By: Yara Zakharia, Esq.While a sizable segment of the U.S. population is working beyond the retirement age, it can never be too early for Americans to prepare for the future. An efficacious management of finances and a familiarity with reverse mortgages are primordial for seniors engaged in long-term planning. When understood thoroughly and utilized properly, a reverse mortgage can be an extremely beneficial retirement tool for the cash-strapped elderly by equipping them with monetary security in their golden years. This article tackles the often-asked question "How does a reverse mortgage work?"
Specialized types of home loans known as reverse mortgages enable retirees and homeowners who are 62 and older to borrow against their home equity and convert it into cash without having to move out of their home. The funds generated from this mortgage against their home need not be repaid so long as the property is their principal residence. Whereas in a traditional mortgage, homeowners make a monthly payment to the lender in order to borrow funds, reverse mortgages operate inversely in that it is the lender that issues monthly payments to the borrower for a specific time period. The loan against the home's value must be paid in full when the property is sold. Reverse mortgage lenders calculate the monthly payment on the basis of the home's value over a twenty or thirty-year term. The loan becomes due when the homeowner dies, moves, or sells the property. One advantage, therefore, of a reverse mortgage is that the homeowner will not be forced to vacate the premises or face foreclosure due to delinquent mortgage payments.
To qualify for a reverse mortgage, an applicant must be at least 62 years of age and own his or her home. The amount that a homeowner can borrow depends on FHA's mortgage ceiling or the home's appraised value, whichever is lower, the current rate of interest, and his or her age. The lower the rate of interest and the older the borrower at the time of application, the higher the credit line for which he or she qualifies. To determine the dollar amount of credit available to them, homeowners may utilize an online reverse mortgage calculator. Typically, they must enter the following minimal mandatory fields:
- Estimated value of the home
- Zip code
- Their age and that of their spouse or other co-owner.
The balance of current mortgages that the prospective borrower inputs is deducted by the calculator. Applicants are not subject to credit history or income qualifications.
Through reverse mortgages, prospective borrowers may tap into their home equity to extract cash which is paid out either as a:
- Line of credit,
- Steady monthly cash advance,
- Lump sum, or
- Combination of these payment options.
Those who choose the credit line method will pay interest only on the funds actually utilized. Most individuals who take out a reverse mortgage are retirees who are in the low-to-middle income bracket, who have acquired sufficient equity over the years, and who have lived in the property for many years. Reverse mortgages offer them a regular source of income and help them pay for unforeseen expenses and long-term care. The mortgage amount due will never exceed the home's value, and the creditor is paid either from the equity of the sale or the home refinancing. When borrowers cease to use the property as their primary residence or sell it, they or their heirs must repay the funds obtained from the reverse mortgage, in addition to interest and fees. Any leftover equity in the home belongs to the homeowner or his or her estate. Upon the homeowner's death, the heirs can either pay the mortgage and keep the home or sell the property in order to repay the loan.
The U.S. Department of Housing and Urban Development (HUD) offers a federally-insured private loan known as the Home Equity Conversion Mortgage (HECM), which enables seniors to supplement their retirement income. To be eligible for a HUD mortgage, the applicant must 1) be at least 62 years of age, 2) be a homeowner or have a small mortgage balance that he or she can repay at the closing with funds from the reverse mortgage, 3) reside in the home, and 4) attend a consumer information session aimed at protecting their financial interests. To be eligible for a HUD loan, the home must be 1) a two to four unit parcel of real property or 2) a single-family residence that the borrower owns and occupies. Some of the dwellings that qualify include manufactured homes, condos, detached homes, and townhomes.
Prospective borrowers should, however, be aware of the following reverse mortgage pitfalls:
- High up-front and closing fees that can quickly chip away at their home equity (i.e. origination fee, title insurance, mortgage insurance, appraisal fees, 2% lender fee, servicing set-aside fee);
- Accumulating interest due to the fact that the loan is not repaid until they die, move, or sell; and
- Less funds for their children's inheritance and emergency expenses due to reduction in the home equity.
