So you’re wondering what a reverse mortgage is? Well, to put it simply, a reverse mortgage is a loan. But a very different kind of loan. Find out everything about a reverse mortgage including what it is, who it’s for, and if it is right for you.
What is a Reverse Mortgage
Any person who is aged 62 or older and who has home equity may qualify for a reverse mortgage. By borrowing against your own home you can receive funds as a lump sum, monthly payment, or even a line of credit. And unlike a traditional loan, you don’t have to make any payments.
Instead, the loan is paid off in its entirety when the borrow dies, moves away permanently or sells the home. Federal regulations require lenders to not exceed loan amounts that would exceed the home’s value. Those same regulations also specify that the borrower or the borrower’s estate won’t be held responsible if the loan balance becomes larger than the home’s value.
You are essentially cashing out your home equity. Your home equity is calculated by taking your home value and subtracting what you owe on your home. A reverse mortgage then takes that lump of money and writes you a check. There are several disbursement options that I will cover in a bit.
You will be assessed interest just like you would on any other loan but instead of paying that out of pocket it is rolled back into the mortgage. That interest may be fixed or variable depending on the type of Reverse Mortgage you chose. Over the life of the loan, your mortgage debt would increase and your home equity would decrease.
Types of Reverse Mortgages
The most common type of reverse mortgage is the Home Equity Conversion Mortgage or HECM. This type is for home values below $679,650 and is what we will be discussing in this article. Most reverse mortgage lenders require at least 50% equity.
6 Payout Options
1. Lump sum
With this option, you get the total amount all at once and your interest will be fixed.
2. Monthly Payments
With this option, you will get monthly payments for as long as you live in the home as your primary residence. Your interest rate will be variable and subject to change over time.
3. Term Payments
Similar to monthly payments but for a set duration. You would get equal payments over a set period of time, such as 15 years.
4. Line of Credit
With this option, a set amount of credit is established and available for use should the homeowner need it. The borrower only pays interest on the amount borrowed. Unlike other forms of credit, the borrower would not need to make payments on the amount.
There is also the option to combine any of the above. The borrow could opt for a monthly payment as well as a line of credit.
6. Purchase a Different Home
You can also use a reverse mortgage to purchase a different home than the one you are living in.
What’s The Difference Between A Reverse and HELOC (Home Equity Line of Credit)?
By now you may be asking, isn’t this the same as a home equity line of credit?
While similar there are some key differences. Unlike a home equity loan, you don’t need to have income or good credit to qualify. In addition, you don’t have to make any loan payments.
For seniors with poor credit or who cannot afford a payment, a reverse mortgage is the only way to access their home equity.
Is a Reverse Mortgage Right For You
Like mentioned earlier, a reverse mortgage may be the only way to access one’s equity without downsizing or selling the home. If extra income is needed to meet your basic living expenses a reverse mortgage may be an option.
As long as you are able to keep up with property taxes, insurance, and maintenance it is a great option to allow for a person to live out their lives in their home.
While a reverse mortgage sounds a lot like free money I assure it is not. Just like any loan you are charged interest and loan fees which go against your equity and the amount you are able to borrow.
When Is a Reverse Mortgage Not Right
If a reverse mortgage is not going to give you enough money or is only a temporary solution it may not be right for you. It also means you most likely won’t be able to pass your home down to your family.
Another potential problem is outliving your reverse mortgage. The risk of a lump sum or term plan is you could outlive that period and now you are stuck in a home with which you no longer any equity in. If you were to sell it would all go to the bank. Same goes for a line of credit, if that gets all used up you’ll have to find a different source of income.
Closing a Reverse Mortgage
When the borrower passes away, moves, or decides to close the reverse mortgage there are several options.
For example, let’s say the borrower rolled into a reverse mortgage with 50% equity. The borrower passed away 10 years later which left them having only 25% equity. The other 25% of the equity had been paid out to the borrower during that 10 year period.
The lenders are required to let any heirs decide whether they want to repay the reverse mortgage, essentially buying the house for what is still owed. Or the lenders can be given the option to sell the home to pay off the loan.
It’s important to note that if the assessed value of the home were to tank neither the borrower nor the heirs would be responsible to make up the difference. That is a risk the lending banks are taking.
How To Get a Reverse Mortgage
The Department of Housing and Urban Development requires any reverse mortgage borrower to complete a HUD-approved counseling session. The session takes about 2 hours to complete and costs about $150.
These counseling sessions are an important part of the process and ensure that the borrower has all the correct information so they can make an informed decision. These sessions take the bank “sales” pitch out of the equation and provide honest objective information.
The borrower’s specific financial circumstances are discussed including any impact on health care or social security that a reverse mortgage may have. As well as going over the pay-out options listed above. The borrower is encouraged to have other family members present during the session if they so, please.
Reverse Mortgage Fees
Since lenders can’t ask homeowners or their heirs to pay up if the loan balance exceeds the value of the home, there is a required insurance to protect the lender should this occur. It’s basically a pool of money the lenders can pull from should the value of the home depreciate.
The Department of Housing and Urban Development sets this insurance premium for reverse mortgages. The rate was last adjusted in October of 2017.
This upfront premium is 2% and is calculated in the following way.
The premium is based on the home’s value, so for a $300,000 home, the premium would be a one-time $6,000 fee.
In addition, all borrowers must pay annual mortgage insurance premiums of 0.5% on the amount borrowed.
Keep in mind, the borrower doesn’t have to pay these fees out of pocket, instead, they are just rolled into the loan balance.
Yes, a reverse mortgage can be a good option for seniors who are experiencing difficulties with making payments. But remember that your age is a significant factor, as is your credit profile and equity. Be wise.