In short, a reverse mortgage is a loan. A homeowner who is 62 or older and has substantial home equity can borrow against the value of their home and receive funds as a lump sum, fixed monthly payment, or line of credit. Unlike a forward mortgage, the type of reverse mortgage used does not require the homeowner to make any loan payments.
Federal regulations need lenders to form the transaction so the loan amount does not exceed the home’s value and the borrower or borrower’s estate will not be held accountable for paying the difference if the loan balance does become bigger than the home’s value. A way this can happen is through a fall in the home’s market value alternative is if the borrower lives a long time.
How a Reverse Mortgage Works
With a reverse mortgage, instead of the homeowner making payments to the lender, they make payments to the homeowner. The homeowner gets to choose how to collect these payments and only pays interest on the returns received. The interest is rolled into the loan balance so the homeowner does not pay anything upfront.
With a forward mortgage, the home is the collateral for a reverse mortgage. When the homeowner moves or dies, the returns from the home’s sale go to the lender. to pay off the reverse mortgage’s principal, interest, mortgage insurance, and fees. Any sale returns beyond what the borrowing goes to the homeowner or the homeowner’s estate. In some cases, the heirs may choose to settle the mortgage so they can keep the home.
Reverse mortgage proceeds are not taxable. While they might feel like income to the homeowner, the IRS regards the money as a loan advance.
Types of Reverse Mortgages
There are three types of reverse mortgages. The most ordinary is the home equity conversion mortgage or HECM. The HECM constitutes almost all of the reverse mortgages lenders offer on home values below $765,600 and is the type most likely to get. If the home is worth more, however, there can be a look into proprietary reverse mortgages.
When taking out a reverse mortgage, there are to receive the proceeds in one of five ways:
Lump-sum: Get all the returns at once when a loan closes. It is the only option that comes with a fixed interest rate.
Equal monthly payments (annuity): As long as one borrower lives in the home as a chief residence, the lender will make regular payments to the borrower. It is also known as a tenure plan.
Term payments: The lender gives the borrower uniform monthly payments for a set term of the borrower’s choosing.
Line of credit: Money is available for the homeowner to borrow as required. The homeowner only pays interest on the amounts taken from the credit line.
Term payments plus a line of credit: The lender gives the borrower uniform monthly payments for a set term of the borrower’s choosing. If the borrower needs additional money during or after that term, they can access the line of credit.
Pros and Cons
Once a person is 62 or older, a reverse mortgage can be a way to get cash when home equity is the biggest asset there is no other way to acquire enough money to meet the basic living expenses. A reverse mortgage permits keep living in the home long as property taxes, maintenance, and insurance are done. There is no need to move into a nursing home or assisted living facility for greater than a year.
Although, taking out a reverse mortgage means shelling out a substantial amount of the equity collected on interest and loan fees. It also means it is likely it will not be able to pass home down to heirs. If a reverse mortgage provides only a short-term solution to financial problems, not a long-term one, it may not be worth the effort. Another problem some borrowers run into with reverse mortgages is enduring the mortgage returns. If there is a pick of payment plan that does not provide a lifetime income, such as a collective sum or term plan, or if taken out a line of credit and use it all up, there might not have any money left when in need of it.