Simply put, a reverse mortgage gives homeowners age 62 and older access to a portion of the equity in their homes. Of course, it’s not quite as simple as that. Although the term “reverse mortgage” often brings with it a lot of outdated connotations, the modern reverse mortgage has evolved into a flexible financial tool heavily regulated by government safeguards. Read on to find out what reverse mortgages are all about.
Explaining Home Equity
Before you can get a full understanding of a reverse mortgage, you’ll need to know a little bit about home equity. Let’s start with an example. Imagine that you decide to take out a mortgage for a $100,000 home. You pay this mortgage like any other by making monthly payments. Over time, the money you pay – in addition to the value your home gains over time – becomes your home equity.
In other words, home equity is (more or less) the amount of your home that you’ve actually paid for. In technical terms, it’s the value of ownership that represents the current market value of the home minus remaining mortgage payments. As you pay off your mortgage, this value increases. If your home rises in price, your home equity will naturally increase alongside it. Given that many homes appreciate in value over time, plenty of homeowners accumulate substantial home equity by the time they reach retirement age. This is one of the many reasons why reverse mortgages are an ideal product for seniors.
How it Works – In Depth
As mentioned above, a reverse mortgage works by giving you access to a portion of the equity in your home. First, if you have an existing mortgage, it will be paid off using this home equity. From that point on, you can use the remaining proceeds however you like – just make sure to stay on top of your property taxes, homeowners insurance, and home maintenance costs. Not too complicated, right? Well, there are several other important details that you should understand about the reverse mortgage:
- You will remain the owner of your home.
- You can sell your home or pay off the loan without any prepayment penalty.
- There are no monthly mortgage payments required. But, you can feel free to make them if you would like.
- You are able to receive your money in a lump sum, via monthly payments, through a line of credit, or by using any combination of the three (more on this in the section below).
- Because reverse mortgages are non-recourse loans, you will never owe more than the value of your home. If you owe more than it’s worth, the FHA will cover the difference.
- If you vacate your home, if it is no longer your primary residence, if you pass away, or if you fail to maintain loan obligations, the loan will come due.
Like a regular mortgage, your loan balance will increase over time due to interest. If you decide not to make payments, the interest for each month will be added to the loan balance. In other words, the amount that you would have paid in interest is added to the amount that must be paid once the loan comes due.
Common Types of Reverse Mortgages
The reverse mortgage often goes by another name – The Home Equity Conversion Mortgage (HECM). This is basically just a fancy term to describe the government-insured reverse mortgage frequently offered on the market today. Keep in mind that, although these loans are insured by the United States government, they are not government loans because they are still issued by private lenders. Check out this brief description of HECMs available thanks to the regulatory efforts of the Federal Housing Administration:
- Fixed Rate HECM – This type of loan will give you access to your money with one lump sum disbursement. Because it’s a fixed rate loan, it will also lock the interest rate in place throughout the entire duration of the loan. Many borrowers use this type of loan to pay off a mortgage balance, medical bill, or other substantial debt.
- Adjustable Rate HECM – The most flexible option, this kind of HECM allows you to receive your money from a line of credit, monthly disbursements, a lump sum, or any combination of the three. With these proceeds, many borrowers choose to delay other retirement benefits and investments which will allow them more time to increase in value. This type of loan is often appealing because the line of credit offers the potential for growth over time.
- HECM for Purchase – Unlike an ordinary HECM, this type of loan allows you to purchase a new home with a substantial down payment. Once the purchase has been made, the loan works like a regular reverse mortgage (no required monthly payments, you own the home, etc.)
Although HECMs are the most common type of reverse mortgage, some private lenders still offer proprietary reverse mortgages. They are not insured by the FHA and are often used for higher-value homes because they are able to surpass the maximum loan limit of the HECM. In other words, if you own a home worth a few million dollars, a proprietary mortgage may be able to give you more money.
However, be aware that, if your lender ever went out of business, you would be left without a reliable means of claiming your promised funds. Getting a government-insured HECM, on the other hand, means that even if your lender goes out of business, you’ll still be able to receive your loan proceeds from the federal government. Another disadvantage a proprietary loan has is that it is not a non-recourse loan. That means, if you owe more than the home is worth, you will have to pay the difference. With a regular HECM, you will not have to worry because your loan will have FHA insurance.
If you have any questions about the loan, the process, or how it might apply to your specific situation, feel free to contact us. We also recommend speaking to your financial advisor.