Understanding the Reverse Mortgage

What is a Reverse Mortgage?As home owners approach retirement, they may be concerned about not having enough money to cover their living expenses on a fixed income. You may have heard of a reverse mortgage as a way to supplement your income, without having to sell your home and downsize.

This guide shows you the details surrounding a reverse mortgage, and how to determine if it is the right choice for you.

What is a Reverse Mortgage?

When you get a traditional mortgage, you borrow a certain amount of money from a bank to finance or refinance a home, and then make monthly mortgage payments with interest. With a reverse mortgage, also known as a Home Equity Conversion Mortgage, you use the home’s equity to get a loan from the lender.

The lender makes payments to you at a specified interval, which can range from a lump sum at closing to fixed monthly payments for the rest of your life, depending on the loan terms. As long as you fulfill the requirements of the loan, you are not required to leave the home. Some people consider a reverse mortgage to be an effective way to supplement their income in retirement.

Who Can Qualify for a Reverse Mortgage?

There are a few simple qualifications you have to meet in order to be able to get a reverse mortgage. Applicants must:

  • Be at least 62 years old
  • Maintain the home (or a unit in a 2-4-unit dwelling) as a primary residence
  • Own most or all of the home outright

If you qualify, you may be able to apply for a loan that is guaranteed by the Federal Housing Administration. The lender will look at your finances to confirm that you can pay for the upkeep on the home, as well as insurance and property taxes. The amount of money you receive is determined by the value of the home, the amount of equity you have and the age of the youngest borrower. Usually, the older you are, the greater percentage you can receive.

Can I Get a Reverse Mortgage With a Current Mortgage?

Although getting a reverse mortgage is available for owners only if they have paid off their home, you may sometimes get a reverse mortgage while you still owe some money on an existing mortgage. In that case, you would use a portion of the proceeds from the reverse mortgage to pay off the current mortgage. However, you should carefully consider getting a reverse mortgage if you still owe a significant amount of money.

Drawing out more than 60 percent of the available money in the first year typically subjects you to a 2.5 percent upfront mortgage insurance premium (MIP) instead of the standard 0.5 percent. You will also be charged interest on all money you receive in the reverse mortgage.

Do I Have to Pay Closing Costs?

Just like any other mortgage loan, the lender has to process your application, pay for an appraisal and prepare paperwork. Beyond the origination fees and the real estate closing costs, you also must pay MIP. Most reverse mortgages are insured by the FHA, and the insurance protects your payments if your lender should go out of business.

It also helps to reduce the burden if you continue to receive monthly payments after the total equity in the home has been depleted. You will usually be charged an upfront mortgage insurance fee that is based on the amount of money you take out in the first year, and then a 1.25 percent rate for mortgage insurance for the life of the loan.

Does the Bank Charge Interest?

The way that the lender makes money on a reverse mortgage is through interest. You may get a loan with a fixed interest rate or an adjustable rate. Fixed-rate reverse mortgages have the same rate for the duration of the loan, while adjustable-rate reverse mortgages can change rates at a regular interval.

Unlike a regular mortgage, you do not have to pay the interest monthly; Interest is accrued on the money you receive as you get it. The more you take in the loan, the more interest you have to pay over time. The interest is paid when the loan matures, through the sale of the home.

When Does the Loan Come Due?

The terms of the standard reverse mortgage allow you to stay in the home for as long as you want, but there are a few caveats. When you sign for the reverse mortgage, you typically agree to provide reasonable upkeep for the home and pay property taxes and insurance. Borrowers who fail to stay current on these payments or maintain the home may be subject to loan maturity.

This could also happen if one or more of the borrowers moves away or sells the home. Loan maturity means that you must repay the loan, usually through the sale of the home. The remaining equity is given to you or your next-of-kin. If you follow all the rules, you can stay in the home until death, even if the payments exceed the total equity in the home.

What If Two People Live in the Home?

The ability to stay in the home almost always applies to the borrowers for the reverse mortgage that live in the home. If there is only one borrower in the home, but two people live there, the loan may come due when any of the above terms are met. In this case, it is better to ensure that all adults planning to live in the home long-term act as co-borrowers. If this is not possible, you should consider housing alternatives for anyone still living in the home once it is sold.

How Do I Receive Payment?

You have a number of options for disbursement of the funds, and your lender may be able to help you pick one. Some people prefer to receive a lump sum all at once, while others like the security of a regular monthly payment. You can even specify that you would like to have the loan as a line of credit you can use as needed. In all cases, you only pay interest on the money you receive.

Getting a reverse mortgage is not for everyone. It may be ideal if you need a source of income in retirement, plan to live in the home for many years, and are able to maintain the property. The way that you receive money affects how much you can borrow, and you will pay a percentage of the loan in closing costs. With those financial obligations in mind, you can decide if a reverse mortgage is a good financial decision for your needs.

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