How Does A Reverse Mortgage Work?

Are you a homeowner aged 62 or older? Would some immediate financial support in the short term sound enticing if you’re okay with paying what is given to you all at once at a later time (with significant interest and fees)? A Reverse Mortgage may be helpful to you. A Reverse Mortgage is a valid option for senior citizen homeowners to find immediate financial assistance, but only if their primary home has a good amount of equity.

What Exactly IS a Reverse Mortgage?

A Reverse Mortgage is a resource that allows homeowners to borrow money, leveraging the home itself as the security for the loan. Unlike traditional loans, money isn’t owed outright, but is due in full when the house is sold, the borrower dies, or if the borrower pays off the total loan amount of their own accord. Borrowers won’t receive reverse mortgage repayment fees, which are instead, added to the total equity of the house with added interest and fees each month. All other payments for your home (homeowner’s insurance, taxes, other mortgage payments) are unaffected and will continue normally. There’s a lot to consider with Reverse Mortgages to properly break down how they work, so let’s break this down into smaller groups of information:

There are Mandatory Requirements to Apply:

  • The applicant must be at least 62 years of age, as anyone younger may find themselves in significant debt if the loan’s compound interest adds up for too long.
  • The applicant needs to be a homeowner, not just any owner, but a homeowner in good standing. The applicant must have full ownership of their home, or at the very least, 50% minimum equity on their home.
  • The house must be the borrower’s primary residence; the house that the reverse mortgage is applied to must be a homeowner’s primary home, with a minimum residence time of 6 months out of the year- properties that a homeowner rents out, and additional residencies (like vacation or seasonal homes) are not permitted for reverse mortgages. 

The Costs and Fees are Determined by Three main Factors:

  • The borrower’s age determines not just applicability for the loan, but the terms and rates, as well. Typically, the older the applicant, the lower the fees and interest rates. This is determined by the perceived length of time from the house being sold (typical time of the full reverse mortgage repayment), or the length of time for the death of the homeowner.
  • The borrower’s equity in their home determines rates on the lenders’ end, and it determines the ease in which the homeowner will be able to pay off the reverse mortgage upon the sale of the house. Homeowners who have spent more time at their residence typically have much better rates than those who haven’t.
  • Remaining mortgage balance affects the total costs as well, as those with a low remaining balance of their mortgage will have a nearly guaranteed ability to pay off their reverse mortgage if the total balance of a borrower’s reverse mortgage is significantly less than the paid amount of their current mortgage.

There are three types of reverse mortgages:

  • Single Purpose Reverse Mortgages are offered by local governments or nonprofit organizations to low income families and homeowners. The funds allocated are given with the caveat that it’s given to only be used for a single purpose, usually for something related to the home itself, such as repairs, renovations, property taxes, or homeowner’s insurance payments. These are typically the reverse mortgages with the smallest amount of allocated funds. 
  • Home Equity Conversion Mortgage (HECM) is the most common version of a reverse mortgage; typically funded by your lender of choice, and insured by the Department of Housing and Urban Development to protect the provider from losses when working with large sums of money; There are federally imposed limits to this type of mortgage due to the federal insurer’s involvement. 
  • Proprietary Reverse Mortgage is typically offered, funded, and insured by a private lending company. The terms are typically less protected and are more in favor of the mortgage lender, but this type of reverse mortgage sets itself apart 

from the other two types: the limits of the loan funds are much higher due to the lack of federal involvement, and due to the private funding, the funds can be used at the borrower’s discretion for whatever they want or need. 

The Mortgage Funds are allocated to the borrower in three ways:

  • Single Lump Sum Payment- like many typical mortgage loans, the reverse mortgage funds can be allocated in one large lump sum, with the total amount of the loan also added onto the house’s balance, with the typical fees being continually added after the initial loan payout.
  • Equal Payments Every Month– For those that may have monthly recurring payments that they need assistance with, this is a viable option. A borrower can get the equal payments allotted monthly, with each monthly payment added onto the house (with the monthly fees and interest) upon each payout. 
  • Line of Credit– By far the most popular and common way borrowers access their Reverse Mortgage funds, the line of credit continually adds its balance to the total balance of your home, and payments can be deferred to the typical sale of home lump payment, or they can be paid off at the borrower’s discretion. While the interest rates are high, this allows the most financial freedom, and reduces financial risk for borrowers who plan ahead with the interest rates and fees.

Know the Risks and Severity of Fees

If you think you may still be interested, and you qualify for the age, homeownership, and financial requirements, you may be able to get a rough estimate with a Reverse Mortgage Calculator. From here, it’s important to either take the time to educate yourself of the Reverse Mortgage process, or enlist the help of a mortgage broker or housing counselor to help guide you through the process, and plan together to consider your projected finances and determine your plans for the future. Those without a plan run a greater risk of losing their home to foreclosure from their lender. 

There are origination fees that add up, small monthly “Maintenance” fees that do add up over time, and interest rates are extremely high and are subject to compounding. There’s also an insurance policy that your lender will require you to pay into, which protects them from losses, but substantially adds to your total reverse mortgage balance. 

Borrowers are still fully responsible for property taxes, homeowner’s insurance, and (if applicable) Homeowner’s Association dues. These are normally included in most monthly mortgage payments, so it’s important to consider that only one of many monthly payments is paused throughout the reverse mortgage borrowing process. If you default on the payments of these fees, the lender of your reverse mortgage has a claim to foreclose on your home, which is the largest risk associated with reverse mortgages.

Know the Borrower’s “Right of Rescission”

All reverse mortgages have the borrower’s Right of Rescission, which allows for three business days for the borrower to fully call the process off, at no charge or penalty to the borrower. This will be reviewed with your lender- but if for any reason, upon review of your terms, you have the right to contact your lender and call off the reverse mortgage entirely. During these three days, it’s advisable to review the terms of your reverse mortgage with a financial professional, and to even review the terms with other family members if they have any stake or involvement in the house you are taking the reverse mortgage out against. 

Apply the terms of the loan against your plans for the future, as well as your family’s plans for the future after you’ve sold your home or if you die; if there’s any second thoughts from any involved party, reach out to your lender as soon as possible. These three days are the only period in which you can reverse the reverse mortgage unscathed. 

Safe and Considered Decision-Making

A reverse mortgage is a valid option for homeowners in great financial standing, for assistance with unexpected life events, health insurance fees & bills, home repair & renovations, or even vacations. It’s important to assess the risk involved, as high and compounding interest fees add up quickly, there are large initial and recurring fees, and if a borrower isn’t careful, they could lose their house to defaulting payments, or lose the benefits of selling their home to the accrued interest of a reverse mortgage over a long period of time. It’s a great resource to those who can consider and anticipate the risks, make sure you do so when considering this option for your house and home.

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