A mortgage is a loan that a person takes out to buy a house. The borrower can’t afford to buy the house outright, so he or she borrows the money from a lender, such as a bank, using the house itself as collateral. That means that if the borrower fails to pay off the mortgage, the bank can take ownership of the house and sell it to recoup the loan amount.
But what is a reverse mortgage?
Consider that in paying off a traditional “forward” mortgage, the borrower builds equity in the house, meaning he or she is increasing the amount of the property he or she owns, while reducing the amount owned by the lender. Logically, then, with a reverse mortgage, the lender provides cash payments to the borrower based on the borrower’s equity in the home. Generally, a reverse mortgage borrower makes no payments to the lender, so the interest on the amount borrowed is added to the balance of the loan.
Reverse mortgages are intended for older homeowners, because payments are frequently deferred until the borrower’s death. At that time, the borrower’s heirs can sell the house and use the proceeds to pay off the reverse mortgage, or refinance the house and make traditional “forward” mortgage payments. Reverse mortgages must also be repaid if the home is sold or otherwise vacated.
Reverse mortgages are only available to homeowners who are 62 years of age or older. They were originally created with the intention of allowing aging homeowners to draw on their home equity to pay for living expenses and health care. However, there is generally no restriction on how the money can be used once it is received from the lender. (Some restrictions on how the money can be spent may apply if the loan is issued by a government or nonprofit entity for a specific purpose, such as a home improvement project.) Additionally, money received from a lender through a reverse mortgage is generally not taxable, nor does it affect Social Security or Medicare benefits.
In addition to the minimum age requirement of 62, in order to qualify for a reverse mortgage, the homeowner must own his or her home free and clear or have only a minimal mortgage that can be paid off at closing. The homeowner must also occupy the home as his or her primary residence, and not be delinquent on any government debt. Since a reverse mortgage, unlike a traditional mortgage, does not require monthly payments to be made by the borrower, the requirements for a traditional mortgage – such as a good credit history and adequate income – are not considered by the lender.
The maximum amount that can be borrowed through a reverse mortgage depends on the type of reverse mortgage. Options for a reverse mortgage include monthly payments for a specific term such as five or ten years, a line of credit, or a single lump sum (which is the only option that allows for a fixed rate mortgage; all other options have an adjustable rate). A homeowner could also choose to receive monthly payments for life, meaning the payments would continue even if the total loan amount ends up exceeding the value of the property. In this event, the borrower’s heirs are not responsible for paying off the excess loan amount.
Most reverse mortgages are Home Equity Conversion Mortgages (“HECM”), which are insured through the Federal Housing Administration (“FHA”), which is part of the Department of Housing and Urban Development (“HUD”). A version with lower fees, called the HECM Saver or HECM Lite, is available to borrowers who agree to reduce the maximum amount borrowed by 10% to 20% of the maximum amount of the standard HECM. HUD requires that homeowners taking out a reverse mortgage receive counseling regarding the requirements and implications of a reverse mortgage, to ensure that the homeowners have a full understanding of what a reverse mortgage is.
When is a reverse mortgage a good choice?
Seniors aged 62 and older considering a reverse mortgage most strongly need to consider how long they plan to remain in their home. In order to qualify for, and maintain, a reverse mortgage, the mortgaged property must be the borrower’s primary residence. Therefore, if the borrower plans to move in a couple of years after taking out the reverse mortgage, he or she will have to repay the loan amount. Closing costs and fees are usually higher for a reverse mortgage than a traditional mortgage, so the expense is only worthwhile if the homeowner continues living in the home for a long time.
Another factor to consider in deciding whether to take out a reverse mortgage is whether the home is necessary to the homeowner’s heirs, and if so, whether the heirs can afford to pay off the mortgage or refinance the home once the borrower dies or moves out. For example, if an adult child lives with the borrower, the borrower should consider whether his or her child will have another place to live, or be able to pay off the loan or refinance for a traditional mortgage once the borrower has moved on.
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