Many homeowners have accumulated equity in their home, and consider encumbering their home with a reverse mortgage. This article illustrates the definition of reverse mortgages, how they work, eligibility requirements and pros and cons.
A reverse mortgage is a loan against home equity. In other words, it allows the borrower to convert equity in the home into income, or a line of credit that can be used for any purpose. The borrower is not required to make periodic payments to the lender, or pay off the loan until the borrower no longer uses the home as a principal residence, or fails to meet the obligations of the mortgage. The Federal Housing Administration (FHA) administers reverse mortgages.
A borrower can apply for a reverse mortgage primarily through a reverse mortgage lender. The borrower must consult with a reverse mortgage counselor, who will charge a fee, which is then rolled into the loan. The proceeds can be taken in monthly payments, a line of credit, or a lump sum. Fixed or adjustable interest rates are also available. If a borrower elects a fixed interest rate, then all proceeds must be taken in a lump-sum payment, and the signatures of both spouses are required.
To be eligible for a reverse mortgage, the borrower must be 62 years of age or older, own the home outright or have a low mortgage balance that can be paid off at closing with proceeds from the reverse loan, and the borrower must live in the home. The borrower must have the financial resources to pay ongoing property charges, including taxes and insurance. The borrower is also required to receive consumer information from a reverse mortgage counselor prior to obtaining the loan.
A reverse mortgage is an expensive form of credit. There are substantial up-front fees such as loan origination fees, mortgage insurance premiums and closing costs as well as ongoing fees such as interest, servicing fees, and mortgage premiums. The fees and interest are often high. The borrower should not be surprised if the amount of the loan is lower than expected after deducting these fees. As with any loan, the borrower should ensure the availability of sufficient funds to cover these expenses.
A reverse mortgage limits the amount of money passed on to heirs and could put a spouse out of their home. When the home is sold or no longer used as a primary residence, the cash, interest, and other reverse mortgage finance charges must be repaid. All proceeds from the sale beyond the amount owed belong to your spouse or estate. Accordingly, the amount paid for the home determines whether proceeds remain to transfer to heirs. No debt is passed along to the estate or heirs, but the heirs will not get the house unless they pay off the reverse mortgage, and the money used to pay off the house is usually taken from the estate, thus reducing the amount heirs receive from the estate. If a borrower takes out an adjustable interest rate reverse mortgage, the borrower should also note the possibility of unexpected diminished proceeds upon the sale of the home.
Astute borrowers will note that death is not the only event that triggers repayment. If only one spouse moves into a nursing home, the reverse mortgage must be paid off, usually by selling the home. This could create a serious problem if the other spouse remains at the home because the reverse mortgage is typically paid off through selling the home.
Despite these disadvantages, a reverse mortgage will convert home equity into cash that can be used to pay necessary expenses.
Borrowers should also beware that some services charge a fee for referring a borrower to an FHA‑approved lender. Borrowers should avoid these services because FHA‑approved lenders are available online at www.hud.gov.
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