Did you know that it is possible to leverage the equity in your home? When buying real estate, we are used to taking a mortgage which accrues interest monthly, and you are supposed to make monthly payments. A reverse mortgage is the complete opposite of that. You already have a home, a lender gives you money upfront, the money accrues monthly interest, but you will not pay the money back until you move out or pass away. Strange, right? You must be wondering why would anybody decide to borrow against a property they struggled so hard to pay for. Here is how reverse mortgages work.
What Is a Reverse Mortgage?
It is also known as a home equity conversion mortgage (HECM). This is a type of loan given to homeowners aged 62 years and above. The loan allows you to change a part of your home equity into cash. Unlike home loans or second mortgages, you do not need to pay your loan until such a time when the home is no longer your principal residence or if you do not satisfy the obligations of the mortgage.
How Reverse Mortgages Works
Regardless of the idea in practice, not all qualified homeowners can get the entire value of their home even when the mortgage is paid off. Homeowners get an amount called the principal limit, which changes from one borrower to another. The amount is determined by:
- The current interest rates.
- The current market value of your home.
- The HECM mortgage limit.
- The age of the youngest borrower.
- The eligible non-borrowing spouse.
- How you decide to receive the payments.
- The type of reverse mortgage you choose to take.
- Other financial obligations or liens tied to your home.
It is usually possible to get a higher principle limit when:
- The homeowner is older.
- The interest rate is lower.
- The property has a higher value.
- The borrower has a variable rate of HECM.
There are various ways which you can choose to get your reverse mortgage payments. They include:
- Monthly payments.
- A line of credit.
- A lump sum.
- A partial sum.
Types of Reverse Mortgages
Reverse mortgages are designed differently to take care of various financial needs.
- Home equity conversion mortgage
This is the most common type, and the federal housing administration insures it. The money can be used to serve any purpose, although the mortgage has a higher upfront cost. FHA issues HECMs.
Proprietary reverse mortgage
It is a private loan not secured by the government. This mortgage type gives a larger principal amount for properties with higher values
Single-purpose reverse mortgage
This is given by state & local government agencies and nonprofit organizations. The loan amount is usually smaller, and it is typically given to take care of a single specific need.
Who Is Eligible for a Reverse Mortgage?
It is not everyone who qualifies to get a reverse mortgage. For you to receive one, the primary homeowner must be 62 years or more, even if the spouse is younger. Here is the criterion that you should meet:
- You must be living in the property as your primary residence.
- You must be the owner of the house or have a large amount of home equity, 40% and above.
- You must be current on property taxes and homeowners insurance before applying.
- You must attend the HUD-approved counselling.
- Existing mortgages must be paid off before or settled by the proceedings you get from the reverse mortgage.
- You must take care of your property and keep it in good condition.
- Your home must be a single-family house, a multi-unit property with up to four units, a manufactured home built after June 1976, a condominium or a townhouse.
Advantages of a reverse mortgage
- As a borrower, you are not obliged to make monthly payments towards your loan balance.
- The funds can be used for healthcare & life expenses, debt settlement, and other days to day bills.
- The funds are a supplemental income for your retirement earnings.
- The proceeds are tax-free.
- As long as you meet the eligibility requirements, the loan is easy to apply.
- The non-borrowing spouse, even if they are under 62, can live in the property for the rest of their lives even if the borrower dies.
- If a borrower is facing foreclosure for an existing mortgage, one can use the proceeds to pay off the mortgage and stop the foreclosure.
- The loan is exorbitantly expensive.
- If you pass away your heirs must repay the loan to continue living in the house otherwise your lenders will have to sell it.
- You must maintain the property and pay homeowners insurance and property taxes.
- The closing costs and other fees are higher, lowering the amount that gets to you.
A reverse mortgage is an excellent way for elderly homeowners to get additional income to supplement their retirement earnings. However, if the balance surpasses the value of your home, you might get into foreclosure or lose your home to the lender.