A reverse mortgage is a type of loan that allows homeowners to borrow money using their homes as collateral for the loan. This type of loan is available to people aged 62 and above. A reverse mortgage differs from a traditional mortgage in that the borrower is exempted from repaying the loan until he/she dies, leaves home, or sells the home. An example of a reverse mortgage is the Home Equity Conversion Mortgage (HECM) insured by the U.S federal government. Despite its popularity, HECM products are only accessed from FHA certified lenders.
Reverse mortgages designed to help senior citizens aged 62 and above and who own their homes outright or at least a sizeable portion of the home equity to quickly gain access to cash to finance their needs such as medical care expenses, buying a new home, renovating their homes and more.
Although the borrower is not expected to make monthly payments as it is with traditional mortgages, the interest and fees add up to the loan balance every month, leading to an increase in balance. Besides, homeowners are expected to pay property taxes, homeowners insurance, retain homeownership, and keep their house in a good state.
With a reverse mortgage loan, the amount the borrower owes to the lender keeps on increasing over time and not vice versa. This is due to the addition of interest and fees to the loan balance every month. An increase in loan balance translates to a decrease in home equity.
Many people tend to confuse a reverse mortgage with free money, which isn’t true. A reverse mortgage is a loan like any other with an interest rate plus monthly fees. The homeowners have to repay the loan by selling the home or surrendering it to the lender.
How Does a Reverse Mortgage Work?
As mentioned above, regular mortgages are subject to monthly payments, unlike a reverse mortgage where you secure a loan in which the lender pays you. What a reverse mortgage does is to convert a portion of your home into cash, which is paid to you. In simple terms, this is paying for your home equity in advance. The money you receive is not subject to taxation. Usually, you’re not required to repay the loan as long as you’re residing in your home. The loan will be repaid when you pass away, sell your home, or move out of the house. This is no different from selling your home to raise money to repay the loan.
Types of Reverse Mortgages
There are two main types of reverse mortgages namely:
- Proprietary reverse mortgages – Also known as a jumbo reverse mortgage, this type of mortgage is offered in the form of private loans.
- Federally-insured reverse mortgages – Home equity conversion mortgage (HECM) is one of the most popular federal-insured reverse mortgages. Most homeowners go for HECM as it is easy to secure.
Upsides to a Reverse Mortgage
We all know that every form of financing has its upsides and downsides, and reverse mortgages are no exception. But in this case, weâre going to look at 5 upsides to a reverse mortgage.
Access to Cash
It’s undeniable that most senior citizens are subject to significant income reduction upon retirement. A substantial percentage of their monthly income is devoted to mortgage payments, leaving them with little cash to spend. Seniors aged 62 and above with considerable home equity can relieve themselves from this burden by refinancing their existing regular mortgage and part away with extra cash from the property by signing up for a reverse mortgage.
Home Ownership Retention
Even though homeowners can repay reverse mortgages, they typically end when a homeowner ceases to exist, moves to another home, or sells the home. In the case of an estate, the beneficiaries have several choices. One, they can choose to sell the property to repay the loan and pocket anything above the loan balance. Second, they can choose to retain the home and refinance the reverse mortgage balance as long as the property value is adequate. Lastly, if the loan balance surpasses the current market value of the property, then there is no other option other than to surrender the title to the lender. The lender will then file a claim with the insurer for any unsettled debt.
The Money You Receive from a Reverse Mortgage is Not Subject to Tax
The Internal Revenue Service (IRS) considers any payments resulting from reverse mortgages as loan proceeds rather than income. In this case, the lender pays the borrower loan proceeds in a lump sum or every month, depending on the agreement between the two while the homeowner continues to reside in the home. The IRS makes a follow up of the accumulated interest and adds up to the reverse mortgage balance. This amount is still not taxable unless the borrower pays off the loan in full. Tax rules are complex and thus the need to seek help from a tax professional.
No Claim Against Heirs
Since the reverse mortgage balance keeps on growing, there is a possibility that the reverse mortgage balance can outdo the current market value of the property with time. Nevertheless, the responsibility to pay off the loan can never surpass the property value. This is not possible because reverse mortgages are regarded as a non-recourse form of financing. This means that the lenders have no legal rights to file a claim against the heirs or other assets.
Reduced Costs
When compared to moving into a new home, the cost of a reverse mortgage is a bit lower. This is because you have to sell your home, move your household items, buy a new home, or rent in a different location, which can be very expensive. The good thing with a reverse mortgage is that you’ll still retain homeownership, thereby avoiding unnecessary costs.
Little Upfront Cash Needed
Out of pocket expenses are kept at a minimum since most of the closing costs and fees linked to reverse mortgage loans can be financed into the loan.
From the above, it is indisputable that reverse mortgage loan is of much benefit to the senior citizens aged 62 and above. To access this form of loan is very easy as long as you’ve built up a considerable amount of home equity.