Reverse Mortgages: How do they work?
Did you know? A reverse mortgage is simply a home equity loan that is designed specifically for older homeowners.
In the past, reverse mortgages were often considered a last resort to drum up some cash and they had a bit of a bad reputation but that has changed in the last few years as reverse mortgages have become more mainstream and are being used a financial planning tool for homeowners.
Reverse mortgage actually date back to 1989 when they were introduced to the marketplace to enable anyone over the age of 62 to access their home equity without having to sell their house.
What is a Reverse Mortgage?
A reverse mortgage is simply a home equity loan that is designed specifically for older homeowners. These loans do not require any monthly mortgage or loan payments.
The entire loan is repaid after the borrower (the homeowner) moves out or dies. These products are sometimes called a home equity conversion mortgage, or HECM.
HECM’s are insured by the Federal Housing Administration (FHA). In order to qualify the homeowner must own the house outright or have a very small mortgage left on the home.
There are age restrictions to these types of loans, in most cases, the homeowner has to be 62 or older. The home must also be your primary residence, you cannot get a reverse mortgage on a second home.
While the borrower doesn’t have to make monthly mortgage or loan payments, they must continue paying property taxes, carrying the required amount of insurance on the home and maintain the home according the guidelines spelled out in the loan documents. ‘
A reverse mortgage uses the equity you have in your home as collateral. The amount of money that can be borrowed will depend on the age of the borrower, how much equity they have in the home as well as the programs lending limits.
Restrictions do apply to these loans and in some cases access to the funds may be restricted for the first 12 months after loan closing. This is due to HECM requirements.
In most cases the loan doesn’t have to be repaid until 6 months after the last surviving homeowner moves out or dies. The estate will then sell the home to repay the balance on the reverse mortgage loan. Surviving heirs will receive any proceeds from the sale that are above and beyond the amount needed to repay the reverse mortgage.
Surviving heirs are not responsible for any additional mortgage debt in the event the home sale does not cover the loan amount.
Does a Reverse Mortgage Make Sense?
Reverse mortgages are most commonly used to cover the cost of medical or living expenses or to supplement retirement income. The money can also be used to cover the cost of home renovations or pay off other high interest debt. In some cases, a reverse mortgage is used to pay off the remaining mortgage on the home to eliminate the monthly mortgage payments.
There are no restrictions on how the money can be used so you are free to use it for any expense you wish.
Reverse mortgages are not ideal for everyone, according to experts, the following people will benefit most from a reverse mortgage:
- Plan on staying in their home as long as possible: Once you sell the home the loan comes due so staying in your home for the long haul makes the most sense.
- Can Afford to Maintain the Home: You still must maintain the home, keep it insured and pay the taxes so if you can no longer afford to maintain your house, a reverse mortgage is probably not an ideal solution.
- Need a Supplemental Income: These loans are great for people that need to supplement their income or have high interest debt to pay off.
- Emergency Expenses: A reverse mortgage also makes sense for people that have a sudden expense, in most cases, this is an unexpected medical expense.
The Cons of a Reverse Mortgage
There are cons to a reverse mortgage and they don’t make sense for every homeowner. The big cons of a reverse mortgage are:
- Fees and closing costs can be expensive: Shop around for the best mortgage rate and a discount on fees and closing costs, which can be expensive on these types of loans. In most cases, the interest rate attached to the loan will be higher than a typical mortgage.
- Maintaining the Home: You are still responsible for the cost of maintaining the home and if are unable to afford those costs, a reverse mortgage doesn’t make sense.
- Losing the Family Home: A reverse mortgage means that the family home is going to be sold when you pass away. Your heirs will get any remaining equity after the home is sold but they cannot keep the house, as the mortgage company will own it.
Ready to Move Forward?
If you are seriously considering a reverse mortgage, the Department of Housing and Urban Development requires that homeowners receive mandatory counseling by an independent 3rd party. There is no charge for this counseling.
These counseling sessions help borrowers review other options. Experts also recommend talking to your entire family before taking out a reverse mortgage, as it will have an impact on your children and other heirs.
Always shop around for the best terms on a reverse mortgage. Look at the various fees as well as the interest rate and find the loan that makes the most sense for your particular situation.