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Reverse Mortgage Loans
A reverse mortgage is a loan taken by senior citizens on the equity of their home—a loan that they will not pay back as long as the home is their principal residence. Although there are no monthly payments, the interest does build up. However, the lender will not loan all the equity; only a portion of the value of the house will be used to calculate the amount available. Usually the first mortgage is paid off, or only a very small balance remains. Sometimes any remaining balance on the first mortgage is paid off from the proceeds of the reverse mortgage. The reverse mortgage money can be taken in several ways:
- Equal monthly payments
- A line of credit,
- A combination of the two.
While a reverse mortgage and a home equity loan both rely on the borrower having equity in the home, a reverse mortgage is different from a home equity loan in many ways. The major difference is that a reverse mortgage does not have payments as long as the home is the borrower's principal residence. However, there are other differences as well. The reverse mortgage is based on age, current interest rate, equity, and the value of the home, but is not based on income; whereas, a home equity loan is based on the borrower's qualifications for a loan, such as a high enough debt-to-income ratio.
The most popular reverse mortgages are the HUD federally-insured private loans. HUD reverse mortgages, offered through the Federal Housing Administration (FHA), require that the borrower:
- Be a homeowner
- Be 62 years or older
- Own the home, or have a low mortgage that is paid off with proceeds from the reverse mortgage at closing
- Must live in the home as a principle residence
Along with no payments, another advantage of a reverse mortgage is that there are no restrictions on how the loan proceeds must be spent. The terms of the loan specify the length of the loan. For instance, as the homeowner, you may take out a 20-year reverse mortgage loan. Even if you outlive the loan, you still don't have to pay it back as long as it is still your principal residence. And even better, the money is tax free.
So does this all sound too good to be true?
There are some disadvantages. For instance, reverse mortgages are extremely expensive. Also, they are not really free. The equity in your home is disappearing. Not only is the loan going against your equity, so is the interest on the loan and the interest on the interest. So why is that a problem? The very real worry is that the money will run out before all the many future expenses that may come your way. So before taking out a reverse mortgage, you should weigh all the possible risks, determine a financial plan for the future years, and look at other options first. An educated decision is always best.