How Does a Reverse Mortgage Work?
Reverse mortgages have become a popular option, or rather financial tool, for seniors looking to access the equity in their homes.
If you are considering a reverse mortgage loan, you may be wondering how does a reverse mortgage work and what the features are, or even the risks.
Over the next few minutes, we’ll explore the ins and outs of reverse mortgages and help you better understand how this financial tool may work for you.
What Is a Reverse Mortgage?
A reverse mortgage is a loan that allows homeowners aged 62 and older to access the equity in their homes. Unlike a traditional mortgage, the borrower does not make monthly mortgage payments to the lender. Instead, the lender makes payments to the borrower, either in a lump sum or as a line of credit, based on the value of the home and the borrower’s age. The borrower is still responsible for paying property taxes, homeowners’ insurance, and maintaining the home.
Are You Eligible?
To be eligible for a reverse mortgage, the borrower must either own their home outright or have a low enough mortgage balance that can be paid off with the reverse mortgage funds at closing. The borrower must also live in the home as their primary residence.
Once the borrower is approved for a reverse mortgage, they can choose to receive the loan proceeds in a lump sum, as a line of credit, or as monthly payments. The amount of the loan depends on several factors, including the borrower’s age, the value of the home, and the interest rate.
A great way to begin gathering these figures are to utilize our reverse mortgage calculator and receive a free, no-obligation analysis.
Unlike a traditional mortgage, the borrower does not make monthly mortgage payments to the lender. Instead, the interest on the loan accrues over time and is added to the loan balance. This means that the loan balance will increase over time, reducing the equity in the home as you are taking advantage of the funds available to you that previously sat un-utilized.
The loan becomes due when the borrower ceases to use the home as the borrower’s primary residence, sells the home, passes away, or defaults on the terms of the loan. Repayment of this loan is usually done by selling the home and using the proceeds to pay off the loan balance. If the home is sold for more than the loan balance, the borrower or their heirs will receive any remaining equity. If the home is sold for less than the loan balance, the lender will absorb the loss.
What Are the Potential Advantages of a Reverse Mortgage?
One of the advantages of a reverse mortgage is that it allows seniors to access the equity in their homes without having to immediately sell or move out of their family home. This can be especially beneficial for those who want to stay in their homes but are having difficulty meeting financial demands of everyday life. As with any mortgage, you must meet your loan obligations, keeping current with property taxes, insurance, and maintenance.
Reverse mortgages also provide flexibility in how the loan proceeds are used. Unlike a traditional mortgage or home equity loan, there are no restrictions on how the money can be spent. Borrowers can use the funds to cover living expenses, pay off other debt, make home improvements, or even travel to visit family or make another check on your bucket list.
Another feature of a reverse mortgage is that it is a non-recourse loan. This means that the borrower or their heirs will never be responsible for more than the value of the home when it is sold. If the loan balance exceeds the value of the home, the lender absorbs the loss.
What Are the Risks of a Reverse Mortgage?
While a reverse mortgage can be a valuable financial tool, there are also risks associated with this type of loan. One of the biggest risks is that the loan balance will increase over time, reducing the equity in the home and potentially leaving less for the borrower’s heirs.
Another risk is that the upfront costs associated with a reverse mortgage can be more than a traditional home loan. These costs may include origination fees, mortgage insurance premiums, and appraisal fees. These costs will be added to the loan balance, and interest will be charged on the total amount.
Finally, borrowers must continue to meet their obligations, such as paying property taxes and homeowner’s insurance, or risk defaulting on the loan. If the borrower defaults on the loan, the lender may foreclose on the home.
An Example of How a Reverse Mortgage Could Work For You
Let’s look at a scenario (for illustrative purposes only, similar results not guaranteed) to see how a reverse mortgage might work in practice. Jane is 72 years old and owns her home outright. Her home is worth $500,000, and she is considering a reverse mortgage to access some of the equity in her home.
After speaking with a licensed lender, Jane learns that she can receive a lump sum of $200,000 or a line of credit of $250,000. She decides to take the line of credit and use the funds as needed.
Over the next few years, Jane uses the line of credit to cover some unexpected medical expenses and make some home improvements. The interest on the loan accrues and is added to the loan balance, which increases over time.
When Jane passes away at the age of 80, her loan balance has increased to $350,000. Her heirs sell the home for $550,000, which is more than the loan balance. After paying off the loan, they are left with $200,000 in equity.
In this scenario, the reverse mortgage allowed Jane to access the equity in her home and use the funds as needed. However, the loan balance increased over time, reducing the amount of equity available to her heirs or estate.
In Summary
A reverse mortgage can be a valuable tool for seniors looking to access the equity stored in their home. However, it is important to carefully consider the advantages and risks of this type of loan before deciding how to proceed.
Working with an experienced lender and counselor can help you understand the loan terms, obligations both short and through the life of the loan and make an informed decision about whether a reverse mortgage is right for you.