A reverse mortgage is a form of equity release, it allows a borrower to turn the equity that has been built up in a home into cash. This cash can be received through a lump sum payment, an ongoing monthly payment or a combination of both. What separates reverse mortgages from traditional mortgages is that the loan does not need to be paid back until one of the following occurs; the owners/borrowers sell the house, the house is no longer the primary residence (this occurs when the owner do not live in the house for a period of 364 consecutive days or more usually as a result of moving into a nursing home or retirement village), or they pass away. The loan can also be triggered into being immediately payable if certain conditions set out in the loan are not met, for example: insurance and property taxes must be kept up to date and the home owners must maintain minimum maintenance standards set out by the lender.
Reverse Mortgage Requirements
There are a number of requirements that must be met before a borrower can be deemed eligible for a reverse mortgage, these requirements are as follows:
- 62 Years of age or older
- Own home outright or have a mortgage balance that can be paid in full with the proceeds of the loan
- Must be the principal residence of the borrower. For example, holiday homes are unable to have this type of loan applied to them
- No income requirements as the balance of the loan (incuding interest) is paid in full at the end
How Much Can Be Borrowed?
The amount that can be borrowed varies on a case by case basis. The most common reasons for these variations are as follows:
- Age, the older the more that can be borrowed.
- Interest rate, the higher the interest rate of the loan chosen by the borrower less that can be borrowed.
- Value of the house, the higher the house value the more than can be borrowed. This also takes into account any repairs that need to be made and if there is any existing money owing on the home.
- The type of reverse mortgage selected, different types are talked about in more detail below.
- The payment method selected, the different payment options are also listed in much more detail below.
Borrowers can choose to receive their reverse mortgage payments in one of the following five ways:
- Tenure - Fixed monthly payments as long as one borrower still lives in the house
- Term – Equal monthly payments for a fixed period of time
- Line Of Credit - Instalments/payment can be taken in amounts and at a time of the borrowers choosing up to a set limit.
- Modified Tenure – Mixture of tenure and line of credit. Fixed monthly payments as long as at least one borrower is still living in the home, along with additional payment at the time and choosing of the borrower up to a predetermined limit.
- Modified Term – Mixture of term and line of credit. Monthly payments for a fixed period of time, along with additional payments as chosen by the borrower.
Types Of Reverse Mortgages
There are three main types of reverse mortgages, their name including some basic information on the differences is listed below:
- Single Purpose Reverse Mortgage – These are offered by some state and local governments and non profit organizations. This type is usually the least expensive option and can only be used for one specific purpose which is set out by the lender. For example a non profit organization may specify that it’s used for home repairs only, whereas a local government may specify that it’s used for property taxes
- Federally Insured Reverse Mortgage – Also known as Equity Conversion Mortgages (HECMs), these are provided by the department of housing and development (HUD).
- Proprietary Reverse Mortgage – These are provided by private lending institutions and can be used by the borrower for whatever they so choose.
Costs Of Reverse Mortgages
Costs are dependent on the type chosen by the borrow, the following costs are related to the most commonly used type (HECM).
- Real estate appraisal, usually $300-$500 depending on the real estate agency and your area.
- Mortgage insurance, 2% of the appraised value of the home.
- Origination fee, the higher of $2,500 or 2% for the first $200,000 and then 1% thereafter. This has a maximum cap of $6,000.
- Title insurance, varies.
- Title, attorney, and county recording fees, varies.
- Monthly service fees, usually between $25-$35 which is added to the reverse mortgage itself.
Most of, if not all reverse mortgages come with something called a non-recourse limit (which is sometimes referred to as a non negative equity guarantee in other countries). This ensures that a borrower can never owe more than the value of the home, in the event that the loan becomes payable this means that the heirs or the original borrower themselves cannot be liable to pay any additional money if it exceeds the houses value.
Pros & Cons Of Getting A Reverse Mortgage
There are many pros to getting a reverse mortgage, as with everything in life there are also significant downsides. Before entering into a contract it’s important to understand both sides of the story.
Reverse Mortgages Pros
- Any lump sum or ongoing payments are not taxable by the IRS.
- Social security and Medicare benefits are not affected in most cases.
- Borrower is able to maintain the title to the home.
- Borrower does not have to make any payments until the loan becomes due (either as a result of it not being their primary residence or the borrowing becoming deceased).
Reverse Mortgage Cons
- High start up costs, can cost up to $8,000 to set up a reverse mortgage which is extremely high when compared to a traditional mortgage (usually in the $5,000 or under range).
- Compound interest quickly adds up, lots of older borrowers don’t realize how quickly compound interest can add up. Leaving them with little money if they want to move into a nursing home or to leave their heirs with any equity left in the home.
- Most loans do not come with fixed interest rates, this can cause rates to rise unexpectedly as these rates are tied to market conditions outside the borrowers control.
- A borrower can default on their loan, causing it to be immediately payable if certain conditions are not met. For example the borrower must maintain the house to minimum conditions which are laid out in their contract.
- Borrowers cannot deduct the interest added onto the loan on their income tax returns, unless the loan is paid back in part or in full.
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