What Is a Reverse Mortgage and How Does It Work?

Sometimes, those in retirement can become stressed about where their money is going to come from. When a person is looking for extra income during the retirement phase of life, they may consider a reverse mortgage. This can be a great way for seniors and retirees to solve that problem quickly! 
We all know about regular mortgages – you find the house of your dreams with your real estate agent, apply for the loan to buy it, and, if accepted, pay back the loan over, typically, 15 or 30 years plus interest. But what is a reverse mortgage? Don’t take it literally – a reverse mortgage is not where you give the loan for someone else to buy a home! When someone takes out a reverse mortgage, the money comes from the equity built up on the home so far. You are basically borrowing back money you’ve paid into your original mortgage loan. 
 
What is a reverse mortgage? 
The official definition of a reverse mortgage is  a mortgage loan, usually secured by a residential property, that enables the borrower to access the unencumbered value of the property. The withdrawn equity is turned into cash and handed to the home owner, a line of credit for the homeowner to use at their will, or a scheduled income stream (usually monthly) – typically the homeowner will live off of these funds during retirement in place of a retirement fund. The loans are typically promoted to older homeowners and usually do not require monthly mortgage payments, but borrowers are still responsible for property taxes and homeowner’s insurance. 
 
Reverse mortgages are meant to allow elderly people to access their long-time home’s equity that they have built up over the life of their loan so far. The home is used as collateral. The payments on the loan are deferred until they pass, sell, or move out of the home – and since there are no required mortgage payments on a reverse mortgage, the interest is added to the loan balance every month. The borrower is typically not required to repay any additional loan balance in excess of the appraised value of the home. In Canada, the loan balance cannot exceed the fair market value of the home by law. 
 
You can use the money from a reverse mortgage however you like, but typically, people use them for debt consolidation, living expenses after retirement, home improvements, helping children with college, or buying another home that will better meet your needs as you age. 
 
What are the benefits of a reverse mortgage?
Your heirs won’t have to repay the loan! In your absence, your heirs can sell the home to cover the debt. They also have the option of paying off the debt to keep the home. Reverse mortgage incomes are often tax free, as well. This is another big plus. You are not required to sell your home, down size, or move to a different part of town. 
The loan gives you a lot of financial freedom. You can use the money from your reverse mortgage however you want to. There are no rules for how it must be spent or when it is allowed to be spent. 
You remain the owner of your home. A common misconception of reverse mortgages is that the lender will take ownership of your home – this is not true. You maintain ownership of your home as long as you comply with the terms of your loan and pay your property taxes and homeowner’s insurance. 
You are protected, even if the housing market declines! Your reverse mortgage is insured by the government, which means ultra high levels of security. If your loan ever surpasses the value of your home, government insurance will cover the difference, meaning the loan will be paid in full using only the money that your home sold for, and nothing additional.
 
Are there any downsides to a reverse mortgage? 
Perhaps, but they’re largely conditional. If you ever want to leave your home, you must pay up on your reverse mortgage loan – in full. Sometimes, due to circumstances out of the homeowner’s control, the amount they are offered for a reverse mortgage loan is less than what they wished for or anticipated. The interest on reverse mortgage loans can sometimes be a little higher than the interest on a regular mortgage loan, but this largely depends on the state of the housing market at the time the homeowner inquires about the reverse mortgage. It can also seem complicated if one is not well educated in how a reverse mortgage works. With a traditional mortgage, you borrow money up front and repay the loan over time. With a reverse mortgage, you accumulate the loan over time and repayment is only due when you no longer live in the home. There is also no tricking your lender in a reverse mortgage situation – if you are found to have your primary residence in a home other than the one you took out a reverse mortgage on, you may be subject to foreclosure. Sometimes, your loan terms may indicate that you can set up a primary residence elsewhere for short periods of time (think a long vacation, or for those who “winter” in warmer places), but this can be uncommon if not directly requested by the homeowner during the reverse mortgage loan process. 
 
What are the different kinds of reverse mortgages? 
There are two different kinds of reverse mortgages – fixed rate and adjustable rate mortgages. Sounds familiar? It should! That’s how regular mortgages work. Things are almost the same between the two types of mortgages. A fixed rate reverse mortgage consists of a one-time, lump sum cash payment to the home owner. But adjustable rate mortgages get a little bit more complicated. There are five options for adjustable rate reverse mortgage. They include tenure, term, line of credit, modified tenure, and modified term. 
 
Tenure reserve mortgages set monthly payments to the homeowner, as long as they or their eligible spouse remain in the home. Term reverse mortgages set monthly payments to the homeowner for a fixed period. Line of credit reverse mortgages offer the homeowner unspecified payments when the homeowner needs them, until they have exhausted their max funds. Modified tenure reverse mortgages offer the homeowner a line of credit and set monthly payments for as long as the homeowner and their eligible spouse live in the home. Modified term reverse mortgages offer the homeowner a line of credit and set monthly payments for a fixed period of the homeowner’s qchoosing. 
 
Who benefits from a reverse mortgage?
To apply for a reverse mortgage, you must be 62 years old or older. If you have a spouse, they must be named on the loan even if he or she is not a co-borrower. You both must live in the home as a primary residence. You may not have any delinquent federal debts. You must own your home outright, or have a considerable amount of equity in the home. You must attend a mandatory counseling session with a home equity conversion mortgage counselor that is approved by the Department of Housing and Urban Development. Your home must meet all FHA property standards and flood requirements. You must also be willing to agree to continue paying all property taxes, homeowners insurance, and other household maintenance fees, as long as you or your eligible spouse lives in the home. 
 
How does one get a reverse mortgage?
There are many places that one could get a reverse mortgage, but many major international banks, such as Wells Fargo or Chase, do not offer them. You will speak with a lender and they will calculate the combination of many factors, such as what amount of equity is already built up in your home, your age and your spouse’s age, the age of your property, and your current income to decide how much they can lend to you. You go through a closing type process, similar to when you take out a regular mortgage, and then receive your lump sum of cash, begin receiving your scheduled payments, or gain access to your line of credit. 
 
What else should I know about reverse mortgages? 
When you are in the process of getting a reverse mortgage, your lender will check your credit history, verify your monthly income versus your monthly financial obligations, and also order an appraisal on your home. It is highly recommended to wait until at least retirement to obtain a reverse mortgage, lest you run out of money too early into retirement. Nearly all reverse mortgages are originally issued as home equity conversion mortgages by the Federal Housing Administration – which comes with strict borrowing guidelines and, usually, a loan limit. There are closing costs, just like with a regular mortgage, and they do tend to be a little costlier than with regular mortgages. Receiving income from a reverse mortgage might affect your eligibility for various other retirement benefits, so be sure that you make a mention of your reverse mortgage if you are interested in other retirement benefits.

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