How Does a Reverse Mortgage Work?

In a typical forward home mortgage, borrowers make payments toward the principal amount of the loan while home equity, or monetary value in the marketplace, builds over the years. Reverse mortgages convert this equity into cash for eligible borrowers, and the mortgage lender pays you instead. Reverse mortgage loans are due at either the homeowner’s death or when the property is vacated for an assisted living facility or nursing home. The eventual sale of the home recoups the lender’s cash outlay.

To qualify for a reverse mortgage, you must be at least 62. You must own your home outright or have a mortgage balance that is low enough to be absorbed by the reverse mortgage. Single-family homes, 2- to 4-unit homes where one unit is owner-occupied, and some condominiums and manufactured homes are eligible. These nontaxable loans will not affect your Social Security or Medicare benefits. Credit checks have not been historically required, though some lenders have begun to require them.

The 3 Types of Reverse Mortgages

  • Single-purpose reverse mortgages: are offered by some not-for-profit organizations and state or local government bodies. These loans are usually the most affordable, and homeowners with lower incomes can qualify. However, these loans restrict the cash usage to approved expenditures such as home improvement or property tax payments.
  • Proprietary reverse mortgages: are created and backed by private companies. These loans may have higher costs but can be used for any purpose. If your home is of high appraised value, these loans can produce the most cash.
  • Federally insured reverse mortgages: are regulated by the U.S. Dept. of Housing and Urban Development (HUD) and are also called Home Equity Conversion Mortgages (HECMs). Functioning like proprietary reverse mortgages, these loans are less expensive and carry federal backing. HECM loans also contain a provision that allows a one-year grace period for assisted living or nursing home residence before the loan matures.

If you are approved for a reverse mortgage, you may receive your cash in one of 5 ways. Tenured payment provides equal monthly payments for the life of the loan; term payments offer equal monthly payments for a predetermined length of time; lines of credit allow you to control how often and how much you access the funds; modified tenure offers a line of credit and scheduled payments for the length of the loan; and modified term payments give you a line of credit and monthly payments for a fixed time limit that you select.

While these terms may seem appealing to elderly homeowners who struggle financially, there are numerous risks. Burning up your home’s equity while you are younger and still relatively healthy may exhaust your financial resources long before you need them most. Often misunderstood by the elderly, reverse mortgages are loans in the truest sense of the word. If you move out of your home and into a costly assisted-living facility, the loan becomes due. If you have no other funds set aside for the expense of a nursing home, you could end up homeless.

Additionally, any resident of the home not listed on the loan, including a spouse, is considered a tenant by reverse mortgage lenders. If the borrower dies or vacates the home due to illness, other residents must move out so the home can be sold. Many couples with age disparity place the oldest spouse as the sole borrower because loan proceeds are larger for older residents; however, in these cases there is no spousal protection when the loan is due.

Borrowers are also required to keep the home well-maintained and insured, and to keep property taxes current. If a forgetful or financially strapped elder doesn’t meet these requirements, the loan defaults and the bank can foreclose. This practice allows mortgage lenders to obtain properties cheaply and flip them for large profits.

Reverse mortgages may also appear to be risk-free for your heirs, because the loan matures upon your death and any excess costs are absorbed by the lender. If your surviving spouse or family want to keep the home, however, they must pay the loan balance in full even if it exceeds the value of the house. If you have no other source of wealth and you rely on a reverse mortgage for expenses, you will have no inheritance to leave.

Reverse mortgages also charge fees that may be difficult to understand. Loan closing costs and lender servicing fees are common, and only HECM loans are legally regulated.The interest on these loans accrues over time, so the longer you tap into cash from your home equity, the more debt you incur. The mortgage interest is not tax-deductible, and most reverse mortgages are loaned at a variable interest rate that can change significantly over time.

If you are interested in a reverse mortgage, consult with an elder law attorney or a financial planner first. There may be other, less costly options available for short-term cash. Local Area Councils on Aging often have resources about alternatives. While a reverse mortgage may be a wise choice in some cases, it is still smart to shop around for the best deal. Watch out for home-improvement sales pitches that suggest a reverse mortgage as funding, and consider the long-term impact on your spouse and family. It may be a better solution to move to a smaller home or work longer, saving this option as a last resort.

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