What Is a Reverse Mortgage and How Does It Work?
March 9, 2021
What is a Reverse Mortgage?
You often-times hear the phrase “Reverse Mortgage” being thrown around on commercials during the nightly news. But how much do you really know about reverse mortgages? Let’s take a look at the often-misunderstood entity and shed some light on the types of Reverse Mortgages and the benefits to be derived from them.
Simply put, a reverse mortgage is a loan. Any homeowner who has reached age 62 and has some significant equity in their home can essentially take out a loan against the value of their home. They can choose to receive that money as a lump sum, fixed monthly amount or they can choose to have it as a line of credit. Unlike a “forward” loan (loans used to finance the purchase of a home), a reverse mortgage does not require the borrower to make monthly loan payments.
The loan amount becomes due in full once one or more of the following happens. The homeowner passes away, moves away to another home, or when the home is sold. To protect the homeowner, Federal regulations are in place to ensure that lenders structure the loan in such a way that the amount borrowed does not exceed the home’s value, and the borrower or their estate will not be held liable for paying the variance if the home’s value is less than the selling price of the house. This can happen if the borrower lives to a ripe old age or if there is a drastic dip in the housing market and the home loses some of its value.
What is Home Equity and How can it Benefit Reverse Mortgage Borrowers.
A reverse mortgage can provide a much-needed capital injection for seniors who have much of their net worth tied up in their homes. These loans can be a great option for homeowners who are no longer working and earning a monthly salary but need money to perform much-needed home repairs.
The National Reverse Mortgage Lenders Association report states that homeowners aged 62 and above hold a collective $7 trillion in home equity. This is the highest it has been since measurement started in early 2000. This number shows the extremely large collective wealth held by seniors in this country. Home equity is only usable wealth if you sell and downsize or borrow against that equity. And that’s where reverse mortgages come into play, especially for retirees with limited incomes and few other assets.
Exactly How Does a Reverse Mortgage Work?
A reverse mortgage is just that, a reverse of the flow of money. Instead of the homeowner making payments to the lender, the lender is now the one making payments to the homeowner. The homeowner chooses how they want to receive the funds and only makes payments on the interest of the payments received. This interest in rolled into the balance of the loan so the homeowner never has to pay anything upfront. The title remains with the homeowner for the duration of the loan and over time the debt increases and the home equity decreases.
The lender uses the home itself as collateral (similar to forward mortgages). When the homeowner passes on or moves out the home is put up for sale and the proceeds from the sale go towards repaying the loan as well as the interest, mortgage insurance, and any applicable service charges. Any money left over after the loan and fees have been recuperated go back to the homeowner or their estate. The IRS considers this money as a loan balance and not income so it is not taxable.
What are the Types of Reverse Mortgages?
There are three types of reverse mortgages:
Single-Purpose Reverse Mortgage
A single-purpose reverse mortgage is offered by state, local, and nonprofit agencies. It is the least expensive process option for a reverse mortgage loan. The state or local government, or nonprofit agency, specifies the reason for the reverse mortgage. Homeowners can use single-purpose reverse mortgage proceeds only to pay for a specific lender-approved item, such as necessary repairs to the home or property taxes.
Proprietary Reverse Mortgage
A proprietary reverse mortgage is used for a larger advance for a home appraised at a high value. For example, if your property is worth more than $765,600, the 2020 lending limit for federally backed HECMs, you may be eligible for a higher loan if you go the proprietary route.
Home Equity Conversion Mortgage
Home equity conversion mortgages (HECM) are federally-insured reverse mortgages backed by the U.S. Department of Housing and Urban Development. An HECM is likely to be more expensive than a traditional home loan, in addition to having high upfront costs. It is the most widely used reverse mortgage because it carries no income limitations or medical requirements, and the loan can be used for any reason.
How Can I Receive the Proceeds From a Reverse Mortgage?
When you opt to take out a reverse mortgage you can receive the proceeds in six ways:
- Annuity (equal monthly payments) – Here the lender makes monthly payments to the homeowner as long as one of the borrowers still lives in the home.
- Lump-sum – Here the homeowner receives one bulk payment. This type is the only one that comes with an adjustable-rate.
- Term payment – Here the homeowner gets payments in equal monthly installments for a predetermined timeframe
- Line of credit – Here the homeowner has access to a line of credit which they can use as needed, Interest is only charged on the amount used and not the entire line of credit
- Term payment with a line of credit – Here the lender gives the homeowner equal monthly payments and if the homeowner needs more funds, they can access the available line of credit
- Equal monthly payments plus a line of credit – Here the lender provides steady monthly payments for as long as at least one borrower occupies the home as their primary place of residence
The Bottom Line on Reverse Mortgages
A reverse mortgage can be a helpful financial tool for senior homeowners who understand how the loans work and the trade-offs involved. Ideally, anyone interested in taking out a reverse mortgage will take the time to thoroughly learn about how these loans work. If you are over 62 years old, there are options for you.
American Bancshares Mortgage offers reverse mortgages to those that are 62 or older. Reverse Mortgages work like an annuity and can help you tap into the equity and enjoy a better quality of life through retirement. If you would like more information on a reverse mortgage contact American Bancshares and apply for a reverse mortgage today.