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Reverse Mortage – How it Works?

Reverse mortgages were designed for older individuals who have paid off a substantial portion of their mortgage and find themselves on a fixed income. Instead of the borrower continuing to pay the lender the monthly mortgage payment, the lender actually pays the borrower a monthly stipend against the equity that the owner has in the home. The borrower must be at least 62 years old and have a good deal of home equity. The loan does not be repaid until the last holder of the mortgage passes away or sells the property. If all owners die, the estate has a grace period of 12 months to either pay off the loan, refinance the mortgage or sell the property. Remaining equity in the property rolls over into the estate.

The official term for reverse mortgages is Home Equity Conversion Mortgage (HECM). They are insured under FHA guidelines and therefore have some substantial restrictions placed on them by the Department of Housing and Urban Development. Lenders must receive approval before they can offer this type of mortgage, whether they be a bank, loan association, mortgage company or any other type of financial institution.

Like any other type of loans, reverse mortgages have both their up sides and their down sides.

The positive aspects of the loans are that they allow a homeowner to remain in their home without making a loan payment and in some cases even receiving a payment. This is especially useful to seniors living on a fixed income. Since credit scores and income are not factors, it’s extremely easy to qualify for one of these loans. Owners have several options when it comes to receiving payouts from the equity including lump sums, monthly payments, a credit line or a combination. The money received from the loan is not taxable. Since the loans are based off equity and total home value, heirs will never be left in a situation where they owe more than the loan is worth.

On the down side, closing costs for these mortgages are higher than conventional mortgages. The income received from the loans may affect the owners’ ability to qualify for certain government programs such as Medicaid.

Though many home owners who have reached retirement age find that these loans fit their living situations nicely, others will find that they are not the best option. Before receiving the loan, HUD requires that borrowers go through a counseling program so they understand exactly what the process entails. Counselors who provide this training must be certified by HUD so they can accurately explain the pros and cons of the mortgage.