Reverse Mortgages: What They Are & How They Work
Reverse mortgage is a loan product that lenders provide to elderly homeowners with home equity as collateral. The product is tailored to supplement the borrower’s income by tapping into his/her home equity while still residing in their home.
Unlike traditional mortgages where the borrower repays monthly installments, with a reverse mortgage he/she receives payment from the lender. The service is known as Home Equity Conversion Mortgage or simply HECM.
Here is all you need to know about the loan and how it works:
The borrower must be a senior who is 62 years or older. For a couple, the younger spouse must meet the age requirement. One has to be the outright owner of the home or have a mortgage whose balance is considerably lower than the home’s value. The home has to be a permanent resident of the borrower and be in good condition prior to applying for the loan.
Since it’s the borrower who gets paid for this kind of loan, credit scores and reports do not play a big role in the qualification. However, he/she must prove the ability to maintain the house and settle housing costs. These include property taxes, insurance, and homeowner’s association fees.
The Loan Amount
The principal amount from a reverse mortgage is dependent on the age of the borrower, current interest rates, and appraisal value of the home as well as the limit set by the Federal Housing Administration (FHA).
FHA insures the loan and as such, it sets the limit on the maximum amount that a home can be mortgaged at. A borrower gets the lesser of the home’s appraisal value or the set maximum claim limit which is currently at $679,650.
An 85-year-old borrower will basically qualify for a higher amount compared to a 70-year-old. The loan amount is usually priced at 42% of FHA maximum limit or appraisal value for 62-year-olds with the percentage going up with the borrower’s age.
Similarly, the more valuable a house is the higher the reverse mortgage. It is upon the borrower to also shop for a lender whose offer carries the lowest interest rates for higher loan amounts.
How a Reverse Mortgage Works
Homeowners get to extract their home equity or a fraction of it depending on the approved loan amount. Home equity, in this case, refers to the difference between the value of your home and any balances on conventional mortgages.
After the loan has been closed, the borrower must immediately pay off any debt left on the traditional mortgage. This frees them up from paying ongoing monthly payments and interests.
The funds can be accessed in a number of ways:
Lump sum payment: Borrowers who opt for this payment must withdraw the whole amount at the close of the loan. This option is popular for homeowners who need to settle other large loans, fund large purchases or settle hefty school fees for their children.
A line of credit: The borrower gets to withdraw as much as they need after the loan has been approved. The remaining funds can then be accessed in any way they see fit. No interest is accrued on the amount that has not been withdrawn/not in use, making it the most popular option.
Monthly Payments: The payment is structured into either term or tenure withdrawals. In ‘term’ payments, the fund is divided by a fixed number of years and you receive the corresponding monthly fixed amounts. Tenure payment, on the other hand, allows the borrower to receive monthly payments for as long as they live in the home.
Combination: Lenders are flexible; they allow borrowers to modify payment to include a combination of any of the above.
The borrower can choose to periodically pay off the loan. They can also pay it off from savings or by selling the property. However if the loan is not cleared during the lifetime of the borrower or if they are absent from the house for over 12 months, it becomes due.
It’s upon the heir of the estate to pay the amount owed. In case they choose not to, the lender gets to sell the house and recover the dues with the surplus going to the heir. In instances where sale doesn’t cover the debt, the loss is paid off by HFA who are the mortgage insurers.
Reverse mortgages are some of the useful financial tools that are available to seniors. That said, borrowers need to understand the different aspects and workings of the loan before they apply for one.