How Does a Reverse Mortgage Work
What is a Reverse Mortgage
The reverse mortgage was created by HUD and it is designed for seniors over the age of 62 years old to draw the equity out of their homes in the form of cash.
Since many seniors find themselves in the position of being house-rich, but cash poor, the loan was designed as a way to alleviate savings problems for older Americans who suddenly find themselves facing large medical expenses, nursing home costs (for another relative) and/or other expenses such as supplementing social security payments or paying for home improvements.
Unlike other types of home equity loans, a reverse mortgage does not need to be repaid as long as the borrower is still using the home as a primary residence.
Reverse Mortgage Basics
How Does a Reverse Mortgage Work
In addition to being over 62 years old, borrowers who are looking to get a reverse mortgage also need to either own their home outright or have a mortgage small enough that it can be paid off with the proceeds of the new loan. The borrower must also live in the home.
Once you move out the loan becomes due within a year, so a reverse mortgage works best for seniors who plan to continue living in their home for the rest of their lives.
During the life of the loan, nothing needs to be repaid, but upon the borrower's death, the home generally will need to be sold in order to pay back the loan. If your children cannot afford to pay off the loan, they will lose the house, but they will not be subject to any additional debt. If the borrower moves, that will also cause the loan to come due as well, something to be cautious of if you think there is any chance you might need to move into a nursing home in the near future.
The amount you'll be able to borrow depends on how much equity you have in your home, current interest rates and your age. The older you are, the more you can borrow and sames goes for the value of your house. The more your property is worth, the more you can borrow.
Payments can be handled in a number of different ways, depending on your needs:
- Line of Credit - works pretty much like a home equity loan, you take money out when you need it;
- Regular Monthly Payments - you elect a monthly payment amount that you will receive every month for the number of months that you choose (term) or for as long as you live in the home (tenure)
- Combination - You can also select to get regular montly payments on either a term or tenure basis, and keep a line of credit open.
- Lump Sum - this isn't mentioned in HUD's FAQ, but it is also possible to get the entire loan amount as a lump sum
Money Magazine on Reverse Mortgages
- Reverse mortgages: Beware the come-ons
The loans can help you tap the equity in your house. Just don't get tripped up by greedy salespeople.
The Pitfalls and Dangers of a Reverse Mortgage
One of the biggest pitfalls of a Reverse mortgage occurs as the result of finding yourself having to move much sooner than expected. If you wind up moving within a few years of taking out a reverse mortgage, the entire loan amont comes due one year after you move. While you will never owe more than the total value of your home, in a depressed housing market, you could potentially having nothing left over after the house is sold.
Another pitfall is the high cost of getting a reverse mortgage. Loan origination fees are very high and other fees also need to be paid, such as a mortgage insurance premium, appraisal fees, closing costs, etc. You may be better off just getting a home equity loan and paying it back if you need a short term infusion of cash.
But one danger that is constantly lurking in the reverse mortgage industry is predatory lenders looking to make fat commissions on those high loan origination fees. Things to watch out for are encouragements to use a reverse mortgage to buy an annuity or buy long-term care insurance. Money magazine recommends strongly against both practices as being not cost-effective in either the short or long term.
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