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What is a Reverse Mortgage? - Uses, Pros & Cons

Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

Older homeowners sometimes take advantage of a special loan called a reverse mortgage. In this lesson, learn how these homeowners can tap into the equity in their home through a reverse mortgage, along with the pros and cons of such a loan.

Definition

Homeowners who are older can benefit from a special type of loan called the Home Equity Conversion Mortgage (HECM), or, as it is commonly called, the reverse mortgage. With a reverse mortgage, older homeowners can receive money by converting some of their home's equity, the difference between the value of a home and how much is still currently owed on it, into cash without the need to sell their home. You can think of a reverse mortgage as the opposite of a mortgage. When you have a mortgage, you pay the lender every month in exchange for a bit more equity each time. When you are done paying your mortgage, you will have 100 percent ownership of your house. With a reverse mortgage, the lender pays you.

The reverse mortgage, plain and simple, is a loan using the house as backup. Just as a bank would determine the amount of money they are willing to lend you based upon your income, the lender in a reverse mortgage loan determines the amount available to loan based upon the equity of the home. However, unlike a regular loan, reverse mortgages do not have to be paid off unless you die, sell your home, or move. If any of these happens, then the house may have to be sold by you or your surviving spouse to pay back the loan. It is very important to note that, although this is a loan, the borrower is always the owner of the house. The lender never takes title or ownership, even upon the borrower's death.

Features

For Whom

The main requirement for qualifying for a reverse mortgage is that everyone listed on the title or deed must be over 62 years old. In addition, a reverse mortgage can only be obtained on your primary residence. It is also very important to note that if the borrower currently still has a mortgage on the house, that mortgage must be paid off with the proceeds from the reverse mortgage.

The older you are, the more money you may be able to get from a reverse mortgage. However, even if you do qualify for a reverse mortgage, it may not be ideal for you. You have to be willing to sell your house if needed to repay the loan. So if you are planning on leaving the house to your children, a reverse mortgage may not be ideal for you.

Payment Options

Although there are a variety of payment options with the reverse mortgage, the most popular is the line of credit. With a line of credit, the total amount of the reverse mortgage loan is made available for the borrower to access at their discretion. Some borrowers may also choose to receive monthly payments of a certain amount for either a specific period of time or for as long as they live in the home.

Pros and Cons

You have to consider the pros and cons before deciding whether to go with a reverse mortgage or not.

Pros

Here are some pros of reverse mortgages.

  • Eliminates your current mortgage payment as you must use the reverse mortgage loan proceeds to pay off current mortgage
  • No monthly payments
  • Can use funds to increase your monthly income
  • Can use payments to pay off other debts

As you can see, a reverse mortgage is ideal if you are retired and on a fixed income. The reverse mortgage can increase your monthly income to give you more financial flexibility when it comes to your spending. There are no stipulations (other than paying off existing mortgage) to what the loan monies can be used for.

Cons

But, like everything, it's not just pros that we need to consider, but also the cons. Here is a list of cons for reverse mortgages.

  • Fees, such as closing costs and mortgage insurance, can be high
  • Still need to pay property taxes and homeowner's insurance
  • Need to maintain the house
  • May not be able to give the house to family
  • Must live in the home as your primary residence
  • Have to repay the loan if you move, sell the house, or die

Most importantly, if you do not pay your homeowner's insurance or you go into arrears on your property taxes, the lender can consider you in default.

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