A reverse mortgage is a type of loan available to seniors and is used as a way of converting home equity into one or more cash payments. The borrower retains ownership of the property and does not have to repay the loan as long as he or she remains resident in the house.
A reverse mortgage must be the first and only mortgage on the property - if there is an existing mortgage, it must be retired with the proceeds from the reverse mortgage. If the property appreciates in value the reverse mortgage may be refinanced to take out more cash against the increased equity.
In a typical mortgage a home owner pays a monthly amount and after each payment the owner’s equity increases until, after the full term of the loan, the mortgage is paid and all debt is removed. In a reverse mortgage, the process is reversed. The home owner receives an amount, the principal and interest of which is accumulated as a lien on the property. If the owner receives monthly payments, then the debt on the house increases each month. Equity decreases with each payment.
To qualify for a reverse mortgage the borrower must be 62 or older. The house must be mortgage-free or the borrower must pay off the existing mortgage with the proceeds from the reverse mortgage (or other funds). The proceeds from a reverse mortgage can be used for any purpose and there are no minimum income or credit requirements. Some lower-value types of dwellings, such as certain mobile homes do not qualify. Before the reverse mortgage will be approved applicants must get HUD-approved counseling. The counseling is a free service for the borrower and his/her family and ensures that they understand what a reverse mortgage is and what the process of obtaining one is.
Some state and local governments also offer reserve mortgage plans, which usually are available only for restricted purposes, such as paying for home repairs or property taxes. The majority of reverse mortgages are FHA insured.
The factors that determine the value of a reverse mortgage that a homeowner may be eligible for include:
- 1. Homeowner’s age.
- 2. The interest rate in effect at the time the reverse mortgage contract is drawn up.
- 3. The value of the property as assessed by Federal Housing Administration (FHA) or Fannie Mae (FNMA)
- 4. The location of the property.
In a reverse mortgage in the U.S., a borrower can opt for lump-sum payments, monthly payments, an increasing line of credit, or a combination of all three. The money received is not taxable and does not affect social Security or Medicare benefits.
If you’re getting a reverse mortgage from a private lender be prepared for slightly higher costs than with other mortgages. In addition to normal closing cost you can expect an insurance premium of 2 percent of the loan and a 2 percent origination fee. Thus a $200,000 loan would have $8,000 in costs beyond the normal closing costs, which are typically some thousands of dollars. Monthly service charges usually add about $30 to the total cost of the loan.
Reverse mortgages offered by state and local governments are the lowest cost loans - they usually feature lower interest rates and fees – however they come with restrictions as noted above.
A reverse mortgage loan stays in effect until:
- the homeowner dies,
- sells the house, or
- moves out of the house for at least 12 consecutive months.
The reverse mortgage must then be paid off , through the sale of the house or by the inheritors of the homeowner’s estate. The lender does not have legal recourse to anything other than the value of the home when the loan is to be paid. That is, if the value of the reverse mortgage actually exceeds the deceased’s remaining equity – i.e. the proceeds are not sufficient to pay off the loan - then the lender takes the loss.
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