Reverse Mortgages: What They Are & How They Work

You may have noticed a substantial increase in the number of advertisements in print and on television soliciting retirement-aged homeowners to inquire about reverse mortgages. But exactly what are they?

Until the concept of the reverse mortgage was born, there were two main ways to get spendable cash from your home: either (1.) you could sell your home, or (2.) you could borrow against your home. The obvious problem with selling your home is that you would have to move, which can be an expensive, frustrating, and unwanted consequence, especially if you enjoy your current home and neighborhood. Of course, the problem with a traditional loan is that you would have to make regular, monthly payments to repay the loan. In addition, to be approved for the loan, you would need to pass a credit check and have adequate income to pay back the loan. The lack of income is the very reason to apply for a reverse mortgage, so this is clearly an obstacle to using the traditional mortgage route. Reverse mortgages solve these issues, so the homeowner can remain in the home while not having the financial burden of another monthly payment.

Simply put, a reverse mortgage is a loan product that allows home owners, who are 62 years old and older, an opportunity to convert the built-up equity in their primary residence into income that they can use for everyday expenses in their retirement years. Proceeds can be used for anything that the homeowner needs or desires, including for example: medical expenses, home repairs, property taxes, daily expenses, or entertainment and travel. They can receive money through a reverse mortgage program, so they do not have to sell their home, give up title to their property, or even make monthly payments. As opposed to a normal mortgage, there are no income or credit qualifications; rather, a reverse mortgage is based on three main factors, including: the age of the homeowner(s), value of the home, and the current interest rates.

There are a variety of ways a homeowner can receive these monies, such as:

*Equal monthly payments for as long as at least one borrower lives in the home;

*Equal but typically larger monthly payments for a fixed number of months selected;

*As a line of credit, which is available for use whenever needed;

*A lump sum cash payment; or,

*A combination of a monthly income and line of credit option, as shown above.

There are many reasons for a reverse mortgage, but chief among them is that elderly homeowners do not want to burden their children with the costs of their ongoing medical care, home repairs, or other living expenses, so a reverse mortgage works well in this situation, as the illiquid equity in their home can be converted into cash.

Although the concept has been around since at least 1961 when the first reverse mortgage was funded, not many homeowners have taken advantage of the opportunity until recently. In fact, only about 55,000 of these unique loans were made by 1999 (since the early-60's), yet this figure had rapidly increased to surpass 150,000 by 2005.

This increase can be attributed to increased consumer protections and education, yet still many older Americans do not fully understand exactly what a reverse mortgage is -- and is not - so, they may be reluctant to inquire. Complicating the matter, they may have only heard "half truths" about these loans or things that are completely untrue.

One common misconception is that the borrower will have to sign the title to their home over to the bank, so the financial institution will own their home. This is not true because a reverse mortgage is considered a loan, despite the fact that repayment does not have to occur until you or your estate sells the home, all of the homeowners die, or all homeowners reside outside the home for more than one year (such as in a nursing home facility). Lenders can also require repayment at any time if you fail to pay your property taxes, maintain and repair your home, fail to keep your home insured, or declare bankruptcy, but these are all fairly standard conditions of default on any mortgage, whether it is a reverse or traditional mortgage loan.
Another misunderstood aspect is that when the equity in the borrower's home "runs out" that the bank will force the owners out of their home or force them to sell the home. Again, this is not true, as the mortgage does not become due until the last surviving borrower dies, permanently leaves the home, or sells the property.

Similar to the fear of running out of equity is that some homeowners fear that they will be put in a situation where they owe more than their home is worth; however, this is unfounded because under reverse mortgage programs, they will never owe more than the value of the home. Since there is never more owed than the home is worth, no debt will be passed on to the homeowner's heirs. When the home is sold or no longer used as the homeowner's primary residence, the homeowner or his/her estate will repay the cash received from the reverse mortgage, along with interest and any other fees to the lender. Any remaining equity in the home belongs to the homeowner or their heirs (if the homeowner has died). If the borrower or their heirs prefer to keep the home, they can simply pay off the reverse mortgage by obtaining a normal mortgage on the property or by using other assets they may have available.

But what are the costs? Most reverse mortgages have an application fee, origination fee, closing costs, insurance, and a monthly servicing fee. These fees can typically be paid by the proceeds from the reverse mortgage, so there are no out-of-pocket expenses to the homeowner.

For additional information, please see the following website:

U.S. Department of Housing and Urban Development:

http://www.hud.gov/offices/hsg/sfh/hecm/...