Intro: What Is a Reverse Mortgage? How Does a Reverse Mortgage Work?
You may be wondering, “What is a reverse mortgage exactly?”
The words themselves sound intriguing, so you may be asking if it could be something of use to you. It might be if you are a senior, are interested in the financial stability of a senior in your life or want to go into the real estate or finance industries.
In this article, we'll go over the following questions:
- What Is a Reverse Mortgage?
- How does a reverse mortgage work?
- What are the various reverse mortgage pros and cons?
What Is a Reverse Mortgage?
A reverse mortgage is a unique type of home loan for seniors aged 62 or older. Similar to a second mortgage, it gives a homeowner access to the equity of his/her home.
A Reverse Mortgage differs from other mortgage options because the borrower will have no monthly mortgage payments. The senior collects much-needed money or credit today and pays back the loan when the individual or his/her loved ones sell the home.
In 2009, half of homeowners that were 62 years of age or older had at least 55% of their net worth in their home equity. When you balance reserve mortgage pros and cons, it may make a huge difference in your finances to be able to make use of that worth today.
Image source: Bigstock
How Does a Reverse Mortgage Work?
A reverse mortgage is a home equity loan that doesn't get paid back on a monthly basis. To offer this loan, lenders tally up the fees and payments you would normally be making over the period of the loan and expect you to pay it back when the house is sold.
This sale could occur after the borrower's death, if the individual decides to move willingly or if he/she must leave to seek professional care.
Reverse Mortgage Basics:
You can choose from different types of reverse mortgages:
- HECMs are the most popular. They are insured by the FHA and are the broadest-reaching and safest reverse mortgage loans.
- Single-purpose reverse mortgages help low-income homeowners get reverse mortgages to address one temporary problem such as a home repair.
- Proprietary reverse mortgages use different reverse mortgage qualifications to address the needs of homeowners with higher home values; however, they are not guaranteed to offer the same protections as an FHA reverse mortgage.
Though the loan amount grows with each passing month, borrowers with HECM loans are not liable for the amount that goes over the home's actual value because the FHA pays the difference.
It is important to read the terms of other loan agreements to determine if they provide this same protection.
Any equity remaining over the loan amount will be yours to collect or leave to a spouse or any heirs.
Borrowers may receive payments in:
- Monthly income
- One-time lump sum
- Line of credit
- Combination of income and credit
Borrowers will not have to make monthly payments, but they are required to pay property taxes and homeowner's insurance. This turns an advantage into one of the many reverse mortgage disadvantages. Defaulting on either payment may result in having to sell the home to pay back the loan.
The FHA will only insure up to a certain loan amount. The amount varies by location and changes periodically, so you may need to keep up to date with FHA reverse mortgage qualifications in order to choose when to get a loan.
Reverse Mortgage Qualifications
Reverse mortgages are pretty easy to qualify for, much more so than other home equity loans. Most notably, you don't need a certain amount of income or credit score.
The only FHA reverse mortgage qualifications are that the borrower must:
- Be 62 years of age or older
- Own the home
- Live in the home
- Prove he/she can continue to pay the property taxes and homeowner's insurance
- Receive HECM counseling before obtaining the loan
Those offering other reverse mortgage plans may have different requirements, such as the single-purpose reverse mortgage qualifications defining a certain goal. There are other factors that don't keep you from qualifying for a reverse mortgage but do impact the amount you can receive.
- Age of the youngest borrower or spouse
- Current interest rate
- Amount of the home's sale price compared with the FHA's loan limit
Reverse Mortgage Pros and Cons
With a reverse mortgage, the question is not so much whether you can get a reverse mortgage but whether it is your wisest option after you take into account all of the reserve mortgage disadvantages.
Reverse Mortgage Advantages
Reverse mortgages are intended to provide seniors access to their home's worth should they need it to:
- Supplement Social Security income
- Pay medical bills or ongoing expenses
- Make home improvements
- Purchase another primary residence
A reverse mortgage can be a lifesaver in the right situation as it can help people in retirement make important improvements in their lives when they may not be able to if they didn't have the loan or had to make the monthly payments on their mortgage.
Reverse Mortgage Disadvantages
Reverse mortgages carry many unique considerations that may turn what should be a great idea into a burden. The very nature of the loan is risky because the payments rise over time while the equity in the home decreases.
The interest rates and fees are higher than most other loans. Also, because there are no monthly payments, it is too tempting for people to see a reverse mortgage as an easy way to address financial decisions despite the fact that reverse mortgage disadvantages often pile up so that it rarely is easy or even a real help.
One important note: If the borrower is forced to move out of the home because of financial difficulties or a need for professional care, he/she will be required to sell the home. You may even be considered to have “moved out” if you must be away from the home for a year because of health care.
For whatever reason you are forced to sell the home, a spouse or family member living in the home will be forced to move out also. If the loan payments equal or exceed the value of the home, the borrower and their family will receive no money from the sale of the home.
A fixed-rate mortgage forces borrowers to take their loan in one lump sum, which is usually the least beneficial payment plan. Other borrowers who aren't forced to get a lump sum often choose to because it looks appealing. However, most people do not have a sufficient use for the lump sum, where they would end up making or saving money in the long term, so they acquire a long-term debt without a long-term payoff.
The reverse mortgage market attracts predators. There are many professionals who pretend to be acting in your best interest though they overstate the advantages and downplay or ignore the risks while some talk you into using your payments in ways that will cost you money rather than make you money.
It is crucial to consult trustworthy advisors and to educate yourself on the reverse mortgage pros and cons applicable to your situation to ensure that the decision ends up being a plus in your life.
Image source: Bigstock
Who Benefits from a Reverse Mortgage?
Some people really do benefit from reverse mortgages because the solutions outweigh the risks. There is a lot of information out there convincing people that a reverse mortgage is a great way to get that boat you've always wanted or to afford extra luxuries.
That isn't really the point, and there are too many reverse mortgage pros and cons to consider to enter into a reverse mortgage so lightly. It is best for those people who really need that money, have no other way to get it, and the benefits given to them by the loan will far exceed the cost.
For example, Margot Saunder from the NCLC says, “If you are 85 years old and have $250 a month in income and a $500,000 house, it's a great idea no matter how much it costs, because the lender will give you money you don't otherwise have.” At 85 years old, you'll be accruing loan fees for a much shorter time than someone will at 62, and your benefit will be much greater than it will for someone who has no trouble meeting their financial needs or can address their financial needs in safer ways.
There are some things to consider when deciding if reverse mortgage pros and cons equal out in your favor:
- Your age
- How long you intend to own your home
- If you can meet your financial needs or desires in any other way
- Your payment plan
- Your intended use for the income
- If you can make the property tax and homeowner's insurance payments
- If someone else lives with you and will be forced to relocate if you move out or pass away
- If you wish to leave an estate behind to your family, the loan amount will very likely cut into or take all of your home's worth
If you are interested in a reverse mortgage but find negative answers to these points popping into your head, don't give up. You may not have to forget about a reverse mortgage altogether but simply choose to use it as a backup should an emergency situation befall you or your circumstances change. Reverse mortgage qualifications (due to loan limits) change periodically, and the disadvantages lessen over time.
Ways to Get a Reverse Mortgage
There are many predators in the reverse mortgage market waiting to mislead you into getting a loan that you won't really benefit from or who will persuade you to do something unwise with your money. They may only get paid if you decide to take the loan, or they may make extra money by selling ideas to you that may not take into account all of the reverse mortgage disadvantages that you need to know about.
You should never contact someone suggested to you who asks for money only to connect you to a counselor. This is a scam. Do be aware that some legitimate and trustworthy counselors are free while some charge a low rate.
To check, you can:
- Contact the National Council on Aging at (800) 510-0301
- Search online for a federally-approved HECM counselor or call (800) 569-4287 toll-free
Conclusion: What Is Reverse Mortgage, and Is It Right for Me?
A reverse mortgage is a home equity loan that can offer seniors access to their home's worth in the most cost-effective and considerate way, where they can better their living situations by utilizing their assets now.
Unfortunately, it is very easy to be misled into making reverse mortgage decisions that end up being a hindrance rather than a benefit. You should only get a reverse mortgage if you have carefully calculated the reverse mortgage pros and cons on your own and have a trustworthy counselor.
Balance the costs, your plan for the money, your other finances, and your needs for your home when making the decision.
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