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A Helpful Guide To Reverse Mortgages and How They Work

What is a Reverse Mortgage?

In less complicated terms, a reverse mortgage is a loan offered to homeowners over 62 years of age.  It is given so that they can pay off their medical and living expenses or just use it as a supplement to their pension. The loan is paid back through the equity of the home when the homeowner ceases to live in residence or passes away.

How Is a Reverse Mortgage different From Traditional Mortgage?

When you get a traditional mortgage, it means you’re borrowing money to pay for your house at the time you want to purchase it. You repay the loan over time, and eventually, your equity gets higher. On the other hand, a reverse mortgage is when you borrow money from a lender and use your home’s equity as a guarantee that it’ll be repaid.

Aside from this, another major difference is that a reverse mortgage is paid off when the homeowner no longer lives in the home. Even though you may not have to make monthly payments to the lender, you still have to continue to pay property taxes and buy homeowners insurance. Not to mention, you also have to keep your house in adequate condition. This is so that the value of your home isn’t reduced.

Getting a Reverse Mortgage While Having a Traditional Mortgage

In theory, getting a reverse mortgage seems like a breeze, but the reality is that many people still owe money on their home, i.e., they still have a traditional mortgage to pay off. If you face a similar situation, you can get a reverse mortgage, but the loan will be bigger. This means you use the money from the reverse mortgage to pay off your existing mortgage. This can work out well if you don’t owe much on your current house. However, in the case that you owe more, there won’t be much money left from the reverse mortgage for you to pay for other expenses.

Selling Your Home

Many retirees eventually decide to sell their home because they may want to move to a smaller home. In this case, selling your home will mean that your reverse mortgage is paid off, but it’s highly likely that you’ll get little of the equity if any. External factors such rising house prices can mean good news. This is because you will gain more equity but overall, it’s difficult to predict the exact amount.

If the Loan Balance is Lower than Your Home’s Value

The rules that apply when selling your home are similar to a traditional mortgage when the balance on your reverse mortgage is lower than the sale price of your home. You sell your home, repay the reverse mortgage and then keep the difference.

If The Loan Balance is More Than Your Home’s Value

Having to repay a loan that’s more than your home’s value sounds stressful, but it’s less likely to occur. However, if it does, you won’t have to pay the difference. All you have to do is sell your house according to the fair market prices. Then, the reverse mortgage you have to pay off will be no more than your home’s worth. The remaining loan balance is paid off by a mortgage insurance company.

If The Homeowner Passes Away

In the event of the borrower’s passing, the loan has to be repaid to the lender. Usually, the homeowner’s heirs sell the home to pay back the loan.

If the Reverse Mortgage Loan Balance is Less Than Home Value

The Heirs will use the proceeds from selling the house to repay the reverse mortgage loan. They keep any difference that remains.

If the Reverse Mortgage Loan Balance is More Than Home Value

Living heirs that have to pay back the reverse mortgage need not pay more than 95% of the appraised value of the home. The remaining loan balance will be paid for by a mortgage insurance company. In case that your heirs want to keep the house, they will have to pay back the entire loan. Either that or pay 98% of the appraised for of the home. Although both are viable options, the heirs only have to pay whichever option costs less.

How Much Can Be Borrowed?

The “Principal Limit”

The limit of money you can borrow is called a “principal limit.” Lenders will determine this by taking various factors into account. These include your age at the time of applying for a reverse mortgage and the interest rate on your loan. It also includes the value of your house on the market. Older borrowers that have high-priced homes and low-interest rates will be offered a higher principal limit. On the other hand, the opposite applies to younger borrowers who own a lower-priced home. They have higher interest rates and will be offered a lower principal limit.

In some cases, a homeowner is married or co-borrowing a reverse mortgage with another person. In these situations, the principal limit is determined based on the age of the younger co-borrower.

The Credit Line Growth Feature

An enabled credit line growth feature allows you to save more money for the future. It does so by using less money presently. The amount of money that you don’t spend in your credit line will continue to grow which. This gives you leverage to borrow up to a maximum amount that is stated in your mortgage contract. The growth of the credit line is determined based on your mortgage insurance premium and interest rate. The credit line growth feature is convenient but doesn’t apply to a fixed rate payment option.

The Costs of a Reverse Mortgage

A reverse mortgagethey can be pretty expensive. Hence, it’s best to be prepared because they resemble traditional mortgages. The similarity is that you have to pay more than the money you borrow. This includes additional charges such as interest and fees. However, these are still distinctly different from the traditional mortgage. The reason is that the amount you owe to the lender grows over time.

Pay Upfront

Reverse mortgages also have some upfront costs at the time of taking a loan. You can choose to pay these costs out of your pocket, but it’s not advisable. Most people pay for those costs using the borrowed money. This flexibility means that you don’t have to bring any money when you see your lender at the time of closing.

You can use money from the loan to pay the upfront costs. However, remember that this would mean you get lesser money to spend on other things. Upfront costs are inclusive of any fees that you will pay to the lender. They also consist of payments to third-party professionals for real estate closing. Moreover, it will also include the initial mortgage insurance premium which has to be paid to the FHA.

Ongoing Charges

You will have to pay ongoing charges for different purposes. These include interest, payments for mortgage insurance and servicing costs. All these payments are charged every month except for interest and your mortgage insurance premiums. These are calculated as a certain percentage of your remaining loan balance.

The ongoing charges will be added to your reverse mortgage loan balance every month. On top of that, these costs compound, so that means you’ll be charged interest. Extra charges such as fee will be charged for the previous month’s interest.

Receiving Your Money

There are three ways to go about receiving your money when you opt for a reverse mortgage. These are either at an adjustable interest rate or fixed interest rate.

1.       Line of Credit System with Adjustable Interest Rate

In this system, there are limits on withdrawals within the first year. The remainder will be given in the second year. This option costs lower since you only pay interest and other charges on the money that you need. Additionally, it also offers the credit line growth feature.

2.      Monthly Payout System With Adjustable Interest Rate

This system is similar to the line of credit except you can receive a payout every month. The payout serves as a supplement to your monthly income. You also have to choose between a term payout system or tenure. You get a fixed payout every month, but there is a difference. Either you get them for a set number of years or as long as they don’t exceed the maximum amount stated on your mortgage loan contract.

Lump Sum With Fixed Interest Rate

This option allows you to withdraw all the money at once. The drawback is that the amount offered is lower than the other systems. Getting a lump sum will also proyouve expensive. This is because you have to pay interest and lender fees on the entire amount. Also, it doesn’t have a credit line growth feature. Moreover, it’s a riskier option for younger borrowers.  This is because it reduces their chances of having adequate funds in the future. They’re more likely to need money in the future for medical expenses.