What is a reverse mortgage?

Posted on: 19th Jun, 2005 12:36 am

If you're a senior, looking to cash out your home equity without having to worry about monthly payments, a reverse mortgage is what you may need. If you'd like to know how a reverse mortgage can help you, and what it's all about, check out the reverse mortgage information below:

What is a reverse mortgage?

A Reverse mortgage (reverse equity mortgages) is a home loan that provides you with a steady flow of tax-free income either in installments or in lump sum. Since the loan provides an easy flow of cash, it is the preferred choice of many seniors in the country.

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How does a reverse mortgage work?

It's just the reverse of a traditional mortgage which requires monthly payments. With a reverse mortgage, your debt accumulates as the bank doesn't collect the payments till the loan period ends or you or your heirs sell. Here are 5 things you should be aware of before you apply for a reverse equity mortgage:

How to get the cash:
You can get the reverse mortgage loan funds in different ways.
- The lender or the company can provide you with a single payment.
- You may ask for monthly cash advances.
- You can apply for a line-of-credit that gives you the opportunity to withdraw a required amount of cash whenever you are in need.
- The lender may allow for a combination of monthly cash advances as well as "credit-line account".
Reverse mortgage limit:
The maximum loan amount offered ranges from $200,160 to $362,790, depending on the county you live in. However under the 2008 New Housing Bill, the loan limit has been raised to $417,000. For high cost housing areas, the limit is further raised to $625,000. However, the loan amount that you will qualify for, depends upon the factors given below:
- Age of the youngest borrower
- The appraised value of your home
- The equity built up in your home
- What loan program you choose
- How you want to get the loan funds
Besides the above factors, the loan limit may also depend upon current interest rates and closing costs on home loans in your area.

How to qualify for the loan:
Unlike other loan options, there is no minimum income or credit requirement to qualify for a reverse mortgage. However, if you have unpaid debt on your home, it should be paid off before you apply for a reverse mortgage or else paid off as soon as you get the loan proceeds. Check out if you are eligible for reverse mortgages.

Loan types you can apply for:
You'll find a variety of loan products available in the market. They're the FHA-insured Home equity conversion mortgage (HECM), the Home Keeper Mortgage offered by Fannie Mae approved lenders, and others. You need to compare these programs and decide on the one that suits you. Check out more on Reverse Mortgages Comparison.

Reverse mortgage interest rate:
These loans are mostly adjustable rate mortgages that adjust on a monthly, semi-annual, or annual basis. The interest rates are usually based on the 1 year U.S. Treasury (T-Bill) or the LIBOR index. However, you'll also find fixed rate HECMs offered by certain lenders. However, rate changes do not affect the principal you get; rather it affects the amount you owe.

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What are the advantages of a reverse mortgage?

Reverse mortgages assisted countless homeowners improve their quality of life upon retirement. These are very flexible financial planning products with limited restrictions attached to them. Key benefits of this offer are listed below-

No restrictions on the use of money:
Money that you receive through a reverse mortgage can be utilized for whatever purposes you want. You can use it for funding the education of a family member, for traveling purposes, for meeting the basic necessities of life or for anything else. You can also park the amount in another account as savings for the rainy days.
Less risks of default:
In a reverse mortgage, there is no chance of losing your home for non-payment. Whereas, in case of a home equity loan, you may lose your home because of non-payment. Again, reverse mortgage lenders donâ€™t have any claim on your other assets and income.
Federally guaranteed:
There are a variety of loan products available in the market. The most widely used reverse mortgage is the federally guaranteed home equity conversion mortgages (HECM). HECMs are managed by the Department of Housing and Urban Affairs. Since these offers are federally backed, you will continue to receive payments even if the reverse mortgage lenders default.
Tax benefits:
Reverse mortgage is treated as a loan. The money that you receive through this route is tax-free. This is regardless of whether you receive the money in monthly basis or in lump sum amount.
Retains home ownership:
As long as you stay in the house, you retain ownership of the house. However, you are responsible for paying for the property taxes, insurance and maintenance.

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Are there disadvantages or dangers of reverse mortgages?

There are 3 reverse mortgage pitfalls to watch out for:

Rising debt and falling equity:
A traditional mortgage requires you to make payments and build up equity. But reverse mortgages reduce your equity because you don't need to make monthly payments, and causes your mortgage debt ratio to increase. Your equity gets lower unless your home value appreciates. Thus, reverse mortgages are often known as "rising debt and falling equity" loans.

Here's an example on "Rising debt and falling equity".

Monthly Loan Amount: $2,000 Yearly Loan Advance: $24,000 Yearly Interest Rate: 8% Original Home Value: $250,000 Appreciation Rate of Home Value: 5% per annum
End of Year	Principal Amount ($)	Total Interest ($)	Loan Amount ($)	Total Home Value ($)	Home Equity ($) (Total Home Value - Loan Amount)
1	24,000	1,052	25,052	262,500	237,448
2	48,000	4,102	52,102	275,625	223,523
3	72,000	9,224	81,224	289,406	208,182
4	96,000	16,495	112,495	303,876	191,381
5	120,000	25,990	145,990	319,070	173,080

As the above calculation shows, even if your home value goes up, it may not be enough to raise your home equity. The rate of appreciation in the home value should be high enough so that even if your loan balance increases, your home equity won't go down easily.

Now, when the appreciation isn't high enough, your equity will reduce, and as a result you may not have a home to leave for your heirs. This is because your heirs will only receive your home when the value of the home is more than what you owe.

Rates and closing costs:
The rates being adjustable can be higher at times thereby raising your interest and hence your debt because you aren't paying monthly. Some reverse mortgages have high closing costs, although under the new housing laws, the costs have been cut down and capped so that older homeowners can afford to get a reverse loan.

Eligibility for Medicaid benefits: The loan proceeds may affect your eligibility to receive Medicaid benefits and Supplemental Social Security income (SSI). However, you can still qualify for Medicare and Social Security Income.

In spite of the reverse mortgage cons, these loans are preferable options when it comes to paying for your healthcare costs, remodeling your home, making a big purchase, or changing your lifestyle. Moreover, if you have debts to pay off, need money for someone's education, or wish to plan for a vacation, reverse mortgages are worth considering.