According to the National Reverse Mortgage Lenders Association (NRMLA) more than 920,000 senior households have used an FHA-insured reverse mortgage loan and more than 625,000 are currently in use.
If a person is 62 or older, does not plan on moving from their home for many years and they’d like to supplement their retirement income, then it’s possible a reverse mortgage is for them.
Reverse mortgages supplement income by tapping into part of a home’s equity. In general, it’s a loan against a principle residence that a homeowner does not have to repay for as long as they live in that home. The homeowner should have significant equity in their home to apply for a reverse mortgage.
Income From a Reverse Mortgage is Usually Tax Free
Income from a reverse mortgage is usually tax-free and the homeowner is allowed to keep the title to their home. Also, it usually won’t affect their Medicare or Social Security benefits.
If the home is sold, or the homeowner moves or passes away, they, their spouse or their estate must repay the loan. At times the house will have to be sold to repay the outstanding loan balance. There are some circumstances that allow a non-borrowing spouse to remain in the home if the homeowner were to pass away.
It’s imperative the borrower understand that with a reverse mortgage they must continue to pay the property taxes, homeowner’s insurance and maintenance on their home. If they do not pay these items the home may be lost to foreclosure.
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Reverse mortgages are a complex financial product that can be costly with extensive closing costs, mortgage insurance premiums and lender fees.
How does a reverse mortgage work?
Interest on a reverse mortgage accrues over time. With each payment received by the borrower, interest is added to the monthly balance which increases the amount that must be repaid later. Interest rates on a reverse mortgage loan can be either fixed or variable. Fixed rate loans are usually allotted in a lump sum payment on a smaller loan amount.
Variable rates are linked to a financial index and fluctuate with market conditions. Variable rate reverse mortgages usually allow homeowners to take out larger loans and offer various payout options. A special note that interest on reverse mortgages is not tax deductible until the loan is paid.
A reverse mortgage loan can be paid to a borrower in various ways:
- A lump sum loan payment check at the time of the loan origination
- A monthly recurring loan payment –This is a monthly check paid to the borrower that can be either short-term (a specified time period) or long-term (until the borrower moves or passes away)
- An open line of credit
- A combination of an open line of credit and monthly cash payments for as long as the borrower lives or a for specified time period.
In general, as the amount owed on the reverse mortgage increases the equity in the home decreases. And essentially, this is what a person who takes out a reverse mortgage is seeking.
While living in their home, the homeowner essentially spends down the equity in the home by receiving a lump sum of money, monthly cash loan payments, or an open line of credit which they can access at will.
Generally Reverse Mortgages Come in Three Forms:
Home Equity Conversion Mortgages or HECMs, which account for about 95 percent of all reverse mortgages, are federally backed/insured by the U.S. Department of Housing and Urban Development (HUD). These loans usually give borrowers the most amount of money based on the amount of home equity and their age. These loans allow borrowers to use the money as they see fit.
Special note: As of March 2, 2015, new rules put forth by HUD require prospective borrowers to meet with an approved HECM Housing Counselor (usually for a small fee) and be subject to a financial assessment. The financial assessment will see if they have the capacity to pay property taxes, insurance premiums, and fees according to their income and credit history.
If the financial assessment results show the capacity to pay is not there, the borrower must set aside a portion of the mortgage loan to pay for taxes, insurance and fees. This is an effort to reduce the number of reverse mortgages that go into default.
To find a HECM Housing Counselor in your area please click here or call
Proprietary Reverse Mortgages are offered by private companies and are not insured by the U.S. government as seen with the HECMs. Mortgage loan payouts may be larger with this type of loan and they can also be more expensive.
Single-purpose reverse mortgages are for those whose income qualifies. These types of loans are not readily available, but they are inexpensive and offered by some not-for-profit organizations and state and local government entities. The money for these loans can only be used for the purposed specified by the lender.
In all, if you think a reverse mortgage loan may be right for you or your loved one, please do your extensive due diligence and consult with a financial planner first.
Until next time,
Ms. Dakar is the author of The Busy Person’s Guide to Personal Finance, a primer to help consumers manage their finances so they can build a substantial nest-egg. She also conducts personal finance seminars where she provides concepts to attain overall financial health.