It is possible to increase the equity in your home with a reverse mortgage. In a reverse mortgage, you own the home outright or at least a significant equity to draw from. It is possible to withdraw a part of the equity without repaying it until you leave the home. If you are wondering why anyone would want to borrow against a home they worked hard to pay off, let us discuss how does a reverse mortgage work and everything you need to know about it.
What is a reverse mortgage?
A reverse mortgage is a loan that allows you to borrow a part of the home’s equity as a tax-free income. However, it is applicable to only those aged 62 and above and who have paid off their mortgage. It is slightly different from the regular mortgage where you make the payments to the lender. In this case, the lender makes the payment to the homeowner.
Those who opt for this kind of mortgage do not have a monthly payment and do not have to sell their home. However, the loan should be repaid before the death of the borrower or before permanently moving out of the home.
It actually supplements retirement income and covers the cost of home repairs. In cases where the regular income is insufficient to cover the expenses, a reverse mortgage will keep you from choosing high-interest lines of credit or other costly loans. Home Equity Conversion Mortgage is one of the most popular types of reverse mortgages.
What is the eligibility for a reverse mortgage?
In order to be eligible for a reverse mortgage, you need to understand how does a reverse mortgage work. The house owner should be above the age of 62 or older. You will still be eligible if the spouse is under 62 but you need to meet the below-mentioned eligibility criteria.
- You should own the home outright or have a single primary line you can borrow against,
- Live in the home as your primary residence,
- The existing mortgage should be paid off using the proceeds from the reverse mortgage,
- It is important to remain current on property taxes, legal obligations, and homeowners insurance,
- You need to participate in a consumer information session which is led by a HUD-approved counselor,
- Maintain the property and keep it in good condition,
- The home should be a single-family home or a multi-unit property with up to four units. It should be built after June 1976. It can also be a townhouse or a condominium.
Types of reverse mortgages
There are three types of reverse mortgages. Let us see how they work.
Home Equity Conversion Mortgage– It is a very popular type of reverse mortgage. It is a federally insured mortgage with a high upfront cost but you can use the funds for any purpose. It is only offered by the Federal Housing Administration-approved lenders and before closing it, the borrower should receive HUD-approved counseling.
Single-purpose reverse mortgage – It is not a very common form of a reverse mortgage and is usually offered by nonprofit organizations and state and local agencies. You can only use the funds to cover one specific purpose.
Proprietary reverse mortgage– This is a private loan that is not backed by the government and you can receive a larger loan advance if you own a high-value home.
How does a reverse mortgage work?
Let us discuss how does a reverse mortgage work. Qualified homeowners cannot borrow the entire value of the home even if the mortgage is paid off. You can borrow an amount known as the principal limit and it will vary based on the age of the younger borrower or the HECM limit and the value of the home.
You can get a higher principal limit if you are older and the property is worth more. The amount may also increase if you have a variable rate HECM.
In case of a variable rate, the options are:
- A line of credit which can be accessed until it runs out,
- Equal monthly payments if you live in the property as your primary residence,
- An equal monthly payment for a fixed period of time agreed on beforehand,
- A combination of both (Line of credit and equal monthly payment) as long as you live in the home,
- A combination of the line of credit and fixed monthly payment for a specific period of time.
Those who choose a fixed interest rate on HECM get a single disbursement. The interest on reverse mortgage accrues each month and you will need to have adequate income to make payment for homeowner’s insurance, property taxes, and maintenance of the home.
What is the maximum amount you can get from a reverse mortgage?
The amount of money will be based on a number of factors like the market value of the home, rate of interest, your age, the type of reverse mortgage, and your financial assessment. The amount will also depend on whether the home has other liens or mortgages.
In case of a balance from a home equity loan, you need to pay it first with the reverse mortgage proceeds. You will never get the full value of your home. You will only receive a percentage of the value.
A reverse mortgage is ideal for those looking for extra income during the retirement years. It also offers flexibility in terms of receiving money: monthly payout, lump sum, and a line of credit. In case of an appreciation in the value of the home, it may become more than the reverse mortgage loan balance and you will receive the difference. However, if the balance is more than the value of the home, you may need to foreclose or give ownership of the home to the lender.