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Tuesday, 20 August 2019
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This Old House - Do-it-Yourself

What is a Reverse Mortgage and How Does It Work?

Written by Posted On Monday, 12 August 2019 07:56

For individuals who are at least 62 years old, have a home mortgage and need supplemental income to help with living expenses, medical bills, etc., something called a reverse mortgage can help. This allows someone to tap into the equity in their home for cash without having to sell their home or borrow against it without incurring a monthly payment. Reverse mortgages are not right for everyone and not for every situation, so research carefully before proceeding. Once the decision has been made, it’s important to understand the process, the different types of reverse mortgages, and to comparison shop.

How does a reverse mortgage work?

A reverse mortgage is like getting an “advance” on the equity of your home. On a typical mortgage, you make monthly payments to your lender or mortgage holder until the property is paid for or until you sell it, which is typically when you see the cash value of the equity in the property. With a reverse mortgage, the lender will take the equity you have built up and convert it to monthly payments that are paid to you. Thankfully, this income is usually tax-free and will not affect Social Security or Medicare. Also, you get to keep the title to your home

Types of reverse mortgages

Single Purpose

    • • The least expensive option
    • • Offered by government agencies and some non-profits
    • • Not available everywhere
    • • Funds can only be used for one purpose such as home improvements, taxes, etc.
    • • Easier to qualify for low-income individuals

Proprietary

    • • Private loans backed by the lenders
    • • Usually more cash for higher valued homes
    • • May qualify for more than the appraised value
    • • Higher up-front costs than traditional mortgages

Home Equity Conversion

    • Federally insured and backed by HUD

Mortgage (HECM)

    1) Amount of mortgage is based on a number factors
  • • Age
  • 2) Appraised value of the home
  • • Current interest rate
  • • Personal financial situation
  • • Choice of types within the HECM category
  • • Single payment payout
  • • Term (fixed monthly advances over time)
  • • Tenure (fixed payments only while you live in the home
  • • Line of credit
  • • Combination of single payout and line of credit

Some things to consider

Obtaining a reverse mortgage means fees and related costs because lenders charge an origination fee and other expenses at closing. These fees are usually higher than those paid with a standard mortgage. Lenders will also charge a fee to service the loan over the contractual period. Online reverse mortgage calculators that will give you an idea of the costs and financial benefits. While you’re receiving monthly payments, the interest on the loan continues to accrue and added to the balance of the original mortgage. This means the amount you owe on your home actually grows during the mortgage term, and interest rates can change, which will affect the balance of your mortgage.

It’s important to know though that interest on a reverse mortgage is not deductible on income tax returns until the loan is paid off. The homeowner is still responsible for the maintenance and upkeep of the property and required to pay taxes and insurance. If, at any time during the loan period, taxes are not paid or insurance lapses or property isn’t properly maintained, the lender can demand payment in full for the loan balance. If only one spouse is a signatory to the reverse mortgage, and that spouse dies, the other may be allowed to live in the property but will not receive the monthly payments. Because reverse mortgages dip into the equity of your home, it’ll have a lower asset value for your heirs. It’s important to realize that because with a reverse mortgage, you or your heirs cannot owe more on a home than it’s worth, when it is sold or loan paid off, you will not have to pay more than the appraised value.

Finding the right loan for you

To find the right lender and obtain the loan that is right for your situation, speaking with a counselor from a government agency such as the Housing and Urban Development is advisable. Comparison shop to compare such things as fees, terms, and various options. If you have limited income, other types of loans may be available that are similar to reverse mortgages. Often, your local Area Council on Aging or eldercare.org is a good resource.

Beware of hard-sell tactics that some lenders use. You could be offered various add-ons to your mortgage that will increase the mortgage costs and balance of the original loan. This is another reason working with a counselor familiar with the type of loan you are pursuing is important. Also, know that you have a three-day right to cancel the reverse mortgage without penalty. You can find online options for reverse mortgage leads that can point you in the right direction to get started.

Reverse mortgages can be a lifesaver for people under certain circumstances, but you must consider the pros and cons, just as you would with any major financial decision. Make your choices from a vantage point of knowledge because your actions will affect your financial situation potentially for years. Do your research.

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Harris Johnston

Real estate investor with ownership stakes in commercial and residential projects in New York City, Philadelphia, Miami, Denver, and Laguna Niguel.

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