How does a reverse mortgage work?

Unlike a home purchase loan, a reverse mortgage doesn’t require the homebuyer to make monthly payments. Instead, it allows people 62 and older to borrow against their home’s value. They can receive funds in a lump sum, as a line of credit, or as a fixed monthly payment. In this article, we will understand how does a reverse mortgage work and various other essential questions you should keep in mind while opting for a reverse mortgage.

Unlike a forward mortgage, which means the type used to purchase a home, a reverse mortgage doesn’t require the homeowner to pay any loan payments throughout their lifetime. The loan amount, up to a maximum, becomes due and payable once the borrower either dies, moves out, or sells their home. Federal regulations require that the amount of the loan be kept below the value of the home. Even if the home’s value goes down, the lender doesn’t have to pay the difference due to the policy’s mortgage insurance.

A reverse mortgage loan isn’t free money. It’s a type of loan where the borrower borrows money with a rising balance, and it charges fees and interest. Eventually, the loan will have to be paid back, by selling the home.

What are the disadvantages of getting a reverse mortgage?

A reverse mortgage can provide a large sum of money by utilizing the equity in a home, but there are some downsides to consider.

One of the main costs is the mortgage insurance premium, which is usually around 2% of the loan amount. Additionally, there are other fees involved such as origination fees and third-party fees.

These fees can decrease the value of the home and reduce the asset value of any heirs. The interest rates for reverse mortgages are variable and not tax-deductible until the loan is paid off.

If the home is in poor condition, it may not qualify for the loan. If the owner passes away or moves out, the loan may need to be paid off early, especially if property taxes or homeowners insurance are not paid.

While Social Security and Medicare benefits are not affected, Medicaid eligibility can be impacted.

How much money do you get on a reverse mortgage?

When you apply for a reverse mortgage, the lender will determine the payment plan and amount you’ll receive based on factors such as the interest rate, your age, and the value of your property.

You can’t borrow 100% of your home’s value and a portion of your equity will be used to cover loan expenses. The amount you can borrow increases with your age and property value, and a lower mortgage rate also means you can borrow more.

A strong financial assessment can also increase your payments, as the lender won’t withhold any money for insurance or taxes.

The maximum amount you can borrow was reduced in 2017 to protect the mortgage insurance fund from losses, making it harder for younger borrowers but beneficial for older individuals who want to preserve their equity.

You can only borrow up to 60% of the total amount in the first year and a lump sum payment will provide only an upfront payment, while a credit line will grow over time as long as funds are available.

Who benefits from a reverse mortgage?

A reverse mortgage can be a valuable financial tool for seniors who own their homes but have limited savings or income to sustain themselves during their retirement years.

This type of mortgage can provide the much-needed funds for covering expenses like medical bills, home repairs, or unexpected costs while enabling them to stay in their homes.

It can also serve as a means to supplement retirement income or pay off outstanding debts or mortgages.

However, it is crucial to understand that a reverse mortgage is not suitable for everyone, and it is advisable to seek guidance from a financial advisor to assess if it is the right fit for your particular situation.

Who should not get a reverse mortgage?

If you’re planning on giving your home to your heirs or charity free and clear, you shouldn’t get a reverse mortgage. These types of loans have high fees, and people who can get a better deal with a refinance or home equity line of credit should consider other options.

What is an alternative to a reverse mortgage?

If you’re considering transferring your house to your beneficiaries, it’s crucial to ensure that your surviving spouse has the appropriate rights to it.

In the event that you’re unable to gather enough funds to repurchase the house from the bank, you may need to relinquish it.

However, this option carries risks and should only be contemplated after conducting thorough research on potential lenders. As an alternative to a reverse mortgage, you can explore the following options.

Refinance Your Existing Mortgage

If you’re finding it difficult to meet your mortgage payments on time due to financial constraints, considering a home loan refinance might offer you some relief by freeing up cash and reducing your monthly financial burden.

Through refinancing, you have the opportunity to secure a lower interest rate, resulting in smaller monthly payments. This can also help you build equity more swiftly by decreasing the annual expenditure on your mortgage.

Moreover, one significant advantage of this process is that it enables you to preserve the equity in your home, eliminating the need to resort to a reverse mortgage.

Take Out a Home Equity Loan

A home equity loan is a type of second mortgage that allows you to borrow money using the equity in your home. Like a primary mortgage, it comes with a lump-sum payment. You can’t draw any funds from the house.

Before the Tax Cuts and Jobs Act of 2017 made it harder for people to deduct the interest they pay on home equity loans, it was generally considered to be a qualified loan.

However, starting from the 2018 tax year, you will no longer be able to deduct the interest on home equity loans unless the loan is used for other qualified purposes. Also, the level at which interest can be deductible on loans of $750,000 or less was lowered.

Take Out a Home Equity Line of Credit (HELOC)

A home equity line of credit offers the flexibility of using your credit limit for various financial needs.

Unlike a home loan, this type of credit line has an adjustable interest rate, and you only pay interest on the amount you use.

The guidelines regarding qualified purposes and tax deductibility are the same as a home equity loan. However, if you default, your home may face foreclosure just like with a home equity loan.

Sell Your Home or Downsize

If you’re not keen on moving and don’t have the means to invest heavily in repairs or upkeep, selling your home could be a fantastic choice.

It provides a simpler option, especially if you have a spacious home that’s becoming burdensome to maintain or if the property taxes are beyond your means. The funds you receive from the sale can then be utilized to either rent or purchase a more affordable residence.

Sell Your Home to Your Children

If you’re considering selling your home to your children, you can opt for a leaseback agreement. This arrangement enables you to sell the property and continue living in it by renting it back from your children using the money from the sale.

By becoming the landlords, your kids can enjoy certain benefits such as tax deductions on property taxes, depreciation, and expenses related to real estate.

Sell Off Other Assets

If you’re thinking about exploring the option of a reverse mortgage to access funds, it’s worth considering alternative avenues that may offer lower interest rates.

Additionally, if your car is seldom used and you’re contemplating selling it, it would be beneficial to explore programs that offer transportation services specifically designed for seniors.

Similarly, if you possess assets such as boats, recreational vehicles, or collectibles, engaging in a conversation with your heirs to gauge their interest in keeping those properties or other remaining assets would be prudent.

Why are people disappointed with reverse mortgages? | How does a reverse mortgage work?

There are certain issues due to which people are often disappointed with reverse mortgages so it is very important that you understand each and every aspect of the reverse mortgage so that you do not

A reverse mortgage can be more expensive than a traditional loan due to the fact that it requires the property to be your primary residence, it may not be assumable, and it may not leave enough equity to your heirs as an inheritance. Also, the premiums for these loans are higher due to the mortgage insurance premium that is charged by the Department of Housing and Urban Development (HUD).

Taking out a reverse mortgage should be considered carefully due to the various fees that are involved in the process. These fees should be included in the loan documents. If you are considering taking out a reverse mortgage, be aware that it can be very expensive. You should also consider other options, such as a Home Equity Loan.

In a reverse mortgage, the borrower’s death is immediately followed by the repayment of the loan. If one of the spouses’ names is on the contract, the house can be sold if one of them passes away. If the other assets cannot be used to pay the mortgage, the house must be sold. This can leave the spouse homeless.

What are the five major steps of a reverse mortgage?

The typical process for getting a reverse mortgage is around 30 days. There are several steps involved in the process, and the decision-making phase is the longest. The five steps to take care of when deciding on reverse mortgage are:

• Initial Application
  • Although the application process is legal, the lender can’t charge you until Step 2 is completed. The reverse mortgage application doesn’t have to be binding, and it can be canceled anytime during the entire process. The fee, loan amounts, and interest rates will be specified in the application.
• Reverse Mortgage Counseling
  • Once an applicant has submitted their application, the lender cannot charge any fees or expenses related to the Home Affordable Refinance program until the applicant provides a signed HECM, which confirms that they have completed the required counseling process. This counseling process can be completed before submitting the initial application in many states.
• Appraisal
  • Getting a reverse mortgage involves an important step called an appraisal, which plays a crucial role in the process. The appraisal needs to be carried out by an appraiser approved by the Federal Housing Administration (FHA) and must adhere to specific guidelines. Consequently, if an appraisal has already been submitted, it is probable that the property’s legal value will need to be reassessed.
• Underwriting
  • After the appraisal is finished, the lender will go ahead and conduct a thorough search of the property’s title, while also acquiring title insurance to ensure that the applicant’s rightful ownership of the home is confirmed. In case of any problems like outstanding liens, trusts, or bankruptcies, the lender will collaborate with the borrower to resolve them. Once the lender gives their approval and the loan is nearing the closing stage, the status will be updated to “clear to close.” This indicates that the final steps for the transaction can be taken.
• Closing
  • The lender and applicant have agreed on a closing date, and the applicant will meet with an attorney or notary to sign their final documents. It’s important for the applicant to carefully review the documents before signing to ensure accuracy. After signing, there’s a three-day period called “right of rescission” during which the application can be canceled.
  • If the reverse mortgage funds are available, the homeowner will receive a check from the title company. In case the borrower used the reverse mortgage to pay off an existing loan, the payoff amount will be sent directly to the lender.

What are the three types of reverse mortgages?

• Single-Purpose Reverse Mortgages
  • Various agencies, including state, local, and nonprofit organizations, offer specialized reverse mortgages for specific purposes. These loans are typically more affordable compared to other types of reverse mortgages and are supported by the government.
  • It’s important to note that not all states offer these one-purpose reverse mortgages. Unlike home equity loans, which provide flexibility in using the funds, these specialized loans restrict the borrower to a specific use, such as covering property taxes or making repairs.
  • One significant advantage of these single-use reverse mortgages is that they don’t require monthly payments like traditional home equity loans or lines of credit. Furthermore, if the borrower moves out of the home and ownership changes, these loans can be forgiven. However, it’s worth mentioning that if the borrower fails to maintain homeowners insurance on the property, the loan will become due.
• Home Equity Conversion Mortgages (HECMs)
  • Federally insured home equity conversion mortgages receive support from the Department of Housing and Urban Development (HUD). These loans may have higher upfront costs compared to traditional home loans. However, they are popular among borrowers as they don’t require medical or income qualifications.
  • To ensure individuals understand the associated expenses and obligations, it is advisable to undergo counseling before applying for a home equity conversion mortgage. It is also beneficial for interested parties to be aware of alternative options provided by government-backed or nonprofit organizations.
  • Following the counseling session, individuals can determine their borrowing capacity with an HECM. Factors such as their age, prevailing interest rates, and home value play a role in determining the loan amount.
• Proprietary Reverse Mortgages
  • Private lenders are responsible for administering these specific types of loans, in contrast to reverse mortgages supported by the federal government. These loans are typically more economical and provide advantages to individuals seeking to increase their available funds.
  • When the value of a property surpasses the lending limit established by federally-backed reverse mortgages, this alternative loan option becomes accessible.
  • Even individuals with low mortgage balances can qualify for a higher amount of funds. Prior to submitting an application, it is recommended that individuals partake in counseling to thoroughly assess the benefits and costs associated with a proprietary loan versus a Home Equity Conversion Mortgage (HECM). The repayment process is akin to that of a regular home equity conversion mortgage.
  • Unlike an HECM, a proprietary reverse mortgage does not include upfront mortgage insurance premiums. Consequently, it may be a more cost-effective choice for individuals in need of a larger borrowing amount. However, the overall affordability is contingent upon the interest rate and the lender’s willingness to lend a particular sum of money.

Who pays back a reverse mortgage?

If you have a reverse mortgage, it usually requires that you pay it back either when you leave the home or when you die, though it can be paid off sooner if the house is no longer your primary residence.

Home equity conversion mortgages are commonly known as HECMs. They must be paid off once the last surviving or eligible non-borrowing spouse or borrower has passed away, or has sold their home or no longer lives in the house for a majority of the year, or use that house as their principal residence

If you are away from your home for more than a year while you’re in a healthcare facility, such as a nursing home, rehabilitation center, or hospital, your co-borrower will have to move out. If you’re an in-eligible non-borrowing spouse, your surviving spouse or anyone living with you will also have to move out or pay back the loan.

Can you sell your home after reverse mortgage?

Yes, you can sell your home after opting for a reverse mortgage but you have to keep in mind that you must pay back your reverse mortgage loan once you sell your home. Doing so will require you to settle the balance plus interest and fees.

• If the loan balance is lower than the amount you sold your home for, you will keep the difference. However, if it’s more than the amount that you sold your home for, the money that you get from the sale will be used to settle the outstanding balance.
• If you’re in default on your reverse mortgage, you can sell your home for a lower price. The money that you receive from the sale will go toward the balance of the loan and the mortgage insurance.

Which bank is best for a reverse mortgage?

Some of the best financial institutions for reverse mortgages are:

• American Advisors Group (AAG)
• Mutual of Omaha Reverse Mortgage
• Reverse Mortgage Funding
• Longbridge Financial

What happens when the owner dies in a reverse mortgage?

If you or any of your co-borrowers or eligible non-borrowing spouses pass away, then your reverse mortgage loan will become due and payable. Your heirs get 30 days from the time they receive the lender’s notice which to allows them to sell, buy, or turn the property over to the lender to settle the debt. This type of loan is commonly referred to as a home equity conversion mortgage.

If your heirs can’t afford to wait for 30 days to sell the property, they can request an extension of the timeline to allow them to obtain financing or sell the home. In such cases, they can get up to 6 months time to sell the home or obtain another source of finance to purchase the home. You can consult a Housing Counseling Agency or an attorney if they have questions.

Key takeaways

Reverse mortgages can be a valuable financial tool for senior citizens who grasp their workings and benefits. These loans can help them avoid unexpected expenses and provide much-needed assistance, provided they have a solid understanding of the loan terms. When considering any loan, it is crucial to thoroughly research the specifics to protect against potential scammers and unscrupulous lenders.

Regrettably, reverse mortgages can be quite intricate, demanding that borrowers do their due diligence before committing to one. It is advisable to refrain from hastily engaging with the first lender encountered. Rates and fees associated with reverse mortgages can vary significantly, as the federal government does not impose standardized rates.

We hope that this article has shed light on the functioning of reverse mortgages and addressed pertinent questions. We eagerly await your valuable feedback in the comments section below. Don’t forget to share this article with your friends and family members who may be interested in exploring this financial product.

FAQs