We've discussed what is a reverse mortgage and what are its pros and cons. Now how does a reverse mortgage actually work? We touched on it briefly on another article but in this article we will take an in depth look at how reverse mortgage work.
How Does a Reverse Mortgage Work?
In a regular mortgage, a monthly payment is given to the lender for the use of buying a house for a set period of time. For a reverse mortgage, a loan is created that the lender pays to the homeowner. A reverse mortgage works by taking a part of your home equity and turn it into a payment. More or less, its a kind of advance payment on your home equity. The payment you get is usually tax-free. There is interest when you decide to get a reverse mortgage. The interest is placed in the loan balance which means a homeowner won't have to pay anything up front. The homeowner also keeps the title of the house property (Investopedia).
The house is then used as collateral for the reverse mortgage. When the homeowner dies, the funds from selling the house will go to the lender in order to repay the reverse mortgage principal, interest, mortgage insurance, and fees. Any funds that exceed what the homeowner borrowed will go to the homeowner (if still alive) or the homeowner's estate. The heirs may also pay off the mortgage in order to keep the house.
Reverse mortgage are only available to homeowners aged 62 and older. Reverse mortgage main purpose is to help retirees have a stable finance during retirement. How much money you can get from the reverse mortgage is determined by your home's value, how much money you still owe on mortgages, other home loans you currently have, and your age.
The older you are the more money you will be able to draw from the loan. The age of the youngest spouse living in the home is the basis for calculating the amount of your home loan.
You can choose between receiving a lump sum, a monthly payment, or a line of credit as payment from the reverse mortgage.
In a reverse mortgage, you don't have to pay anything for as long you or your spouse live in your home. Only when you and your spouse leaves your home or pass away that they payment becomes due.
When this happens, your heirs are given a choice to decide wether they will buy or sell the house to pay off the loan. The sales from selling the homes is used to pay off the loan. Even if your loan exceeds the value of your home upon selling, the loan is still considered paid.
You don't also have to worry about going homeless because you're unable to pay off the loan. The government has laws that protect the homeowners from going homeless.
Take note that the bank does not own your home, as what some people perceive. It's on lien by the bank. Meaning they have a right to your home until you pay off your debt like the traditional mortgage. The bank only has the first claim of the proceeds of the sale but you still own the home.
However, there are also rules you have to follow to keep the loan. You must live in the home and it must be your primary residence. You also have to pay its insurance, mortgage, and other fees. You also have to keep the house well-maintained.
Reasons for You Take Out Reverse Mortgages
You can use reverse mortgage as a means to pay and clear your existing mortgages, home equity loans, and other debts.
You can also use it as a fund to draw money in case of unexpected expenses like medical, home repairs, or helping out a family member.
You can also use reverse mortgage to add more funds to your retirement.
A good reason to take out a reverse mortgage is that it serves as your direct draw for funds without having to compromise your other financial investments. This means your passive income won't have to be affected for your retirement.
Do Your Own Research
There are tons of resource material you can get from the internet regarding reverse mortgages. As an advice better check out first government websites like the Federal Housing Agency and Consumer Financial Protection Bureau about reverse mortgages. Or you can check out the NRMLA website. They have a sitemap which guides you on the steps to follow when taking out a reverse mortgage.
And don't worry, before taking out a reverse mortgage, you are required to take a counseling session with a certified reverse mortgage counselor in order for your application to be accepted. Lenders are required to give out a list of various reverse mortgage counseling agency. It's up to you to schedule a session with one and you have to pay the fees. To avoid scams, if the lender tells you not to go on counseling or tries to push you to pick an agency of their choice, then there's a high probability that it's a scam.
To help you out, here is a link to a list of certified HECM counselors
To have additional security, you can consult with your personal lawyer or financial advisors. They should be more knowledgeable about reverse mortgages.
Reverse Mortgage is a great financial tool to have but also keep in mind that there are other options also. You may want to leave your home to your children when you die and taking out a reverse mortgage may make it difficult for them to inherit it.
There are other options you can choose from offered by financial institutions or the government. Reverse mortgages isn't for everyone, especially if you have high mortgage payments.
Keep your options open and remember to consult reverse mortgages expert and financial advisors before taking out a reverse mortgage.