(LifeWire) - Aging homeowners who want to convert the equity they have amassed in their homes into a steady income - without having to sell their house or move - may find the answer they are looking for in a reverse mortgage.
That is, as long as they don't mind the expenses or the potential consequences to their heirs.
Available, in general, only to homeowners age 62 or over, reverse mortgages reverse the normal flow of payments on a home-equity mortgage. Instead of the homeowners making regular payments to the bank in exchange for a lump sum of cash, the bank makes payments (or extends a ready line of credit) to the homeowner in exchange for the bank's eventual claim on the home.
In other words, homeowners with a reverse mortgage never need to make another home mortgage payment until they die, sell their house or permanently move out of it. The bank pays them instead.
For homeowners, significant protections are built into the loans. Among them:
- Security: The lender can never force the sale of a home. The decision of when to sell or leave the home is entirely up to the homeowner.
- No debt risk: Homeowners and their heirs can never be forced to pay more on a reverse mortgage than the home is worth. If the eventual sale of the home doesn't cover the loan amount, the lender eats the shortfall. On the other hand, if the sale of the house yields more than the balance of the loan, the homeowners or their heirs can keep the difference.
How It Works
The amount of money that can be made available to a borrower is calculated according to the youngest borrower's age, the appraised value of the home and the prevailing interest rate. In some cases, Federal Housing Administration lending limits may put a cap on the loan amount.
Borrowers who have an existing mortgage on their house can still get a reverse mortgage, but the old mortgage will have to be paid off before the borrowers get anything out of the deal. For example, if a house qualifies for a $200,000 reverse mortgage but the homeowners still owe $150,000 on their original home loan, the old mortgage will be paid off with reverse mortgage funds, leaving only $50,000 for the borrowers.
Money from a reverse mortgage can be paid in a variety of ways. Most borrowers take their payments in the form of a repayment-free line of credit, which lets them draw money from their approved loan amount whenever they need it.
Funds can also be disbursed by a method called "tenure," which provides equal monthly payments as long as at least one borrower continues to occupy the house; by "term," which provides equal monthly payments for a fixed period of time; by "modified tenure," which provides a combination of a line of credit with monthly payments as long as a borrower is in the home; or "modified term," which provides a combination of a line of credit with fixed monthly payments over a set period of time.
Beware of Fees
Upfront fees on a reverse mortgage can be quite high. Typically, loans covered by the FHA - which include the majority of reverse mortgages written in the United States - levy an upfront charge called the service fee set-aside, which is calculated at a rate of $30 or $35 a month projected over the youngest borrower's expected life span. This can easily result in a charge of several thousand dollars, which is immediately tacked onto the loan amount.
Because of that charge and other upfront fees, it is generally recommended that borrowers look for other options unless they plan to remain in their homes for at least two to three years. Also, because reverse-mortgage money does have to be repaid, borrowers who want to leave their homes to their heirs may want to consider other options.
It is important to remember also that reverse mortgages don't erase all of the costs of home ownership. Borrowers will still have to pay their property taxes and take care of all the other costs of property upkeep.
And while reverse-mortgage payments will not affect a borrower's Social Security or Medicare payments, those who receive Medicaid will have to spend any reverse-mortgage funds they receive immediately in order to avoid having them counted as assets.
Because of the complexity of reverse mortgages, borrowers are required to receive counseling before they can sign these loan documents. You can obtain local lists of counselors approved by the US Department of Housing and Urban Development by calling 1-800-569-4287.
