Homeowners who have lived in their homes for many years often have substantial equity built up, and for many, this represents a significant portion of their net worth. A reverse mortgage offers a way to tap into this wealth without selling the home.
This comprehensive guide explores the concept of reverse mortgages, breaking down what they are, how they work, and the critical factors to consider.
What is a Reverse Mortgage?
A reverse mortgage is a loan available to homeowners, 62 years or older, allowing them to convert part of the equity in their homes into cash. Unlike a traditional forward mortgage, in which the homeowner repays the lender, in a reverse mortgage, the lender makes payments to the homeowner.
The homeowner is not required to repay the loan until the home is sold or otherwise vacated. As long as the homeowner lives in the home, maintains the home, pays insurance and taxes, the homeowner can live without making any monthly mortgage payments.
Types of Reverse Mortgages
There are three main types of reverse mortgages:
- Home Equity Conversion Mortgages (HECMs) are federally insured reverse mortgages backed by the U.S. Department of Housing and Urban Development (HUD). They represent the majority of reverse mortgages.
- Single-purpose reverse mortgages are offered by some state and local government agencies and non-profit organizations and can only be used for one specific purpose, which is determined by the lender, such as home renovations or property taxes.
- Proprietary reverse mortgages are private loans that are backed by the companies that develop them. They can offer higher loan advances to borrowers with higher-valued homes.
The Mechanics of a Reverse Mortgage
To qualify for a reverse mortgage, you must be at least 62 years old, own your home outright or have a low mortgage balance, reside in the home as your primary residence, and not be delinquent on any federal debt.
You also must have the financial resources to pay ongoing property charges, including taxes, insurance, and home maintenance.
You can choose to receive the loan proceeds in several ways: as a lump sum, as monthly payments, as a line of credit, or a combination of these. The total amount you can borrow depends on your age, the current interest rate, the appraised value of your home or the federal HECM mortgage limit ($765,600 as of 2021), whichever is lower, and the initial Mortgage Insurance Premium (MIP) option you choose.
When you take out a reverse mortgage, you hold the title to your home, and the loan does not need to be repaid until you sell your home, permanently move out, or pass away. Upon this event, the loan, along with interest and fees, becomes due.
If your home is sold, and the sales proceeds exceed the amount owed on the reverse mortgage, the remaining money goes to you or your estate.
Factors to Consider
While a reverse mortgage may seem like an attractive option, it is crucial to consider the following:
- Fees and Interest: Reverse mortgages come with various fees and interest, including origination fees, upfront and monthly MIP, servicing fees, and interest on the loan balance, which accrues over the life of the loan.
- Impact on Public Benefits: Reverse mortgage loan proceeds are considered loan advances and not income, but if you were to retain the proceeds in a bank account beyond the end of the month, it could affect your eligibility for public assistance programs like Medicaid.
- Impact on Heirs: When you pass away or permanently move out, your heirs will have a limited time to repay the loan balance. This repayment is usually done by selling the home. If the sale of the home is not enough to pay off the loan, your heirs will not be responsible for any additional amounts. However, if the home sells for more than the amount owed, your heirs will receive the remainder. Therefore, a reverse mortgage could potentially diminish the inheritance for your heirs.
- Living in the Home: With a reverse mortgage, you must continue to live in your home as your primary residence. If you need to move into a nursing home or assisted living facility for more than 12 consecutive months, the reverse mortgage would become due, which could force a sale.
- Homeownership Responsibilities: Even though you’re receiving money from a reverse mortgage, you are still responsible for maintaining your home and paying for homeowners’ insurance, property taxes, and utilities. Failure to do so can lead to foreclosure.
Conclusion
Reverse mortgages can be an effective tool for seniors to tap into their home equity and improve their financial situation. They provide the flexibility to use the funds as desired, whether to cover everyday expenses, pay off debts, or finance home improvements.
