Whenever you hit an age threshold, perspectives change. All of a sudden, you are not 20 anymore, walking around with a world map in your side pocket and funding your traveling binge with the money you’re cashing in on renting your home. All of a sudden, you’re 62 years old and part of a target category for those commercials everywhere with the big, bold texts reading ‘How does a reverse mortgage work so that you can convert your home equity into cash?’
You might be or might not be a cash-strapped senior. Either way, the TV ads sound too charming not to put on your glasses for a better look into the whole scheme. After all, it does seem like a no-brainer. Why not benefit from a life’s struggle to gain financial independence and top your equity to generous levels?
The main appeal of a reverse mortgage is that you get to stay in the home you love while receiving money from the lender to pay for all of old age’s necessities. If you’re barely scraping by, these additional funds can pay for medical expenses or debt payments. However, as always, temptations come in pair with pitfalls. In this case, the pitfalls come in the form of high fees and interest.
Below we’ll run you through the basics of reverse mortgage loans, including the types, upfront costs, and inner workings, plus the pros and cons of signing off your assets not to your family or grandchildren, but to the lender.
How Does a Reverse Mortgage Work? – The Curious Case of Living Off Your Home
A Peek Behind the Curtains of an ‘Ideal’ Financial Concept
Once upon President Ronald Reagan time, the first FHA-insured reverse mortgage was signed into law. The Congress gave the financial product a nice spin with the motto ‘POLISHING NOT TARNISHING THE GOLDEN YEARS.’ The first client to jump on the ‘Home Equity Conversion Mortgage’, or HECM bandwagon was Marjorie Mason from Kansas.
At the time, reverse mortgages still carried the stigma of being a last-resort source of income. But how does a reverse mortgage work nowadays? Its popularity has expanded due to heavy celebrity advertising and the instant appeal it has for the ‘home-rich, cash-poor’ elderly population.
After all, how does a reverse mortgage work if not for your benefit, you may wonder. Nevertheless, take the whole concept with the conventional grain of salt. In the end, this financial product might well amount to more debt and one of the most expensive loans in your life.
What Does a Reverse Mortgage Entail?
The reverse mortgage resembles its traditional counterpart, the classic mortgage. Unlike it, though, the reverse type is a loan you can pay not through your income or monthly mortgage payments, but using your home as collateral or security. The lender then pays you cash in a single sum, on a monthly basis or a line of credit (it’s up to you to decide).
This allows you to borrow money against the equity you’ve built in your home over time which, according to your life expectancy, will be calculated differently. Usually, the older you are, the more equity you have for show and the more money you can expect. The amount you receive will be based on a percentage of the value of your home.
The reasoning behind these seemingly lean requirements is connected to the catch of a reverse mortgage. When you move, sell the house, fail to pay your bills, taxes and insurance or pass away, the mortgage becomes due.
Basically, how does a reverse mortgage work if not as a more complex garage sale? The loan slowly drains all the equity in your house until your payment might not sufficiently cover your expenses. In such a dire case, you’re left either homeless or asset-poor. Moreover, if you die, the debt will have to be repaid by whoever you left behind – spouse, heirs, or your estate.
The HECM versus the Non-HECM Reverse Mortgages
In case you’ve already decided for a reverse mortgage, there are three different types you can choose from. The Home Equity Conversion Mortgage, or HECM, the first to be handed to an American citizen in 1988, is the most common. Non-HECM loans include proprietary and single-purpose reverse mortgages.
- HECM mortgages are issued by private banks and insured by the Federal Housing Administration. Hence, they are also the most popular among the elderly. Carrying U.S. federal credentials, these loans may have no income limitations and the payments are tax-free. However, the HECM mortgages are capped at $625,500. Also, spending is not entirely unrestricted. With an HECM, you might not be able to access more than 60% of your loan in the first year.
- Single-purpose reverse mortgages will not pose any spending limitation concerning time, but you do need to specify the purpose for your loan from the beginning.
- Proprietary reverse mortgagesoffer loans that are higher than the HECM amount. Whilst they might benefit those who own high-value homes backed by more equity than the federal government reverse mortgage could cover, these private loans do not come with a federal insurance. Also, they are considerably heftier than the regular HECM loan. Since the private lenders are the ones to determine the eligibility requirements, we will further focus on the Home Equity Conversion Mortgages.
Who Can Benefit from a Reverse Mortgage?
How does a reverse mortgage work for your benefit? Taking a reverse mortgage makes sense for people who:
- Will not move address in the foreseeable future.
- Have the financial ability to keep up with the monthly bills, taxes, and house insurance fees.
- Can afford, through their equity or residual income saved in the piggy bank for rainy days, to deal with an unexpected turn of events, such as disease or medical home care.
Who Can Qualify for the HECM Reverse Mortgage?
In 2015, the FHA introduced a financial assessment applicants must undergo in order to qualify for a reverse mortgage. Other requirements state that the person applying must:
- Be at least 62 years old.
- Own the house or at least have a low mortgage balance.
- Have the house registered as a primary
- Not carry any federal debt.
- Have the financial ability and willingness to pay for all his/ hers expenses.
- Agree on participating in an approved counseling course offered by an HECM counselor.
- Live in a single family home, an HUD-approved condominium project or townhouse, or a manufactured home that meets federal requirements.
The HECM counselor will, no doubt, explain the upsides and drawbacks of choosing a reverse mortgage. However, for a preview, here are a few pros and cons to the HECM loan. Just so you won’t be caught unaware.
Pros of the reverse mortgage:
- Money in your pocket.
- Lenient eligibility.
- No monthly payments from you.
- Tax-free payments.
- You don’t have to explain how you’re using your proceeds.
Cons of the reverse mortgage:
- High fees and interest rates.
- Upfront costs that can easily tack on thousands of dollars.
- Loss of freedom of movement and financial independence. Remember, you’re old and your healthy might take a turn for the worst. If you need to move into an assisted living facility, you’ll have to repay the loan.
- You must maintain the house and pay all the property taxes and insurance.
- Your house might turn into a burden for your heirs if, upon your demise, they will have to pay the reverse mortgage. Also, because of rapidly growing interest, they will be stretched for their dollars in the long run.
A Mortgage of the Last Resort – But How Can You Resist Thomas Magnum?
In the end, how does a reverse mortgage work if not like your usual type of loan, only with higher fees and interest rates? Here’s why most financial experts will advise on a reverse mortgage only as a last resort option. Unless you proceed with caution, the heavy duty requirements of this financial alternative might very well send you to an early grave.