What is a Reverse Mortgage? How Does it Work?

Fewer than 1% of homeowners take advantage of the home equity to enjoy additional funds.

If you’ve paid off your mortgage like the 38% of other lucky homeowners, your home is now pure equity. Why let these funds sit and do nothing? 

You may have heard of a reverse mortgage, but what exactly is it, and how does it work? There are different reverse mortgage types that can be perfect for homeowners needing funds for medical bills, financial emergencies, or even to enjoy a luxurious retirement. Keep reading to join the 1% of homeowners taking full advantage of reverse mortgages.

What is a Reverse Mortgage?

To understand reverse mortgages, let’s briefly recap how standard loans work. A home buyer borrows a sum from the ≈ to purchase a house and pays it back monthly with interest. Therefore, a reverse mortgage is when a home buyer receives monthly payments or a lump sum from the bank, remortgaging a portion of the home’s equity. 

Receiving money from the bank might sound too good to be true. Indeed, there are pitfalls and hidden costs. As a result, you must understand how reverse mortgages work before getting tangled in a financial agreement you cannot afford.

What are the Different Types of Reverse Mortgages?

There are three different types of reverse mortgages.

• Single-purpose reverse mortgages: The lender specifies how you must spend the proceeds, for example, on home repairs (such as urgent plumbing costs) or as a deposit for another property. It’s the most affordable type of reverse mortgage. 

• Home equity conversion mortgages (HECMs): You can spend the proceeds however you like. However, it often has high closing costs.

• Proprietary reverse mortgages: Private lenders might offer a larger loan on high-value homes over $500,000. They’re similar to HECMs in price.

What are the Pros and Cons of Reverse mortgages?

Reverse mortgages aren’t for everyone; you risk passing the responsibility on to your heirs if you die. Ensure it’s the right decision before proceeding.

Pros

• Financial flexibility and additional income during retirement.

• Co-borrowers can stay in the house and continue to receive payments even if their partner passes away or moves out.

• You don’t have to make monthly mortgage repayments.

• Depending on the loan type, you can use the funds for anything.

Cons

• Higher interest rates mean you could lose more money over time.

• You could lose your home if you don’t uphold your end of the contract.

• You reduce the equity in your home. 

• Upfront costs could be costly.

How Much Money Can You Get from a Reverse Mortgage?

The proceeds from a reverse mortgage depend on several factors:

• The amount of equity you have in your home.

• Your age.

• The property’s current market value.

• Current interest rates.

• The type of reverse mortgage.

You must pay the outstanding balance first with the reverse mortgage funds if you have any other loan.

How Do you Repay a Reverse Mortgage?

Receiving a monthly check from the bank isn’t free. It is still, technically, a loan. And you must pay it back. When the borrower dies or moves permanently out of the home, the bank will discuss repayment options with the heirs. Generally speaking, they will have 30 days to decide. Options include:

• Selling the house and using the proceeds to repay the reverse mortgage balance.

• Keep the property, and pay the loan balance with other funds.

• Take out another loan on the property to cover the remaining reverse mortgage balance.

When Do you Repay a Reverse Mortgage?

In most circumstances, you won’t have to repay your reverse mortgage if you still live in the house. However, in the following events, the loan becomes payable:

• Death.

• Selling the property.

• Living outside the home for more than a year.

• Not paying property taxes or home insurance (if it’s a condition of the reverse mortgage).

• Not maintaining the house.

Summing up

Reverse mortgages involve complications and pitfalls if you don’t understand how they work. However, if you know the pros and cons, they can be an excellent way to supplement your retirement income, pay for unexpected costs, or pay for home improvements. As with any loan, shopping for the best rates is a good idea. Discuss the loan with your heirs to ensure they understand their role.