Reserve mortgages, how do they work?

Reverse mortgages allow older people to access the equity they have built up in their homes. Re-payment of the equity is deferred until the person sells the home or passes away.   

How a reverse mortgage works

A reverse mortgage is a form of loan that allows you to turn some of your home’s equity (the value of your home minus the amount you still owe on your mortgage) into cash.  While a reverse mortgage can be a good source of cheap credit, it is important to remember that at the end of the day, it’s a loan like any other. As such, it carries an interest rate that can be either fixed (stays the same over time) or variable (it is subject to change at the lender’s discretion). Borrowers often view reverse mortgages as preferable to other forms of credit as their interest rates tend to be on the low side, although this isn’t always the case.

Unlike a home equity line of credit, a reverse mortgage does not need to be repaid until the borrower moves, is no longer able to meet the requirements of their mortgage, or passes away. A reverse mortgage can be paid out to you in a lump sum, in regular installments, as a line of credit (on an as needed basis), or some combination thereof.

Types of reverse mortgages

There are three types of reverse mortgages.  Single-purpose reverse mortgages are offered by local governments and are intended for low-income homeowners.  They must be used for a specific purpose outlined by the lender (i.e. necessary home repairs). Federally-insured reverse mortgages, or Home Equity Conversion Mortgages (HECMs), are provided by the federal government. These are the most common type of reverse mortgage, and have no income requirements or strings attached to their use (unlike single-purpose mortgages, you can use a HECM for anything you like, such as a new car or a child’s wedding). Finally, proprietary reverse mortgages are offered by private lenders, and offer higher levels of credit than the other types of equity loans discussed, but also generally carry higher interest rates. These are not recommended for low-income borrowers or those with a modestly valued home, as they have a history of predatory practices towards financially vulnerable clients.

As with any loan, it’s important to consider whether an increase in debt is absolutely necessary. Reverse mortgages may be preferable to more expensive forms of credit, but you should evaluate all of your options before making a move.

The downsides of having a reverse mortgage

Unable to refinance and difficult to understand terms. Often borrowers may enter into loan agreements without completely understanding the terms of the loan. Sometimes a loan will not allow you to renegotiate terms, and borrowers are stuck with paying a high interest rate which is hard to pay off. And often borrowers were not aware that their adjustable interest rate would increase so quickly, both situations can cause hardships for the borrower.

High interest rates and upfront costs. Interest rates on reverse mortgages can be 1.5% higher than regular home loans, and final costs could include lender fees, mortgage insurance premiums, finance charges and closing costs, all of which add up.

A strain on heirs. If you plan to leave your property to your heirs, they will have the option of paying the loan in full or 95% of the balance, If they can’t settle this debt with their own funds, the home must be sold in order to repay the lender. Also if you decide to sell the home you will have to repay the balance as soon as your house is sold.

Loss of equity in your home. Over time, the high accrued interest on your reverse mortgages may drain any remaining equity in your home. Moreover, some homeowners have found that lenders fail to keep accurate records, and there were obstacles when attempting to prevent foreclosure—such as slow response times (critical during foreclosure), receiving erroneous information or instructions, and general unresponsiveness. Before entering into an agreement, it would be wise to seek counsel of a trusted third party reverse mortgage professional or financial advisor.

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