How does a Reverse Mortgage work?

Reverse Mortgage Information - What is a Reverse Mortgage and how do they work?

What is a Reverse Mortgage?

Reverse mortgages are a type of secured home loan with a real twist.  This type of loan is often misunderstood and reverse mortgage information can be patchy or inaccurate which leads to confusion over exactly what they are an how they work.  This article is intended to give you a solid overview of exactly what is a reverse mortgage and what isn't. 

Like any other secured debt they give the lender a claim over the asset used as security, in this case your home, and in the event of the asset being sold, the lender is entitled to the first share of the proceeds.

Unlike a standard mortgage however the lender cannot force a foreclosure and sell the property in the event of non payment.  There are a few reasons for this but the main one is that there are no mandatory repayments.  Rather than making regular instalment repayments, the interest that is charged on the loan simply adds up and rolls into the total debt.  The debt is only repaid when the house is sold.  The term "reverse mortgage" refers to the fact that the loan balance increases over time rather than going down, like a standard loan.

Another great aspect of a reverse mortgage is that it can never go "upside down" - the total debt cannot exceed the value of the property.  So even if the value of your home drops to below what the total debt is, there is no carry over, and the loan is always fully discharged.

What is a reverse mortgages limitations?

The primary limitation of an RM is the amount you can borrow initally.  In ost cases, a lender will only offee to lend a proportion of the total equity you currently have in the home.  This is to ensure that when the loan needs to be repaid, there will be sufficient funds to do so when it is sold.

 
Reverse Mortgage Rates

Interest rates on reverse mortgages are higher than standard mortgage and refinance rates.  This is the trade off for higher flexibility in repayments as well to compensate for risk the lender runs of the equity in the property dropping to below the total loan value.

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Repayment options

When it comes to repaying a reverse mortgage you have a few choices:

  • Pay the balance of in a lump sum or in instalments, just like a regular mortgage loan (often called pre payment).
  • Sell the house, at which point the total debt is repaid from the proceeds of the sale (if sufficient).
  • Upon your death, the beneficiaries of your estate will need to either repay the loan if they wish to keep the house, or sell the house and use the proceeds to settle the mortgage.
In essence if you want to repay the loan early, you can - there are generally no penalties for perpayment -otherwise the loan will be repaid upon your death, or the sale of the house.  It's also important to note that if you move, the loan needs to be repaid as well.

Who can get a Reverse Mortgage?

Reverse Mortgages are only available to Seniors, and only to those who have built up siginificant equity on their property.  Why?  As crass and tasteless as it may sound, these loans are only availabe to seniors for the simple fact that their life expectancy is lower.  Given that the loan is repaid on the sale of the house and no repayments are required beforehand, the lender needs to know that they will not be waiting another 50-60 years before the loan is repaid.  The lender requires significant equity in the property in order to ensure that once the loan balance incereases they will still be able to recover the debt from the sale of the home.

 


Reverse Mortgage Information: Advantages and Disadvantages in a nutshell

Advantages

The main advantages of a reverse mortgage are: 

  • No monthly repayents unless you want to
  • The lender cannot foreclose or force early repayment
  • Proceeds of reverse mortgage can be used as cash immediately in a lump sum or over time as a tax free income
  • No credit or income criteria - easy to qualify
  • Cannot go "upside down"
  • Funds can be "drip fed" or released as a lump sum.
 

Disadvantages

The major drawbacks of reverse mortgages are:

  • Higher interest rate
  • You cannot move from your home unless you repay the loan
  • Only available to those over 62
  • Total loan amount is restricted by the equity you have when the loan is taken out
  • If no repayments are made the balance can increase quickly.

 

Like any financial product, a reverse mortgage can be very helpful in the right circumstances, however it shouldn't be something you enter into quickly.  Research which lenders offer reverse mortgage loans, check their rates and terms.  Just because you don't have to make regular repayments doesn't mean the debt isn't srill adding up - an unmonitored reverse mortgage can quickly balloon out and reduce or in some cases even eliminate the inheritance you will be leaving behind.  Do a little reasearch and check the reverse mortgage information available from different souces to compare.  If you've spent a lifetime building up your equity it makes sense to protect that investment.  These types of loan have become increasingly popular in recent times and there are no a lot more lenders offering these types of equity release products.  The fact that RM's can't go "upside down" is very comforting to many older people, especially in times when property prices have fallen - as has been the case in recent years.  In reality the lenders take all the risk with RM's - while the interest rates might be higher than a standard mortgage refinance this is more than offset by the lenders inability to foreclose.

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