Reverse Mortgage: How Does It Work?

Many Americans that reach retirement don’t have enough money saved to sustain themselves through that new period. Rising health care, living expenses and limitations on Social Security are some of the reasons.

A reverse mortgage is a potential solution for those who need help to cover expenses. But what is it exactly?

Reverse Mortgages: The Basics

A reverse mortgage allows you to borrow against the equity in your house. This means that you receive monthly payments from your home’s value instead of paying down your loan.

Some of the main requirements are:

  • Being 62 years or older.
  • Only reverse a mortgage on your primary residence.
  • You must attend counseling via the Department of Housing and Urban Development (HUD).

In most cases, you’ll be able to use the money for anything you want. Generally, reverse mortgages are designed for people of retirement age who want to lower or eliminate their monthly mortgage payments in order to better cover their expenses.

How Does A Reverse Mortgage Work?

Getting money from your home loan might sound incredible. But, if you haven’t finished paying your mortgage and you aren’t selling your home, where is the money coming from? A reverse mortgage is still a loan. So all the money you receive from it is coming out of your own pocket. That’s important to remember.

Where The Money Comes From

Your house has monetary value, and if you sell your house, you can collect the funds. However, a large portion of those funds will go toward paying off your existing mortgage. This is in the case you haven’t already paid off your existing mortgage. Basically, a reverse mortgage allows you to do this without putting your home for sale.

Your lender will order an appraisal of your house in order to determine the size of your loan. Then, they will use that loan to pay off your existing mortgage. So the remaining funds are what you receive. In addition, if you own your home free and clear, you can get the full value of the loan.

Accounting For Interest, Taxes, Insurance And Fees

A reverse mortgage is not free money. “Reverse” is referring to your loan balance. While you remain in control of your property and receive payments, a monthly interest is added to the loan balance. Unless you decide to make payments, this will increase your debt throughout the life of the loan.

Even if you don’t make those payments, you won’t be able to defer all payments on your house. You will still need to pay:

  • Property taxes
  • Closing costs
  • Origination fees
  • Homeowners insurance
  • Home maintenance

If you fall behind on property taxes or let your home deteriorate, you could lose your home to foreclosure. That’s why these are very important obligations to know.

Paying Back The Loan

Eventually, you’ll have to pay back the full loan. When you decide to sell your home, the money from that sale will go toward paying back your original mortgage, the payments you received and the interest. So you won’t make as much money on the actual sale as you might have with a traditional mortgage.

Pros And Cons

It’s important to know all the pros and cons to make sure this is the right choice.

Pros Of A Reverse Mortgage

  • Remaining in your home and your name stays on the title.
  • Access to your home’s equity without selling your home or making monthly mortgage payments.
  • Reverse mortgages are immune from declining home values. This is because they’re nonrecourse loans. Nonrecourse loans don’t allow the lender to take more than the collateral (your house) to restore your debts. So, you’ll never owe more than what your home is worth.
  • Your spouse may be able to remain in your home after you pass away, even if they are not the borrower.

Cons Of A Reverse Mortgage

  • Reverse mortgages lower the amount of equity you have in your home.
  • Your loan balance will increase if you don’t pay down your interest throughout time.
  • A reverse mortgage can make it difficult for your heirs to take advantage from the equity in your house after you pass away.

Bottom Line

Reverse mortgages can be a good option for seniors who need more monthly income. However, this might not be the best choice for you if you want to pass your home down to your heirs, or if you plan on vacating the home in the near future. You should take into consideration your current financial situation and where you want to be a few years down the road.

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