How Does a Reverse Mortgage Work?

Creating a steady stream of income to live comfortably in retirement is something that too many Americans struggle with. Overall, 75% of Americans don’t have enough money stashed away for retirement.

But there are alternatives to simply having enough money saved in your 401(k) or IRA.

Theirs is also a reverse mortgage.

According to the National Reverse Mortgage Lenders Association, more than 900,000 senior households have used an FHA-insured reverse mortgage loan and more than 600,000 are currently in use.

If a person is 62 or older, does not plan on moving from their home for many years and they’d like to supplement their retirement income, then it’s possible a reverse mortgage is for them.

Reverse mortgages supplement income by tapping into part of a home’s equity.

In general, it’s a loan against a principle residence that a homeowner does not have to repay for as long as they live in that home.

The homeowner should have significant equity in their home to apply for a reverse mortgage.

Income from a reverse mortgage is usually tax-free and the homeowner is allowed to keep the title to their home. Also, it typically won’t affect their Medicare or Social Security benefits.

If the home is sold, or the homeowner moves or passes away, the spouse or the estate must repay the loan. However, there are some circumstances that allow a non-borrowing spouse to remain in the home if the homeowner were to pass away.

It’s imperative the borrower understand that with a reverse mortgage they must continue to pay the property taxes, homeowner’s insurance and maintenance on their home. If they do not, the home may be lost to foreclosure.

Reverse mortgages are a complex financial product that can be costly with extensive closing costs, mortgage insurance premiums and lender fees.

How Does a Reverse Mortgage Work?

Interest on a reverse mortgage accrues over time.

With each payment the borrower receives, interest is added to the monthly balance, which increases the amount that must be repaid later.

Interest rates on a reverse mortgage loan can be either fixed or variable.

Fixed-rate loans are usually allotted in a lump sum payment on a smaller loan amount.

Variable rates are linked to a financial index and fluctuate with market conditions. Variable rate reverse mortgages usually allow homeowners to take out larger loans and offer various payout options.

Keep in mind that interest on reverse mortgages is not tax deductible until the loan is paid.

A reverse mortgage loan can be paid to a borrower in various ways:

  • A lump sum loan payment check at the time of the loan origination.
  • A monthly recurring loan payment.
  • An open line of credit.
  • A combination of an open line of credit and monthly cash payments for as long as the borrower lives or a for specified time period.

In general, as the amount owed on the reverse mortgage increases, the equity in the home decreases. And essentially, this is what a person who takes out a reverse mortgage is seeking.

Generally reverse mortgages come in three forms:

Home Equity Conversion Mortgages, which account for about 95% of all reverse mortgages, are federally backed/insured by the U.S. Department of Housing and Urban Development.

These loans usually give borrowers the most amount of money based on the quantity of home equity and their age. These loans allow borrowers to use the money as they see fit.

Proprietary reverse mortgages are offered by private companies and are not insured by the U.S. government. Mortgage loan payouts may be larger with this type of loan and they can also be more expensive.

Single-purpose reverse mortgages are for those whose income qualifies. These types of loans are not readily available, but they are inexpensive and offered by some not-for-profit organizations as well as state and local government entities.

The money for these loans can only be used for the purpose specified by the lender.

In all, if you think a reverse mortgage loan may be right for you or your loved one, please do your extensive due diligence and consult with a financial planner first.

Until next time,

Amber Lancaster

Senior Research Manager, Banyan Hill Publishing

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