Ever wonder how a reverse mortgage works? For folks that have lived in their home for a long time, they may very well be sitting on a substantial amount of equity. Home prices have increased greatly over the last thirty years. This has left a great many homeowners with valuable equity in their homes and many different options to access that equity, with home equity loans and mortgage refinances being the most common.
For older Americans, there is another, less common option that is growing in popularity as home prices have increased and baby boomers have moved closer to retirement age: the reverse mortgage. But do you know what it is, and do you know how a reverse mortgage works?
What exactly is a reverse mortgage, and how does a reverse mortgage work?
A reverse mortgage is a loan product that allows homeowners 62 years of age and older to use their equity to generate tax-free income, without having to sell their home or take on a new mortgage payment. In fact the reverse mortgage is exactly what the title states, the reverse of a standard mortgage.
With a standard mortgage, the borrower (or homeowner) makes monthly payments to the lender (or bank or mortgage company), in order to pay back the loan that the lender originally lent them for the purchase or refinance of the house. This payment includes interest that the lender charges the borrower for the loan. In a reverse mortgage, the situation is reversed; the lender makes monthly payments to the borrower. However, in both a standard and reverse mortgage, the lender secures their loan amount by using the house as collateral.
There are a few factors that determine how much money a borrower will receive from a reverse mortgage, such as the value of the home, the borrower’s (and co-borrower’s) age, current interest rates and any lending limits that may be standard for your geographic area. As a rule of thumb, the older the borrower and the more valuable the home, the larger the available loan amount.
Homeowners can choose how they want to receive their payments, either as a lump sum, monthly payments or as a line of credit. The line of credit is the most popular option, with nearly 60% of reverse mortgage borrowers choosing this option to draw income or a lump sum off the line at the time of their choosing.
The proceeds from a reverse mortgage can be used for anything, completely at the discretion of the borrower, though most borrowers use the funds for home repairs or modifications, health care expenses, to settle other debts, or for a long-planned vacation.Reverse mortgages are available for nearly all property types, with the exception of co-ops.
If you are in retirement, or nearing retirement, and think this may be the product for you, here is some more detail about exactly how a reverse mortgage works.
For reverse mortgage borrowers with an existing mortgage, that mortgage will need to be paid off completely, so that the new reverse mortgage will be the only lien on the house. If the proceeds from the reverse mortgage are not ample to pay off the existing mortgage, the borrower will need to access savings or other sources to pay off the rest of the existing mortgage amount. In this scenario, the borrower won’t have access to any additional funds from the reverse mortgage; however, they will no longer have a mortgage payment!
The more common scenario is one in which there is a small or no mortgage on the home, and the borrower is able to access nearly the full amount of the reverse mortgage to use at their discretion. No monthly payments are due on the loan and the loan is repaid when the owner moves or sells the home, passes away, or ownership otherwise changes hands. If the home is sold and the proceeds of the sale exceed the mortgage amount, the balance belongs to the borrower or their heirs.
In most cases, there is nothing out of pocket, however, there are substantial costs that are built in to a reverse mortgage. Therefore. one very important facet of the reverse mortgage process is the consumer counseling that is required for borrowers contemplating this type of loan.
Your lender can help you find counseling agencies, and most programs are approved and monitored by HUD. The counseling is required to make sure that the terms and risks of the program are clear to you. Counselors are obligated by law to review with you all of the implications of the new mortgage, and what your potential options are.
If you are interested in a personalized analysis of what the costs and terms of a reverse mortgage would be for you or a family member, click here for further information. Or use the form on the right side of this page to drop me an email requesting your personalized analysis.
Overall, for older Americans contemplating a stress-free retirement, a reverse mortgage may be the right solution! Just make sure that you know your options and goals… and how a reverse mortgage works.
Lester Bleich, New York State Licensed Mortgage Loan Originator 