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How Do Reverse Mortgages Work?

Posted On Friday, 31 July 2020 02:33

In 1961, a new loan was established to help Nellie Young—a widow who’d lost her husband and livelihood. The name of this new loan was “reverse mortgage” that permitted her to obtain the home’s equity in cash, thus removing the need to provide a monthly mortgage payment.

Reverse mortgages require much forethought and planning to determine whether they’re suitable for your financial condition and portfolio. You need to understand the procedure thoroughly—from dealing with the Department of Housing and Urban Development or HUD-approved professional to understanding the limitations of your mortgage. Furthermore, you may require the assistance of an experienced reverse mortgage professional like The Reverse Mortgage . It’ll ensure there aren’t any shortcomings in your mortgage application.

Here’s a detailed guide to help educate you on the nitty-gritty of reverse mortgage loans.

What Is A Reverse Mortgage?

In the case of a typical mortgage, you have to make monthly payments to your mortgage lender to buy your property over time. However, in a reverse mortgage, the roles are reversed. Now, you’ll be paid by the lender.

Reverse mortgages take a slice of equity from your property and repay it in the form of monthly income. This loan is tax-free and isn’t subject to return the borrowed amount, provided you don’t leave your home. You only have to repay when you sell your property, move out, or die, in which case your spouse or real estate clears the loan on your behalf.

How Do Different Kinds of Reverse Mortgages Work?

The three types of reverse mortgages are explained below:

1. Single Purpose Reverse Mortgage

A single-purpose reverse mortgage turns a homeowner’s home equity into a passive income stream. Like any reverse mortgage, the homeowner receives an advance payment on their equity from the mortgage lender.

These kinds of mortgages make the most sense for senior citizens who’ve paid off their homes and need consistent money to keep their finances afloat. 

The homeowner keeps the title of the property when they get the reverse mortgage. Furthermore, as payments are based on the property’s existing home equity, government authorities don’t tax the loan, considering it as a source of income, rather than a debt. A side benefit of this is that eligibility for Medicare and Social Security isn’t affected.

One drawback of single-purpose mortgages is that they restrict the usage of the received loan. 

For example, a mortgage lender may impose the condition that the reverse mortgage should only be spent on financing a home’s renovation. Or, spend payments on the items and fields that serve the lender’s best interests, such as insurance and property taxes. 

Because of these limitations, such mortgages are easy to obtain and bear minimal interest rates. 

However, there’s only a limited number of lenders who’re willing to provide these mortgages. Mostly, non-profit organizations and government institutions offer single-purpose reverse mortgages.

2. Home Equity Conversion Mortgage

The most widely accessible form of reverse mortgages is Home Equity Conversion Mortgage (HECM). They’re insured by the U.S. HUD and don’t subject borrowers to any restrictions on usage. You can use it to pay off personal debts, or finance a yard remodel—it’s totally up to you.

However, there’s a cap on the amount you're allowed to borrow via home equity conversion mortgage. You need to hire a counselor working under an independent housing counseling institution to file your loan to the HUD.

Until 2015, Home Equity Conversion Mortgage (HECM) borrowers didn’t have to prove their creditworthiness. However, when HUD observed that many borrowers were defaulted on their payments and lagged on their property taxes, they imposed a modest financial criterion.

Now, to obtain a HECM, you need to meet the following eligibility requirements:

• 62 years or older.
• Significant home equity in a permanent residence or a property they plan to buy with the disbursement funds of a reverse mortgage.
• A Federal Housing Administration (FHA) or manufacture approved single-family residence.
• Existing mortgages cleared with HECM proceeds first.

The credit requirements vary, but they aren’t as strict as those imposed in standard loans.

3. Proprietary Reverse Mortgage

Senior homeowners can buy off the equity in their homes through a private from through a proprietary reverse mortgage loan. These loans aren’t widely accessible and contribute to only a small fraction of the reverse mortgage market compared to HECM.

Proprietary reverse mortgages aren’t federally insured, so lenders get to set their own terms. One aspect lenders especially try to regulate is the loan amount. Keeping their risk tolerance in mind, they offer the borrower an amount that doesn’t disadvantage their interests.

The home’s appraised values are used as a gold standard to gauge the final loan figure. Sometimes, it’s enormous, especially when a home’s value is much higher than the government's designated limit. This is also why they’re called jumbo reverse mortgages and primarily aimed towards senior homeowners with expensive properties to their name.

One thing to keep in mind is that you will not get an advance monthly insurance premium with these mortgages as they’re not federally protected. You still don’t have to pay back a dime, but these premiums will limit your borrowing capacity.

How Does The Reverse Mortgage Process Work?

1. Meeting a Reverse Mortgage Professional

After consulting a reputable reverse mortgage professional and getting firsthand knowledge on reverse mortgages, you have to determine whether a reverse mortgage will fit your individual needs. If everything goes to plan, you can move to the next step—reverse mortgage counseling.

2. Reverse Mortgage Counseling

You will have to hire an independent reverse mortgage counselor certified by the U.S. Housing and Urban Development Authority. A reverse mortgage professional can help you in this regard, directing you to the closest HUD-certified counselors in your locality.

The counselor will provide a detailed account of reverse mortgages, dispensing and discussing the following documents and information:

• A “Preparing for Your Counseling Session” document further expounding upon reverse mortgages.
• A copy of the Total Annual Loan Cost (TALC) Disclosure. This form paints a complete picture of the loan’s changing cost at different periods.
• A copy of loan comparisons to explain payment options and expenses.
• A loan authorization schedule that projects the growth of the loan balance over time if reverse mortgage payments are not received.
• The “Use Your Home to Stay at Home – A Guide for Homeowners Who Need Help Now” booklet.
• Reverse mortgage product options.
• Borrower Eligibility Criteria for different reverse mortgage loans.
• Going over financial obligations, such as taxes, and insurance, to verify and cross-check all the terms and conditions.
• Relaying how your reverse mortgage can affect your heirs and estate.
• Providing alternative options like financial assistance, grant, and federal tax programs.

3. Verification

After a successful reverse mortgage counseling session, you’ll get a certificate, which has to be submitted to your reverse mortgage professional.

4. Applying For the Loan

Now, you can proceed to the application process. Your reverse mortgage representative will help you obtain and compile the necessary documents and also suggest suitable fund disbursement pathways and interest rates. Hence, they’ll make sure your application is complete. 

5. Session With A HUD Approved Appraiser

Then, a HUD-approved appraiser will knock on your doorstep. The appraiser will make an accurate estimate of your property’s value, based on market conditions and note down if any repairs are required.

6. Processing

After this, a lender’s underwriter will review and process your loan application. When you get the green signal, you'll sign and finalize all documentation, and put the final stamp on your loan.

However, you still have an out at this point. A three-day right of rescission is given to every homeowner in case they changed their mind.

7. Closing

If you don’t retract your application and move on with the loan's closing, the first disbursement of funds will soon arrive in your hands. However, this isn’t the end of the road.

You still have to adhere to all loan terms and conditions religiously. Failure to comply may cause the loan to default, leaving you to pay the reverse mortgage. Worse, your house will go into foreclosure, and you'll be given the notice to evict the premises. 

To prevent this, make sure you abide by all loan obligations, including:

• Paying home fees, insurance, and taxes.
• Keeping your home in acceptable condition and making repairs.
• Not taking a leave from your home for more than a year and using it as your permanent residence.

The Verdict

Reverse mortgage loans are mainly geared toward senior homeowners. To make sure you know all about reverse mortgages before the commencement of the application process, consult your reverse mortgage professional. A reverse mortgage professional will discuss your options, assist with your application, and make sure your counseling session with a HUD-approved counselor succeeds. You also have the opprotunity to cancel your reverse mortgage application at the loan processing and review stage, if you think you’re not ready to go through with the loan. Hence, once you close the deal, you'll have to adhere to all loan requirements to prevent your home’s foreclosure.

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