How does a reverse mortgage work?
Over the past several years there have been several television commercials with spokesmen pitching reverse mortgages. However, it is still not a term that is very well understood by most people for a very good reason.
Mortgages come from lenders and are what people use to purchase homes, not earn money. However, the reverse mortgage is a unique arrangement that allows people who own their homes to acquire money while using their property as collateral.
In a simple explanation, a reverse mortgage is a loan that is secured by your property and designed to defer the mortgage interest. Reverse mortgages are not free money from the government, trading your home ownership for cash, or just for those desperate for money.
In fact, reverse mortgages can be a simple, practical way to get more money for the things that you need.
History of reverse mortgages
There are different types of reverse mortgages, but the most common is the Home Equity Conversion Mortgage (HCEM). Created in 1989 by the Federal Housing Administration, the HCEM basically takes a traditional mortgage and flips it on its head.
For example, a traditional mortgage requires the owner to pay monthly payments over a pre-specified period such at 15 to 30 years. However, with the reverse mortgage the interest is not due until the loan reaches its full maturity.
All that is required is the homeowner to reside on the property and pay the property taxes as well as the insurance. By complying with the rules, they can take advantage of not having to make regular payments on the money that is borrowed.
This means that your life does not change in that you still own your own home, pay the property taxes and insurance. As with any mortgage, you will receive a proper statement each month that details all the interest changes as well as the information on your balance. About the only difference is that there is no coupon or notice for you to send a monthly payment since it is not necessary.
Who qualifies for a reverse mortgage?
If you are a US citizen and permanent resident, you qualify for a reverse mortgage if you are 62 years old or older if you have built up substantial equity in your home. The overall loan amount that you can qualify for will depend on a few factors.
- Your Age
- Home Value
- Current Rates
Since the reverse mortgage is based on your home, there are no requirements in terms of your income or credit score. All that is required is that your home is considered a primary residence and you continue to pay the property taxes and home insurance.
Why choose a reverse mortgage?
There are several reasons why you should choose a reverse mortgage if you are in need of additional money to pay bills, purchase new things, or simply have a greater supply of cash to rely upon for the unexpected.
Repayment of Loan: You can repay the loan voluntarily. However, the balance is not due until the last borrower passes away or makes another home their primary residence.
Your heirs will be given up to a full year to sell or payback the loan itself. If either event does not occur, the lender will foreclose on the home. However, if you should sell the home for less than what was borrowed, the government mortgage insurance that is part of the reverse mortgage will make up the difference.
No Penalty for Payment: One of the niftiest advantages is that you can make voluntary payments on the mortgage interest either in part or full without any penalty. In addition, you can also deduct the mortgage interest just as you would with a traditional home loan or even pay off the entire loan at any time.
Avoid Potential Debt for Heirs: There are those who believe that a reverse mortgage will allow the bank to swallow up all the equity of the home and leave your heirs with a mountain of debt. That is simply not the case. While no one can predict the rate that your home will appreciate, your heir will still have options even with the reverse mortgage.
Tax Paid: Because the money that is received from a reverse mortgage is not considered income, it will not be taxed like income.
This it because you are borrowing against the money that you have already put into the home and that would be double taxation.
Downsides of a reverse mortgage
One potential downside is that while reverse mortgages do not affect your ability to obtain public benefits such as from social security or Medicare, having excess funds to your income may change the type of qualifications that you have with needs based programs such as SSI and Medicaid.
So, be sure you fully understand the ramifications of what a reverse mortgage can do before taking one out.
Who reverse mortgages work for best
A reverse mortgage is really for anyone who owns their home that has substantial equity and they need money to meet their current needs. A reverse mortgage is a better option that traditional borrowing because you will never be in danger of having to lose your home if it is your primary residence.
Whether you need the money for a particular event such as medical expenses or simply want to have more cash on hand, then a reverse mortgage may be right for you.
However, a reverse mortgage is not recommended for those who play on moving soon or within the foreseeable future as that will break the contract and the money borrowed will have to be paid back.
You will need to fully understand all the ramifications of a reverse mortgage before taking one out for you and your family. If you are not planning on moving anytime soon, then this is an excellent way to get extra money with far fewer downsides that traditional borrowing.
However, it is important that you have the reverse mortgage reviewed by a trusted third party so that you are getting what you expect. In addition, you will want to look at the HECM reverse mortgage as that is the one with federal safeguards put into place for your protection.
When researching a reverse mortgage, it’s important to speak to your family and trusted financial advisor to weigh both the pros and cons.