How A Reverse Mortgage Works

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.

A Primer on Reverse Mortgages

It is not unusual today to find people living in $1 million homes who are almost entirely dependent on social security to get by.

Economists report that as housing prices have skyrocketed over the past several years, the amount of money that households are saving through 401(k) plans and FDIC insured savings accounts has fallen. For many people approaching retirement age that means they may be “equity rich” and “cash poor” at the same time. It is not unusual today to find people living in $1 million homes almost entirely dependent on social security to get by.

A 1994 Advisory Council on Social Security trends and issues concluded that reverse mortgages could provide an additional source of income for seniors, although at the time housing prices were not high enough to make this a meaningful source. Well, things have changed.

A reverse mortgage is still a loan with your house as the collateral, but it is entirely different from the kind of mortgage you got when you bought your first house. These are the major differences:

The Lender Pays You

That’s correct. You do not make a monthly payment with a reverse mortgage. The lender pays you, and the loan can be set up so that you can get paid in a lump sum, you can get paid regular monthly amount, or you can get paid at the times and in the amounts you request.

The terms of the loan determine what each of these amounts would be. The primary determining factors are your age, the value of your house, and the prevailing interest rates at the time.

You Continue to Live in Your House

Staying in your house is really the whole purpose of reverse mortgages when you get down to it. The twist is that instead of paying somebody else to live there, you get paid while you continue to live there.

You are actually required by the terms of the loan to continue to live in the house as your principal residence. You can spend any amount of time visiting your children and grandchildren, you can travel for pleasure, and you can continue to spend summers at the lake, so long as the house remains your principal residence.

You Retain Ownership of Your House

A reverse mortgage is not a sale. You keep all the rights of ownership that you had before the reverse mortgage loan. You do not need the lender’s permission to paint the house a different color or to remodel. You can put your house on the market and sell it to the highest bidder. You can will it to your children.

If there is a change in ownership, such as by sale or through the death of the last surviving owner, the reverse mortgage will have to be paid off at that time. The lender would be entitled to receive from the proceeds of the sale only the amount you actually received from the lender plus all accrued and unpaid interest to date. Any amount remaining after paying off the reverse mortgage lender would go to you, to your surviving spouse, or to your estate.

The Principal Amount of the Loan Increases with Each Payment

Another way of saying this is that you control the amount that must eventually be paid back by controlling the amount of money you actually get from the lender. A reverse mortgage is still a loan, and the money plus interest has to be paid back at some time, usually from the sale of the house after you and your spouse no longer live there.

Because the principal amount of a reverse mortgage cannot be determined until after you no longer live at the property, neither can the maturity date of the loan. This can be a difficult concept to wrap your mind around because it is so different from conventional mortgages.

You Can Never Owe More than the Value of Your House

This is true for the reverse mortgage product sponsored by the Federal government that we offer, the Home Equity Conversion Mortgage (HECM), although it may not be true for privately created reverse mortgage programs.

The benefit of the Federal program is that you, your surviving spouse, or your estate, can never owe more than the loan balance or the value of your house, whichever is less. Your reverse mortgage lender cannot require repayment from you, your surviving spouse, or your heirs, or from any asset other than your house.

There are no income or credit requirements to qualify for a reverse mortgage.

To be eligible for an FHA HECM, you must be a homeowner 62 years of age or older, own your home outright, or have a low mortgage balance that can be paid off at closing with proceeds from the reverse loan, have the financial resources to pay ongoing property charges including taxes and insurance, and you must live in the home.

If you would like a personalized analysis of all the ins and outs of a reverse mortgage for yourself or a loved one, check out this page on my website, or feel free to contact me.