What is a "Reverse Mortgage?"
Also known as a Home Equity Conversion Mortgage (HECM) a reverse mortgage, is a popular way older homeowners (62+) can convert part of the equity in their homes into tax-free income without having to sell the home, give up title, or take on a new monthly mortgage payments.
Before explaining a reverse mortgage, let's review the features of a Standard Mortgage:
With a standard loan or mortgage, your income stream is used to 'qualify' for the mortgage or loan. The lender will want to see that you have enough cash flow from your job and other sources of income in order to make the payments.
By securing this loan or mortgage against your house, the bank has extra security. After all, if you stop paying, they can take away your house.
As the years go by and you continue to make the payments, you will build up 'equity', which is the difference between what your house is worth, and how much you owe on the loan or mortgage What you owe will be continually reducing as you pay off the principal.
A Reverse Mortgage … Reverses The Process:
A reverse mortgage, in contrast, requires no proof of income, no credit checks etc .. You simply have to own the home you are borrowing against.
The reason for this is that interest payments are 'rolled up' on the reverse mortgage – ie they are added to the loan, and not repaid monthly.
Over time, of course, this starts to eat up your equity, because as each interest payment is added to the loan, interest starts being charged on the previous interest too!
Who Would Benefit From A Reverse Mortgage?
Older homeowners (62+), who struggle on limited pensions are usually living in properties that have soared in value in recent years. With reverse mortgages they can unlock some of the value in their homes and remain in the property at the same time, thus enhancing their retirement years.
These reverse mortgages are becoming more popular with seniors.
Paying Back The Loan
There are NO monthly payments due on this type of mortgage while it is outstanding. The mortgage / loan is repaid when the homeowners cease to occupy the home as a principal residence, whether the homeowner (the last remaining spouse, in cases of couples) passes away, sells the home, or permanently moves out.
Depending on the size of the loan and the current real estate market conditions, there may actually be no equity left when the loan is finally repaid. If the debt comes to exceed the value of the property, the FHA or the lender takes the loss.
As well, loans under these programs are without recourse. This means that lenders can not attach other assets of borrowers or their heirs in the event that the reverse mortgage debt exceeds the property value.
On a another note, if the home is sold and the sales proceeds exceed the amount owed on the reverse mortgage, the excess money goes to you or your estate.
There will always be some concern with homeowners who would like to leave an inheritance for their children and the home is to be that cash inheritance.
As with all loans, be careful not to default on regular or common charges, such as property tax, insurance, utilities etc, as these could all lead to the loan / mortgage being reclaimed early (foreclosed).
Typically, the lender will have an option built in to the contract to increase your debt by paying these charges on your behalf, should you default, and this is not an option you want them to exercise, as you will then start paying interest on those charges too!
Reverse mortgages can be very useful, but treat carefully as they can also have a sting in their tail.
Keep an eye on the outstanding balance every month, versus the value of your home for peace of mind.
And as with most major decisions, speak to an expert who knows your situation and long term plans before applying for a reverse mortgage. As a matter of fact, in the US, mandatory counseling is required prior to applying for this type of mortgage. An approved counselor will educate you about reverse mortgages and determine whether this is your best option. Then, given your particular situation assist you in determining which reverse mortgage product best suits your needs.
A site for people over 50 years of age, has also entered the picture as a major information source for this type of mortgage. They have a guide and many articles that can help you figure out if there is a reverse mortgage product right for you. As mentioned previously, speak to your trusted advisor before making any decisions in this matter.