What Is a Reverse Mortgage?

For most individuals, mortgages offer a pathway to buying a home. Regardless of whether or not it is your very first time as a homeowner or you seek to upgrade to greener pastures every few years, a mortgage can help you to find the financing required. A reverse mortgage essentially turns this equation upside down, as a financial institution will loan you money against the equity you have built up in your home. So, what is a reverse mortgage?

Like any financial product, there are both advantages and drawbacks that accompany reverse mortgages. There are also a number of stipulations that do not make this arrangement right for everyone.

How Do Reverse Mortgages Work?

In order to understand how reverse mortgages work, it is helpful to remember how a traditional mortgage functions. In a standard mortgage, a borrower will receive financing from the bank that they will use to purchase a home. Over the course of years and decades, the borrower will repay the mortgage (both principal and interest), gradually accumulating more and more equity (i.e. ownership) in the property until the entire obligation is paid off.

Reverse mortgages work in the opposing direction. In essence, a bank or financial institution will provide you with a loan based on the amount of equity in your home that you have accumulated. Instead of making monthly payments to the financial institution, you will be on the receiving end of these monies.

This is perhaps the biggest distinction between a reverse mortgage and other types of loans. While most loan obligations decrease in value over time (i.e. with every mortgage payment you make, the overall debt you owe will go down), reverse mortgages will actually increase the debt that you owe as the years pass. This includes both the borrowed funds and the interest charged.

It is important to remember that the monies that you borrow will need to be repaid at some point, either by your or by your family. What makes a reverse mortgage unlike other types of debt is that it is secured by your home. While it is not a requirement, it is generally understood that the proceeds from the selling of the house will be used to repay the debt obligation incurred through the reverse mortgage.

What Are the Requirements of a Reverse Mortgage?

Reverse mortgages are a particular type of financing, and therefore not everyone can qualify for them. Here are the stipulations that you need to meet in order to be eligible for a reverse mortgage.

(1) Age requirements: To qualify for a reverse mortgage, at least one of the recipients must be over the age of 62. For this reason, many individuals pursuing this type of financing are in their retirement years.

(2) Primary residence: The home used to secure a reverse mortgage must be the primary residence of the borrower. If the reverse mortgage holder moves, sells the home, or passes away, this is a trigger for the debt to be repaid.

(3) Equity stake: You must have built up a decent amount of equity in your home. While this varies by lender, a good rule of thumb is that you should own at least 50% of your house if you wish to obtain a reverse mortgage.

(4) HUD approval: If you are looking to obtain a Federally-insured Home Equity Conversion Mortgage (also known as an HECM), you will need to meet with a U.S. Housing and Urban Development-approved mortgage counselor. This is to ensure that you are capable of paying for the upkeep, property taxes, maintenance costs, and homeowner association fees (see below), as well as to confirm that you are not getting swindled by unscrupulous lenders.

(5) Upkeep and maintenance: As you will continue living in your house, you will remain responsible for paying for upkeep, maintenance, and property taxes (and homeowners fees, if applicable). Being delinquent on any of these expenses is a breach of the reverse mortgage contract, which can allow lenders to foreclose upon your house.

What Are the Advantages of a Reverse Mortgage?

There are a number of advantages of a reverse mortgage.

First and foremost are the cash payments that the recipient will receive. Since the intended customers are by definition in their sixties or older, this can help retirees supplement their income during their later years when they may no longer be working.

In addition, the money is a loan, and is therefore not considered taxable income. For some individuals, this added sum of money can allow them to remain in their current home while remaining current with their monthly payments (including any outstanding mortgage payments if the house is not completely paid off).

HECM reverse mortgages are non-recourse loans, meaning that the loan can never rise above the value of the home. Unlike a traditional mortgage, you can never be underwater with an HECM reverse mortgage. In practice, this means that the loan recipient or the family will not need to come up with additional funds if the proceeds from selling the house are insufficient to repay the obligation in its entirety.

What Are the Disadvantages of a Reverse Mortgage?

As with any financial transaction, there are a number of costs incumbent with a reverse mortgage. Some are obvious, while others are less apparent.

The biggest drawback from a reverse mortgage is that you will be borrowing against your house. If you are planning on leaving an inheritance to any beneficiaries, you are in essence decreasing the amount of funds that they will eventually receive.

For this reason, a reverse mortgage may not be worth your while. If you are tight on cash in your later years, selling your house and moving to a smaller residence or cheaper location might be a better choice for you. This will allow you to gain extra cash without borrowing against your home.

Also, as with any financial arrangement, there are fees and costs involved with a reverse mortgage. These comprise of origination fees paid to the lender, along with other closing costs paid to third parties such as appraisal fees and inspections. Interest obligations will also accrue as the loan grows.

When doing your cost-benefit analysis, do not forget that you will remain on the hook for real estate taxes, property upkeep, and any maintenance expenses. Very frighteningly, failure to make these payments could allow the lending institution to demand the payment of the loan in its entirety. If you cannot come up with the capital required, your home could be foreclosed upon. For that reason, it is absolutely vital that you fully understand whether or not you will be able to meet these obligations. If you have any doubts, a reverse mortgage is not for you.

Conclusion: Should You Consider a Reverse Mortgage?

Understanding whether specific financial arrangements are right for you is both art and science. There is no substitute for running the numbers, and looking at the cold hard facts of your finances.

Whether or not you should consider a reverse mortgage revolves around looking at your current finances, as well as your intentions regarding your beneficiaries.

While reverse mortgages can provide cash to those in need of additional funds in their later years, there is a big cost to this financial arrangement. By borrowing against the equity in your house, there will be less inheritance for you to leave behind. Additionally, taking a reverse mortgage puts you at increased risk of losing your home to foreclosure – and that’s a risk many are not willing to take.

For this reason, it is absolutely vital that you fully appreciate the pros–and very meaningful cons–of a reverse mortgage before signing on the dotted line.

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