Reverse Mortgages How Do They Work?

A reverse mortgage is a special type of home loan that lets you convert a portion of the equity in your home into cash.  No repayment of the mortgage (principal or interest) is required until the borrower dies or the home is sold.  Borrowers are still responsible for paying property taxes and insurance on the property and must continue to use the property as a primary residence for the life of the loan.
 
After accounting for the initial mortgage amount, the rate at which interest accrues, the length of the loan and the rate of the home price appreciation, the transaction is structured so that the loan amount will not exceed the value of the home over the life of the loan.  These types of mortgages have large origination costs relative to other types of mortgages. These costs become part of the initial loan balance and accrueinterest.  And any existing liens on the home must be paid off with the proceeds of the reverse mortgage.
 
A reverse mortgage provides income that people can tap into for their retirement. The advantage of a reverse mortgage is that the borrower's credit is not relevant, and is often unchecked, because the borrower does not need to make any payments. Additionally the payments from a reverse mortgage to the homeowner(s) are not taxable.  Because the home serves as collateral, it must be sold in order to repay the mortgage when the borrower dies (in some cases, the heirs have the option of repaying the mortgage without selling the home).  If there are funds left over after the sale of the home, the funds are distributed to the heirs.
 
The Home Equity Conversion Mortgage (HECM) is FHA’s reverse mortgage program. A HECM loan is issued by private banks and insured by the Federal Housing Administration (FHA).  Non-HECM loans are available and can be considerably more expensive than a HECM; however, the vast majority of reverse mortgages are HECM loans.  To qualify for a HECM loan you must be:
  • At least 62 years old
  • Own the home outright (or have a low mortgage balance)
  • Occupy the home as your primary residence
  • Not be delinquent on any federal debt
  • Be capable of making timely and full payment for ongoing property taxes, insurance, HOA fees, etc.)
  • And your home must meet certain qualifications
     
Senior citizens should carefully analyze the options of a more traditional mortgage, such as a home equity loan, against a reverse mortgage.
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