments. It is not actually due until the last surviving borrower passes away, sells the home, or moves out. The lender does not take possession of the property, but your heirs must pay the balance due. This is usually done by means of a traditional mortgage or the sale of the house.
A good feature of reverse mortgages is that the borrower or estate will never have to pay back more than the house is worth when the loan is due. For example, let's say somebody took out a reverse mortgage for $200,000. Over the course of time, the value of the house depreciated. It's worth only $150,000 when the time comes to pay back the loan. No more than $150,000 needs to be paid. The $50,000 left over remains with the borrower or estate. If the home is worth more than the loan balance, only the balance must be paid.
The loan income is not taxable and will not affect eligibility for Social Security or Medicare benefits. Supplemental Security Income and State Medicaid benefits are not affected as long as you spend the loan payments in the month you receive them.
Types of Reverse Mortgages
There are three types of reverse mortgages to choose from. It is advisable to consult a financial advisor or mortgage counselor to help you make an appropriate decision.
FHA-insured: This type of loan includes an insurance policy to protect you in the event the lender folds or otherwise defaults. The FHA-insured loan has an adjustable interest rate. A change in the interest rates will not affect the income you receive from the loan, but it will affect how quickly the balance grows. These loans typically have closing costs and sometimes a monthly servicing fee. However, these fees can usually be included in the loan, making upfront costs negligible. It is also important to note that the FHA-insured reverse mortgages will pay less cash than the other types.
Lender-insured: This type of reverse mortgage also includes an insurance policy to protect you from default. The insurance premiums, as well as the interest rate, can be either fixed or variable. The lender-insured reverse mortgage will usually pay more than an FHA-insured loan, may allow you to borrow less than the full value of your home, and may even continue paying an annuity after the home is sold. These annuity payments are taxable and may affect eligibility for Supplemental Security Income and Medicaid.
Uninsured: This type of reverse mortgage is set up with a fixed term, a fixed interest rate, and no insurance premium is required. Whereas the other types of reverse mortgages are not due for as long as you live in your home, the uninsured loan has a fixed time frame for repayment. If the borrower is unable to pay when the loan is due, the house may have to be sold to satisfy the debt.
A reverse mortgage is intended for use as a tool to supplement retirement income and offer some extra financial security to retirees. It benefits the homeowners, not the heirs to the estate. If you have your heart set on leaving your home to your family, the reverse mortgage is not a good option. If your main concern is improving your cash flow and being prepared for emergencies, the reverse mortgage can be very useful.
Reverse Mortgage Basics