A reverse mortgage is typically used to get cash out of your home. Instead of borrowing to buy a home, you are borrowing against a home that you already own. This allows you to use the cash now for expenses, and pay back the loan when you die or sell the home.
Individuals 62 years and older can tap their home equity and obtain a reverse mortgage. Here, a bank, credit union or mortgage company places a lien against a senior citizen‘s home in exchange for periodic or lump sum payments. The full amount borrowed does not come due until the borrower dies, moves out of the home, or sells the home. In short, a reverse mortgage allows a homeowner to turn home equity into cash while remaining in their homes.
To determine the loan amount on a conventional loan, the lender looks at the home value, creditworthiness, income, assets, and other potential risks that may be associated with loan repayment. The reverse mortgage is different because there are no income or credit score qualifications. The age of the borrower(s), the home value, and the expected interest rate are used for determining the loan amount.
With the conventional mortgage one receives a lump sum and has to make monthly payments. With the reverse mortgage one receive cash without making monthly or immediate repayment. Funds can be received in a lump sum, monthly payments, line of credit, or a combination of these.
Unlike traditional mortgages, reverse mortgages do not require monthly mortgage payments. The interest and fees on the mortgage are added to your loan balance each month. Over time, your home equity will decrease as your loan balance grows. It’s the reverse of a traditional mortgage.
Many reverse-mortgage borrowers run into trouble, pulling all the equity out of their home, using up the cash, then finding they are unable to afford insurance, taxes and upkeep for the property. Some couples have been foreclosed on when only one spouse was listed on the deed, and that person subsequently died or moved into a nursing home.
Experts stress that a decision to take a reverse mortgage is best made with input from financial advisers, accountants and estate-planning attorneys. A reverse mortgage borrower still owns the home, which means continuing to have ownership responsibility.
Reverse mortgages can be complicated, and they require various fees, but they may offer a practical way to tap home equity in specific circumstances. Borrowers can take proceeds as a line of credit or monthly payments, and they will pay an adjustable interest rate. After the first year, the borrower can take the balance of available proceeds.
The upside is that you can get this payment for life, which can work in your favor if you live longer than actuarial estimates project. If you receive more payments than your home is worth, you (or your heirs) will never owe more than the value of the home.
The downside in that scenario: There won’t be anything left for your heirs.
Homeowners considering a reverse mortgage should not enter lightly into the decision. These products can offer a much-needed lifeline to assets or an unnecessary drain on assets to the unsuspecting consumer. In any event, they are generally more costly than other loans.