How Do Reverse Mortgages Work?
If you are a homeowner and you’re 62 or older and you need additional income or you need to pay for health care expenses, you may want to consider a reverse mortgage. A reverse mortgage allows you to convert part of the equity in your home into cash without you having to sell your home or pay any additional monthly bills. But take things slowly and study the pros and cons carefully.
A reverse mortgage may not be right for you. A reverse mortgage can use up the equity in your home, which means fewer assets for you and your heirs. So if you were planning to leave your house to your adult children, a reverse mortgage may not be the right move to make. If you do decide to get a reverse mortgage, review the different types and comparison shop for the best deal. Wondering how reverse mortgages work? When you have a regular mortgage, you pay the lender every month with a monthly mortgage payment. With a reverse mortgage you get a loan and this time the lender pays you.
Reverse mortgages take part of the equity in your home and convert it into payments to you. The money you get with a reverse mortgage is generally tax-free. With a reverse mortgage, you don’t have to pay back the money for as long as you live in your home. When you die or sell your home or move out, you or your spouse or your estate would repay the loan. In some cases this means selling the house to get the money to repay the loan.
Types of Reverse Mortgages
There are three different kinds of reverse mortgages. There are single-purpose reverse mortgages. These are offered by state and local government agencies and non-profits. There are proprietary reverse mortgages, which are private loans. And there are federally-insured reverse mortgages also known as home equity conversion mortgages (HECMs).
Let’s take a closer look at the three different types of reverse mortgages.
Single-Purpose Reverse Mortgages. The first thing to know about single-purpose mortgages is they’re not available everywhere. And these loans may only be used for one purpose, which the lender specifies. For example, a lender may say a reverse mortgage may only be used for home repairs or to pay property taxes. Most homeowners with low or moderate incomes can qualify for single-purpose reverse mortgages.
Proprietary Reverse Mortgages. Proprietary reverse mortgages are private loans that are backed by the companies that develop them. If you own a home with a high value, you may get a bigger loan advance from a proprietary reverse mortgage. So if you own a home with high value and you have high equity too, you may want to check out a proprietary reverse mortgage since you may get a bigger payout amount.
HECM Reverse Mortgages. HECMs are federally-insured reverse mortgages backed by the U.S. Department of Housing and Urban Development (HUD). HECM reverse mortgages can be used for any purpose.
With a reverse mortgage of any kind you get a loan in which you borrow against the equity in your home. With a reverse mortgage you keep the title of your home. And with a reverse mortgage you get advance payments on part of your home’s equity.
Impact on Taxes and Benefits
With a reverse mortgage the money you get is usually not taxable and it won’t affect your Social Security or your Medicare benefits. When the last surviving borrower dies, sells the home or no longer lives in the home as a principal residence, the loan on the reverse mortgage has to be repaid.
Watch Out For Fees
Reverse mortgage lenders charge an origination fee and other closing costs as well as servicing fees over the life of the reverse mortgage. HECM reverse mortgages also charge mortgage insurance premiums.
How Much Do I Owe?
As you receive money through a reverse mortgage, interest is added onto the balance you owe each month. So with a reverse mortgage the amount you owe grows over time.
Interest Rates May Change
Most reverse mortgages have variable rates and are tied to a financial index and change with the stock market. Some reverse mortgages, mostly HECMs, offer fixed rates. These fixed rate reverse mortgages tend to require you to take your loan as a lump sum at closing. With a fixed rate reverse mortgage the total amount you can borrow is less than what you could borrow with a variable rate mortgage.
Maintaining Your Home
With a reverse mortgage, you keep the title of the house and you are still responsible for your home’s upkeep. You are still responsible for property taxes, homeowners insurance, utilities, maintenance and other homes expenses.
Getting a Financial Assessment
A financial assessment is required when you apply for a reverse mortgage. Because of this, your lender may require you to pay a set amount to pay your taxes and homeowners insurance during the reverse mortgage loan. This amount reduces the amount of money that you can receive in payments.
What Is Left for Your Heirs?
Reverse mortgages can use up the equity in your home, which means fewer assets for you and your heirs. If passing down an inheritance to your heirs is important to you, you may want to think carefully about signing on for a reverse mortgage. With a reverse mortgage there will be less to pass down to your heirs.
What Is a Non-Recourse Clause?
A non-recourse clause means that you and your estate can’t owe more than the value of your home when the reverse mortgage loan is due. With a HECM reverse mortgage, if you or your heirs want to pay off the reverse mortgage loan and keep the home rather than sell it, you would not have to pay more than the appraised value of the home. So no matter how much you borrow you won’t have to pay back more than the appraised value of the house.
How Much You Can Borrow
How much you can borrow with a HECM or proprietary reverse mortgage depends on your age, the type of reverse mortgage you choose, the appraised value of your home, current interest rates and the financial assessment of your ability to pay property taxes and homeowners insurance.
With reverse mortgages, the older you are, the more equity in your home, the more money you are likely to get in a reverse mortgage.
Counseling for A Reverse Mortgage
Before applying for a HECM reverse mortgage, you must meet with a counselor from an independent government-approved housing counseling agency. And some lenders offering proprietary reverse mortgages also require counseling.
With a HECM counseling session, a counselor must explain alternatives to HECMs, such as the other types of reverse mortgages. A counselor will be able to help you compare the costs of different reverse mortgages and explain how fees and costs and payment options affect the cost of the reverse mortgage. You can find a counselor by visiting the HUD website. Counselors usually charge a few for their services, typically $125. And you can pay this fee from the proceeds of the loan you will receive from a reverse mortgage if need be.
How would you like your money? With a HECM reverse mortgage you have several payment options to choose from. There is the single disbursement option. This option is only available with a fixed rate loan. And this option typically offers less money than other payment options.
A term option gives you fixed monthly cash advances over a specific period of time.
A tenure option offers fixed monthly cash advances for as long as you live in your house.
A line of credit lets you draw down the loan proceeds at any time, in amounts that you choose until the line of credit is used up.
And there is a combination of monthly payments and a line of credit that you can choose as well.
Not sure which one to choose? Go over your options with a counselor. That is what they are there for.
You want to choose the type of reverse mortgage that is right for you and then choose the appropriate payment option. And if you decide a reverse mortgage is not the right choice for your family that is a valid choice as well. Give yourself plenty of time to review your options. A home is the biggest purchase many people make in their lifetime. Borrowing against it with a reverse mortgage is a big decision. So don’t rush it. You want to be comfortable with your decision either way.
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