A reverse mortgage allows people who are 62 or older to leverage any equity in their homes. A homeowner has the ability to withdraw an amount of home equity without ever needing to repay it, with a reverse mortgage. That is to say, it must be repaid once the owner has left the home. This should only be considered if an ample amount of equity has been built. But, why would anyone want to do something like this? Here’s everything you need to know about a reverse mortgage.
What is a Reverse Mortgage?
This type of mortgage lets homeowners ages 62 and up, who have paid off their mortgage, to temporarily borrow a portion of their home’s equity. The equity is treated as tax-free income. For a typical mortgage, payments are made to lenders. However, with a reverse mortgage; the lender has to pay the requesting homeowner. In this case, the balance of the loan is due once the prospective borrower passes away, decides to sell the home, or moves to another home. The loan is limited Federally. This means that regulations have been put in place to ensure the amount borrowed does not surpass the value of the home. The regulation also states that the homeowner and their estate aren’t responsible for paying any difference if the borrowed amount outweighs the value of the home. This could happen in a situation where a home’s market value plummets. One other way is if the borrower lives a long life.
How Does a Reverse Mortgage Work
As stated before, the lender makes payments to the homeowner. The homeowner has full power to choose how they want to receive payments (refer to the next section for the types of ways). Also, they only pay interest on what is received. Nothing needs to be paid upfront since the interest is added to the loan balance. Also, the homeowner gets to keep the home’s title. Note that, this loan results in home equity decreasing and homeowner debt increasing, over time.
Your home becomes collateral in the case of a reverse mortgage. When the homeowner passes away or moves, any funds made from the sale of the home is given directly to the lender. This helps repay interest, principal amount, any mortgage insurance, and fees for the reverse mortgage. Any proceeds made beyond the loan amount goes to the homeowner’s estate, if deceased, or the homeowner themselves, if alive. Proceeds made from the reverse mortgage are not taxable by law. But, the IRS does consider the proceeds as a loan advance.
The Different Types
There are three different types of reverse mortgages offered: single-purpose reverse mortgages, federally-insured reverse mortgages (HECM), and proprietary reverse mortgages. The HECM or Home Equity Conversion Mortgage is the most common representing nearly all reverse mortgages offered by lenders. With a HECM, the homes’ value must be below $765,600. This is the type we will focus on.
When you choose this loan option, you can decide how you want to receive the proceeds:
- Monthly Payments (annuity) – The lender will make consistent monthly payments as long as a borrower is living in the home. The borrower must be a principal resident.
- Line of Credit – Proceeds are available at the disposal of the borrower as needed. The borrower would only need to pay interest on the amount of money they chose to borrow.
- Lump-Sum – The full loan amount borrowed is received at one time, once the loan is closed. What is different with this option is that it comes with a fixed rate while the others have an adjustable interest rate.
- Term Payments – The lender pays the borrower set payments every month for a specific term, such as 15 years. The loan wouldn’t extend beyond this term.
- Term Payments + Line of Credit – The borrower is given monthly payments from the lender for a set term, like option 4, but if the borrower ends up needing more funds after or during the life of the loan, they have access to a line of credit.
- Equal Monthly Payments + Line of Credit – The lender makes consistent monthly payments as long as a borrower is living in the home as a principal resident. Like option 5, if the borrower needs more money after or during the loan, they have access to a line of credit.
To be considered for a reverse mortgage, the primary homeowner must be 62 years of age or older. If one of the owners is under 62, a reverse mortgage still may be an option if other requirements are met. here are the standard requirements:
- If a mortgage already exists, proceeds received from a reverse mortgage must be used to pay the existing mortgage.
- The homeowner must be keeping up with property taxes, any homeowner association fees, homeowners insurance, and any other legal obligation.
- The property must be maintained and in satisfactory condition.
- The borrower must own the home outright.
- The homeowner must be living in the home that is the primary residence.
- Borrowers must participate in a consumer information session. The session must be led by a HUD-approved counselor.
- The home has to be a single-family home, a townhouse, a manufactured home constructed after June 1976, or a multi-unit property with no more than 4 units.
Is This Right for You?
If you are 62 or older and looking for additional income during retirement, a reverse mortgage is a good option for you. Many even use the proceeds received to supplement social security, pay for medical expenses, home care, and even renovations. The flexible options of how your payment is received are also a favorable part of a reverse mortgage. Also, if the value of the home appreciates over time and becomes worth more money than the loan amount, you may receive the cash difference.