What is a Reverse Mortgage and How Does it Work?

What is a Reverse Mortgage and How Does it Work? April 11, 2012

As you get older and reach retirement age, coming up with ways to generate a steady income can be difficult. While you may be entitled to a pension or Social Security, it might not be enough to live in a comfortably in retirement.  For someone in this situation, they might be considering a reverse mortgage.  In short, a reverse mortgage is a type of loan that is only available to senior citizens over the age of 62 and who own their homes.

What is a Reverse Mortgage?

A reverse mortgage operates in an opposite manner from what a normal mortgage does. Instead of paying the mortgage lender, the mortgage lender pays you. The mortgage lender essentially buys the equity in your house over time.

There are three basic types of reverse mortgages:

Single-purpose reverse mortgages: These are generally offered by some state and local agencies as well as some non-profit organizations.  As the least expensive option, they’re designed to provide the homeowner access to the equity in their home for a specific use (i.e. to pay property taxes, home repairs, or other improvements).

Federally insured reverse mortgage: These are known as Home Equity Conversion Mortgages (HECMs) and they’re backed by the government, more specifically, the U.S. Department of Housing and Urban Development.  HECM loans are widely available and have no restrictions on use.  To qualify for a HECM reverse mortgage, you must meet with a qualified counselor – a list of counselors can be found here: www.hud.gov/offices/hsg/sfh/hecm/hecmlist.cfm.

Proprietary reverse mortgages: These are offered and backed by the private companies that develop them.

Who Qualifies for a Reverse Mortgage?

Not everyone can qualify for a reverse mortgage. In order to get this type of loan, you have to be at least 62 years old. You also have to have your own paid off for have very little debt against it. In order to qualify, you also have to go through a counseling session with a qualified reverse mortgage counselor. During this counseling session, the counselor will make sure that you understand how the reverse mortgage works and make sure that it is the best option for you. You have to continue paying the taxes on the property and making repairs to the property while you live in it.

How Much Can You Receive?

If you are looking into a HECM or proprietary reverse mortgage, your payout will depend on a number of factors.  Age, home equity, and outstanding loan balance will have an effect on the amount you can access.

The money you receive is not taxable, which is a positive feature of a reverse mortgage.  Even more, it usually won’t affect your Social Security or Medicare Benefits, but you’ll want to discuss this aspect with the Social Security benefits office and your CPA.

Paying the Money Back

Remember, a reverse mortgage is considered to be a loan that must be repaid based on the terms you set or when you move or pass away.  Depending on how you set up your loan, you may not have to make a payment during your lifetime.  If you outlive the payments for your equity, you won’t have to repay the lender as long as you keep living in the house. If you sell the house, then you’ll have to use the money from the sale to repay the lender. If you pass away, the executor of your estate can repay the debt from life insurance proceeds, other assets or he can sell the house to repay the debt.

Accessing the Money

If you are interested in getting a reverse mortgage, you have a few different options when it comes to accessing your money. What most popular options is to receive money from the lender in the form of a monthly payment. This option is popular because it gives you a regular income from the equity in your house.

Another option to consider is getting a line of credit against the equity. With this approach, you can get the money when you need it instead of through a monthly payment.

A third option is to borrow a specific amount of money at the beginning of the loan term. This is like taking out a home-equity loan on your house.

You can also combine any of these options together. For example, you could set up a line of credit and get a monthly payment from the equity.

Reverse Mortgage Precautions

If you or someone close to you is considering a reverse mortgage, there are some precautions that you should take.  First, be cautious of sales pitches that use pressure to push a reverse mortgage.  Sometimes you’ll see reverse mortgages pushed by home improvement services suggesting them as a creative and convenient way to pay for home improvements.  Don’t give into the pressure.  Do your own research and ignore sales pitches that suggest an urgency or pressure to move forward.

For most reverse mortgages, you have at least 3 days after the closing to cancel the deal in writing.  If you feel that someone is committing fraud with a reverse mortgage, you should report it to the FTC: www.ftccomplaintassistant.gov  1-877-FTC-HELP

A reverse mortgage isn’t for everyone and should be researched carefully.  It’s wise to seek advice from a financial planner before you entertain a reverse mortgage.

Do you think a reverse mortgage is a good idea or not?

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