What is Reverse Mortgage? - Types and Advantages

You might have wondered many times what do older people do incase they need money for emergency use or require huge amounts of money to run some practical ideas. As they do not have a fixed source of income, carrying out big changes becomes very difficult.

 

People at such an age might live in a big house but do not have big money to carry out life-changing processes. Here, Reverse mortgage is a powerful tool that allows people at such age to mint money against their house’s value and have funds to deal with any emergency situation.

 

Before delving into the blog deeply, understand the concept of mortgage with its types and components.

 

Introduction

 

In a layman's language, a reverse mortgage is a loan for a person who is 60 or older and has considerable home equity. So, he can borrow money against the value of the house and receive money as a lump sum, fixed monthly payment or line of credit. 

 

Unlike the working of a forward mortgage which is used to buy a home, in a reverse mortgage the homeowner doesn’t need to make any loan payments.

 

In a Reverse mortgage, the borrower needs to pay the entire loan balance when he dies, moves away permanently or decides to sell the home against which he has been sanctioned the loan. 

 

Federal rules demand that lenders need to structure the transaction so the loan amount doesn’t trespass the home’s value otherwise the borrower or borrower’s estate won’t be accountable for paying the difference if the loan balance does pass the threshold. 

 

This situation could arise if the home’s market value takes a serious hit or if the borrower lives a long time.

 

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Working of a Reverse Mortgage

 

In a reverse mortgage, instead of the homeowner making routine payments to the lender, it is the lender who makes payments to the homeowner. The homeowner gets to choose the payment mode and also the option of only paying interest on the proceeds received. 

 

The interest is gelled into the loan balance so the homeowner doesn’t need to pay anything up front. In addition, the house still remains under the name of the homeowner. Over the loan’s mortality, the homeowner’s debt increases over time and home equity tends to decrease.

 

The home is supposed to be the collateral for a forward mortgage as well as reverse mortgage. When the homeowner decides to move or dies, the profits from the home’s sale go to the lender who eventually has to pay off the reverse mortgage’s principal, interest, mortgage insurance, and fees. 

 

Any sale revenue beyond the borrowed amount goes to the homeowner (if still alive) or to the homeowner’s assets (if the homeowner has died). In some situations, the heirs may choose to pay off the mortgage in order to keep the home.

 

Taxes do not apply on reverse mortgage proceeds. While they might feel like income to the homeowner, the Income Tax considers the money to be a loan advance.

 

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Types of Reverse Mortgages

 

There are three kinds of reverse mortgages:

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Types of Reverse mortgage

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• Single-purpose reverse mortgages:

 

These are the least expensive options among all of them. They’re offered by some state and local government bodies, as well as non-profit agencies, but their availability is limited to some areas and are not available everywhere.

These loans can be used specifically for only one purpose, which is specifically stated by the lender beforehand. 

 

 

• Proprietary reverse mortgages:

 

These are private loans that are carried forward by their parent companies. If you own a higher-valued home, you may be applicable to get a bigger loan advance with the help of a proprietary reverse mortgage. So if your home has a higher appraised value and you own a small mortgage on it, you might qualify for more profitable funds.

 

 

• HECM(Home equity conversion mortgage) or simply conversion mortgage:

 

The HECM represents almost all of the reverse mortgage lenders have to offer on home values below $765,600 and is the preferred type you’re most likely to get.

 

Generally no specific income is required for a HECM. However, lenders must conduct a financial assessment when approving your loan. They’re evaluating your willingness and commitment to your obligations and the mortgage requirements. 

 

 

What are different ways of receiving payments?

 

When you choose to take out a reverse mortgage, you can avail the proceeds in one of six ways:

 

1. Lump sum: This method allows you to receive all the money from the reverse mortgage at once when your loan comes to an end. Also, this is the only viable option that comes with a fixed rate of interest, unlike the others who have a variable rate of interest.

2. Equal monthly payments (annuity): The borrower will continue to receive steady payments from the lender, for as long as at least one borrower lives in the home as a primary residence.

3. Term payments: The borrower continues to receive money from the lender in the form of equal monthly payments for a set period of time as decided by the borrower. 

4. Line of credit: In this method, there is an option for the homeowner to borrow money as per his needs. The homeowner is only required to pay interest on the amounts actually borrowed by him from the credit line.

5. Equal monthly payments plus a line of credit: This option is a combination of equal monthly payments and line of credit as the lender provides steady monthly payments for as long as at least one borrower lives in the home as a principal residence. If the borrower needs some extra money at any point, they can easily access the line of credit.

6. Term payments plus a line of credit: The lender gives the borrower money in the form of equal monthly installments for a set period of time that the borrower prefers, such as 10 years. If the borrower requires extra money during or after that term, they can easily access the line of credit.

 

It’s also quite possible to use a reverse mortgage called a “HECM for purchase” to buy a different house other than the one you currently live in.

 

In any case, you will typically need at least 50% equity which is calculated based on your home’s current value and not what you paid for it—to qualify for a reverse mortgage.

 

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Advantages of a Reverse Mortgage

 

Key advantages and benefits of Reverse Mortgages include:

 

• Flexible commodity: The Reverse Mortgage can be classified as a very flexible commodity that can be utilized in various ways by the different types of borrowers according to their needs.

Households suffering from financial shortage can tailor the product to their liking and de-stress their finances. Households with adequate resources might consider this as financial planning for the future.

• Low Risk: Under a Reverse Mortgage your house can not be seized for non-payment of dues as there are no payments required to be carried out on the loan until you decide to permanently leave the house. Also, Reverse Mortgage Lenders have no claim or stake on your income or other financial assets.

However, you must continue to pay for maintenance, taxes and insurance to secure your home. 

• Assurity: With a Reverse Mortgage comes the assurity that you will never owe more than your home’s value at the time the loan is repaid, even if the money from the lenders has exceeded the value of the home. This is a useful advantage if you secure a Reverse Mortgage and then your home value starts to decline.

• Financial freedom: A Reverse Mortgage enables you to live in your home for as long as you wish with absolutely no monthly mortgage rents and you can also get access to financial aid incase of an emergency.

• Tax Free: As a Reverse Mortgage is a loan, the money derived from it is considered to be tax-free, whether you receive it as fixed payment or in a lump sum.

• Flexible Payment Options: You can receive the Reverse Mortgage loan funds as per your preference in the form of a lump sum, annuity, credit line or some combination of the above if it suits, all depending on the type of loan you choose.

With the various options in the credit line, you can ensure easy access to cash whenever you need it.

• Federally Insured: The Home Equity Conversion Mortgage (HECM) is the most widely used and available type of Reverse Mortgage. It is federally insured by local government bodies. This becomes important because even if your Reverse Mortgage lender offends laws, you’ll still continue to receive your payments timely.

• Minimal Restrictions: How you use the financial funds received  from a Reverse Mortgage is up to one’s requirement and needs. It is not affected by any restrictions whatsoever. 

• Home Ownership: With a Reverse Mortgage, you retain your home ownership and you can live freely in your home without any restrictions or disturbance. With the only requirements being to timely keep up insurance, property taxes and maintenance for your home.

• House guarantee: You can live in your home hassle-free for as long as you want when you opt for a secure Reverse Mortgage.

• Improving wealth: There are a variety of ways in which a Reverse Mortgage can assist you in preserving your wealth. Some financial planners recommend Reverse Mortgages to:

1. Preserve and increase the value of your home equity: The Reverse Mortgage grows annually if you take the loan amount in the form of line of credit. This makes sure the value of your home and your reverse mortgage line of credit stay untouched over time which eventually might become larger than the house's future value if the market starts to take a hit.

2. Maximize wealth: Personal finance can be complicated but the prime motive stays intact i.e. to maximize returns and minimize losses. A Reverse Mortgage can be one of the tools you use to maximize your overall wealth.

 

 

Conclusion 

 

The information above provides a full description about the working of Reverse mortgages and its advantages. Reverse mortgage has become a reason for many people’s happiness as they have fulfilled their dreams with the money and are even leading successful lifestyles due to this special loan.

 

With the many advantages, it also comes with serious drawbacks which makes it dangerous too. So it is advisable to first understand your situation and then take up Reverse mortgage. After all, a loan is supposed to be paid back but if used judiciously it can reap fruitful results.