How Does a Reverse Mortgage Work?

While the real estate market continues on the road to recovery, there has been quite a buzz recently regarding reverse mortgages. The advertisements for reverse mortgages are geared at individuals aged 62 and older, and they are usually endorsed by a celebrity within the same age range. Taking out a reverse mortgage can be extremely beneficial to retired individuals, as it allows them extra money to take care of various monthly expenses, and the loan does not have to be paid back as long as the homeowners remain in the home.

When a reverse mortgage is taken out on a home, the loan amount is based on the home’s current value, current interest rates, and the borrower’s age. A reverse mortgage allows for the homeowner to release the amount of equity in their homes in order to turn it into monthly income, which is extremely beneficial to retirees. The reverse mortgage lender is paid through the sale of the home, and this can occur when the last occupant passes on, the homeowner moves, or the homeowner does not fulfill the loan contract. The reverse mortgage balance will increase as time goes on due to interest and various fees, and this will in turn reduce the borrower’s equity.

The Three Types of Reverse Mortgages

There are three types of reverse mortgages – Single Purpose, Proprietary, and Home Equity Conversion. Single Purpose reverse mortgages tend to be offered by state governments as well as nonprofit organizations, and they are used for a single specific purpose. The homeowner is given a one-time loan that can be used to pay off property tax, as well as take care of home renovations. A Proprietary reverse mortgage is a loan that is tied to a private company. The private company is in charge of choosing specific lenders to handle the loan process. Qualifying criteria is minimal, but proprietary loans usually come with high up-front lending fees. Home Equity Conversion mortgages are the most popular form of reverse mortgage in today’s real estate world. They are insured by the FHA, and they are also government-guaranteed.

Calculating a Reverse Mortgage

A reverse mortgage is calculated using the following factors: Interest rates, credit line growth, the value of the home, interest rate cap, and fees. The fees include appraisal fees, insurance premiums, loan servicing fees, origination fees, and closing costs. It is very important that individuals considering taking out a reverse mortgage take a good look at their budget, calculate their potential loan amount, and deduct any expected fees from the total. This can be done by using an online mortgage calculator, an easy to use internet tool that will correctly calculate these amounts.

Reverse Mortgage Example

This example is based on a single retiree, age 67, living in Los Angeles County. Their home is valued at $300,000 dollars and the homeowner owns the home outright. A variable rate HECM would allow the borrower approximately $174,000 if they choose a lump sum payment. If they choose a line of credit with a monthly compounding rate of 0.3723%, they would be allowed a credit line of approximately $174,000 would grow in five years to approximately $184,000 if the credit remains unused. If the borrower chooses monthly payments, they would receive approximately $1,000 a month.

Qualification and the Reverse Mortgage Process

To qualify for a reverse mortgage, the homeowner must be 62 years of age or older, and they must occupy their home as a principal residence. The homeowner must also own the home outright, or if they do have a mortgage payment, it must be low enough that the balance can be paid off with the loan. Typically, homes must be a single family dwelling, but individuals that own a two to four unit property can also qualify, as long as it is their primary residence. Condominiums and townhomes may also be considered, depending on the applicants’ specific criteria.

The amount of the reverse mortgage loan will depend on a variety of different factors. The homeowner’s age and the location of their property are considered, as well as the home’s total value. Homeowners can also choose how they receive their loan. They can opt for a line of credit, a lump sum, or a monthly loan advance at a fixed rate.

The benefits of a reverse mortgage tend to outweigh the risks, but it is important to know what is required when it comes time to repay the loan. A reverse mortgage does not have to be repaid until the last remaining resident of the home moves out, sells the property, or passes on. In the event of the homeowner’s passing, the loan will have to be repaid by their heirs, but the estate will never owe more than the appraisal amount. The homeowner is also responsible for real estate taxes and homeowner’s insurance, and if these payments become delinquent, the homeowner may risk losing the loan.

Make an Informed Decision

If you are a homeowner that feels a reverse mortgage loan is the right choice for you, it is always a good idea to consult with an experienced reverse mortgage counselor before making your final decision. The AARP is a great resource, and can refer you to a counselor through the HUD network. By weighing out the pros and the cons, creating a realistic budget, and knowing where you stand financially, you will be able to determine if taking out a reverse mortgage is the right step to take in securing your financial future.

Author: Scott Skyles

Since 1995, Scott has been involved with over $1 Billion in mortgage fundings and is recognized as an expert in residential mortgage lending. Scott is licensed and able to originate mortgage loans in all 50 states. You may follow Scott on your favorite social networks: Facebook | Google+ | Twitter

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