What is a Reverse Mortgage?
By: Stephen Bishop Jr.
Published: November 2007
Reverse mortgages are unfamiliar to many. So what exactly is a reverse mortgage? Well, a reverse mortgage is a loan intended for seniors, age 62 and older, which allows homeowners to borrow money against the equity of their home. Home equity is simply the difference between your home’s fair market value and any unpaid debt on it.
Reverse mortgages can be used by homeowners that have a small amount of debt left on their home. They can also be used by those that have paid off their mortgages completely. Homeowners that choose to use a reverse mortgage can receive the payments of the loan in several different ways. They can receive them as a lump sum, fixed monthly payments, or as a line of credit. Some reverse mortgage plans allow homeowners to receive the loan using a combination of these methods.
So, how does the lender determine the amount that you will receive? This depends on several factors. These include the location of the home, the interest rate on your home at the time of closing, the method in which you choose to receive the loan, the value of the home, and the age of the homeowner. In fact, older homeowners receive larger loans than younger homeowners.
So, how long does the loan last? Typically, a reverse mortgage loan lasts until the homeowner dies, sells their home, or leaves for an extended period of time, usually 12 or more consecutive months. For example, reverse mortgage loan payments may be given to a homeowner that is in assisted living, but for only an extended period of time. The loan can be used for anything the homeowner believes is necessary. Because senior citizens are the only ones that can qualify for a reverse mortgage, the loans are often used for medical expenses, prescriptions, traveling expenses, retirement, and more. Some may choose to use the loan to pay existing debts, normal living expenses, property taxes or home insurance, and even the cost of the reverse mortgage loan itself. Paying property taxes and home insurance with some of the proceeds of the loan may be a good idea. Why? Many reverse mortgage lenders consider a missed payment on either property tax or home insurance a default on the reverse mortgage loan.
There are various lenders that offer reverse mortgages, and their costs may differ dramatically. Private lenders generally have the highest costs for reverse mortgages. Private lenders’ reverse mortgage costs differ and depend on the company in which originated the loan. Many private lenders charge origination fees on top of the closing costs of the home. Private lenders may also add a monthly service charge. Along with private lenders, there is the FHA-insured Home Equity Conversion Mortgage (HECM). The HECM reverse mortgage charges closing costs, a two percent origination fee, as well as a two percent insurance premium. Some local and state governments provide reverse mortgages with lower rates. These usually are very limited in terms of location and qualification. Most reverse mortgages provided by local and state governments restrict the ways in which the homeowner may use the loan.
HECM Reverse Mortgage Costs (example):
- Fair Market Value Price of Home: $350,000
- 2% Origination Fee: $7,000
- 2% Insurance Premium: $7,000
- Plus Closing Costs of Home (several thousands of dollars)!!
Reverse mortgages are often avoided due to their high costs. As mentioned, you are allowed to pay for the costs of a reverse mortgage using the loan itself. In doing this, costs and fees are added to the original loan principal. Unfortunately, the costs and fees combined with an increasing loan principal will result in more interest for the homeowner to contend with. With this in mind, many choose to go another route when attempting to free up their home equity. Many homeowners consider an agreement that involves selling their home and renting it back from the buyer. Some may simply move to a cheaper neighborhood or location. Others may choose to settle for a home equity line of credit (HELOC). No matter what option you take, make your decision wisely.