Reverse mortgages are sometimes illustrated as a way to obtain additional cash flow. In its simplest terms, a reverse mortgage is a type of home loan that lets homeowners who are 62 years or older convert a portion of the equity in their homes into cash. As with any form of loan, it’s important for homeowners to be aware of a reverse mortgage’s provisions and how it affects their financial position before moving forward.
Types of reverse mortgages
The most commonly used reverse mortgage is the Home Equity Conversion Mortgage (HECM) offered by the US Federal Housing Administration. According to the U.S. Department of Housing and Urban Development, “the equity that you built up over years of making mortgage payments can be paid to you.” The funds are generally available as a lump sum, line of credit or monthly allocation. Funds received are not taxed, but there is interest accrued on the loan itself that is deferred until it’s time to repay. The HUD department noted that unlike with a traditional home equity loan or second mortgage, an HECM does not have to be repaid “until the borrowers no longer use the home as their principal residence or fail to meet the obligations of the mortgage.”
The Seattle Times notes that there are two other types of reverse mortgages: a single-purpose reverse mortgage loan provided by local government and nonprofits that can be used by borrowers to pay property taxes or make home repairs, and a proprietary reverse mortgage loan for owners with high-value homes that “are worth more than the Federal Housing Administration’s $625,500 lending limit for HECMs.” This article refers to the stipulations of a HECM, as single-purpose and proprietary reverse mortgages are far less common.
The basics of a reverse mortgage
There are three initial requirements for an individual to secure a reverse mortgage: a prospective applicant must be at least 62 years of age; the home that is the source of funding must be the applicant’s primary residence; and the home’s original mortgage must be fully paid off or at a low balance that can be paid with funds from the reverse mortgage. The extra cash that comes from a reverse mortgage is made possible by years of faithful mortgage payments.
While a traditional mortgage requires you to make monthly payments to a lender, in a reverse mortgage, the lender makes payments to you until the home is sold or vacated.
This option may be favorable for individuals who are planning to spend the remainder of their lives in the home they own.
Responsibilities to consider
It’s important to understand that the borrower is still responsible for homeowner’s insurance payments, along with proper maintenance of the home and other associated expenses such as homeowner’s association costs. Before an HECM can be obtained, a borrower must meet with a qualified counselor to review all applicable details and obligations associated with a reverse mortgage.
A significant detail to be conscious of is the future of the home itself. While reverse mortgages are described as turning one’s home equity into cash, that money must eventually be repaid. For those who plan to move elsewhere at some point in the future or wish to leave their home to an heir, a reverse mortgage can lead to complications. According to the Consumer Financial Protection Bureau, a HECM “must be paid off when the last surviving borrower or eligible non-borrowing spouse dies or no longer maintains the home as his or her principal residence.”
It is also important to stay up to date on the latest rules and regulation regarding reverse mortgages. The Wall Street Journal reported that as of October 2, new federal rules will “raise upfront costs for some homeowners seeking a reverse mortgage, and reduce maximum loan amounts for most.”
Whether you are considering a reverse mortgage for yourself, or for a relative, it’s imperative to understand the complexities of this type of loan and weigh the potential advantages along with the complications that can come with a reverse mortgage. While a reverse mortgage can be beneficial for some, they’re not always suitable for everyone and it remains essential to have a solid strategy that properly addresses how your assets will be handled later in life.