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If you’re over the age of 62, getting a loan isn’t always an easy thing to do. And if you do find a willing lender, paying it back is going to be even more difficult, especially if you don’t have a steady source of income. So what do you do if you’re confronted by unexpected medical expenses, or if you’re finding it hard to pay off the balance of your mortgage loan?
Well, if you’ve been living in the same home for a long time, you ought to have accumulated a decent amount of equity. And if that is the case, reverse mortgages might be the perfect loans for you.
What is a reverse mortgage?
A reverse mortgage is a loan offered to any person above the age of 62 against the value of their home. As a senior citizen, you can choose to receive the funds as a lump sum, as fixed monthly payments, or as a line of credit.
Unlike the traditional mortgage, or a forward mortgage, that you used to buy your home, you do not need to make monthly payments to repay the loan. Instead, the lender gets his money back either when you die from your spouse or whoever is settling your estate, or when you sell the home yourself.
There are three types of reverse mortgages. They are:
- Proprietary reverse mortgages, which are offered by private lenders.
- Single-purpose reverse mortgages, which are offered by NGOs as well as some state and local government agencies.
- Home Equity Conversion Mortgages (HECM), which are federally insured reverse mortgages.
Simply put, a reverse mortgage is a loan that is an advance on a part of your home equity. You get to keep the title of your home. The money that you receive is usually not considered taxable income, and will not affect your Mediclaim or social security benefits.
While in some cases, your spouse may be allowed to continue living in the home after your demise as well, the loan usually has to be repaid by selling the house when the last surviving borrower has either died or no longer uses the home as a primary residence and sells the home.
All of this may make reverse mortgages sound like the perfect senior citizen loan. However, here are some red flags for you to consider.
- Lenders charge borrowers a whole host of fees. These include origination fees, closing costs, and servicing fees for the duration of the loan. Home Equity Conversion Mortgage borrowers are also liable to pay mortgage insurance premiums.
- These loans are not interest-free. Interest is added to the amount you borrow every month, so you actually owe more than you borrowed by the time it is paid back.
- Most reverse mortgages have variable interest rates. This means they are tied to a financial index and are liable to fluctuate with market trends. HECM loans offer fixed interest rates, but variable interest rates offer more options on how you could get your money through reverse mortgages.
HECM loans tend to offer borrowers only a lump sum upon closing, and in the bargain, you may end up getting less than a variable interest loan may have paid you.
- Until the loan is paid off entirely, the interest on the reverse mortgage is not tax-deductible.
- A reverse mortgage allows you to keep the title of your home. This means that you’re still responsible for paying your energy bills, property taxes, and homeowner’s insurance.
Failure to pay these bills may force the lender to ask you to repay your loan balance.
A lot of lenders will do a financial assessment before approving your reverse mortgage. They may also include a clause for a “set aside” amount to pay for your annual insurance and taxes during the loan period. This will lower the amount you actually get to use from your reverse mortgage.
- With regard to HECM loans, your spouse may get to continue staying in the same home after your demise even if he/she didn’t sign the loan agreement. However, the money you were getting from the HECM will stop, since they aren’t a borrowing spouse.
- A reverse mortgage can eat up all your equity in your home, leaving you with fewer assets for your heirs. A lot of these loans come with a non-recourse clause, which states that at the time of closing the loan when the home is sold, you cannot owe more than the value of your home.
In the case of HECM loans, if your heirs want to settle the loan rather than sell the home, they will not be expected to pay more than the appraised value of your home.
Types of reverse mortgages
Let us now try to better understand how the three different types of reverse mortgages work. This will help you decide which type of loan suits your needs best based on the pros and cons of each type.
Proprietary reverse mortgages
These are loans backed by the private financial institutions that offer them. In these loans, if your home has a higher appraised volume and you have a small mortgage, you will be eligible for more funds. Similarly, the higher the value of your home, the more loan advance you will be eligible for.
Single-purpose reverse mortgages
These are the least expensive reverse mortgages and are offered by local and state government agencies as well as some NGOs. These loans, however, aren’t available, and the lender specifies what the loan can be used for.
For example, the lender may give you the loan only to use for home improvements, or repairs or for medical expenses. This is aimed at low or moderate income homeowners.
Home equity conversion mortgages
These are federally insured reverse mortgages. They’re backed by the US Department of Housing and Urban Development. HECM loans can be used for any purpose.
Both proprietary reverse mortgages and HECM loans are quite expensive and often have high upfront costs. So think twice if you intend to take a loan and live in your home only for a short period of time. The factors based on which your eligibility for a reverse mortgage is calculated are:
- Your age.
- Loan type you want.
- The appraised value of your home.
- Current rates of interest.
- A financial assessment about your capability and willingness to pay property taxes, insurance, and other expenses.
Generally, the older you are, the less you owe on your home, and the more equity you have in your home, the more money you will be paid.
While applying for a HECM loan or in some cases, even a proprietary reverse mortgage, you may be required to meet with a counselor. The counselor has to tell you about the costs and financial implications of the loan as well as educate you about the other two reverse mortgage options. They ought to help you make a comparative judgment after weighing the costs and other terms of all three options.
HECMs might not be for any particular income bracket, but they will check your ability and willingness to bear the expenses of bills, taxes, and insurance before they approve your loan. You can choose to either take your money as a lump sum, as a monthly payment, or as a line of credit. For a small fee, you can even change that option.
However, your lender will decide how much you can take in your first year, based on your age, interest rate, the value of your home, and the financial assessment. This is called an initial principal limit.