Reverse Mortgage Calculator
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A Guide to Understanding How Reverse Mortgages Work
Reverse mortgages are financial opportunities that come to older homeowners later in their life. These loans are popular yet fairly complicated, so it is important to learn all you can before deciding on obtaining one. However, in the right circumstances a reverse mortgage can certainly help the recipient to enjoy their latter years and harvest some of the equity they have earned.
As with all financial decisions, there are pros and cons to weigh out and understand before deciding on a lending product. This article looks to outline the basics of reverse mortgages, detailing who might benefit from them and what they might expect from the various programs available to today’s qualified applicants.
How Does a Reverse Mortgage Work?
Reverse mortgages are for people who are over the age of 62, are homeowners with built-up equity in their property, and living in the US. While there are different programs available that can disburse the proceeds or require specifics of the loan’s use, the basic criteria for qualification remains generally the same across all reverse mortgages.
In all of them, you will have to maintain the property. This includes but is not limited to all taxes, landscaping, HOA fees, and other costs associated with the home’s legal ownership.
There are three different reverse mortgages to consider, and they will all borrow against the equity earned in the home. The funds from a reverse mortgage are generally non-taxable and usually do not affect income levels for other programs from which you may be receiving benefits, e.g., Medicare, Social Security. Do note though, applied interest rates are NOT tax deductible…so the loan proceeds themselves are not taxed, but the interest applied to the loan balance, could be.
An interest rate is applied to the balance owed, which can be either a fixed or variable rate, depending on loan type and provider. The loan has to be repaid in full when the last borrower dies, moves (changes it from being a principal residence) or sells the home.
Under some circumstances, a surviving spouse can live in the house after the borrower dies, but usually the way to keep the home is to pay off the loan in full. There are stipulations with some loans that help the loan balance remain equal to the appraised value of the home – so even if the borrower left a balance that exceeded the home’s value, it would be reduced to match the appraisal. The survivors would be responsible for only the appraised value of the home.
The fact that a reverse mortgage cashes in on the home’s equity is the issue that makes this loan a different one than many – for it can affect your legacy and what you will be able to leave to your spouse and heirs. If you cash it all in, you cannot also pass it on.
Remain aware too, that there are going to be fees associated with closing, and often ongoing with a reverse mortgage. The specifics of whether or not you’ll need PMI (mortgage insurance) might depend on both the loan type and the lender who funds your deal.
Knowing more about the three different types of reverse mortgages helps you to determine which one would be the right decision for your situation.
Types of Reverse Mortgages
- Home Equity Conversion Mortgages (HECMs) – Backed by HUD and insured by the federal government, HECMs can be used for any purpose. To apply for one of these reverse mortgages, an applicant must first speak with a HUD counselor. The counselor will help the applicant to understand all of the implications of the loan, as well as any potential alternatives to consider. Talking with the counselor is not an option, it is a prerequisite – and you can learn more on the HUD site, here.
- Proprietary reverse mortgages – These are the loans offered and backed by private companies. They generally are for borrowers with higher-value homes, preferably (to the lender) with a smaller mortgage. The value of most proprietary reverse mortgages is seen when you have a higher appraisal value on your property, so qualify for better deals.
- Single-purpose reverse mortgages – These are aimed at low- and moderate-income borrowers and offered by non-profits, as well as state and local agencies. Availability of these loans may be dependent on the lender, so you will not find the same offers everywhere. These are usually the cheapest reverse mortgages, and are aimed at a single usage, like home repair or tax payments, and the purpose is determined by the lender.
Of all three loan types, the HECMs will offer you the most variety and choice, as far as the cash disbursement and terms you can negotiate:
- Term Payments: a set term of receiving monthly payments
- Tenure Payments: monthly payments as long as you live in the home
- Single Disbursement Payment: a lump-sum payment, usually offering less in amounts than other HECM options
- Line of Credit: you can draw amounts you choose until you reach your credit limit. Pay taxes on only the money you use, not all that is available to you.
- Combination Payment: uses a monthly payment in conjunction with an extended line of credit
As like the other reverse mortgage options, HECMs will usually be a variable interest rate, unless you receive a lump sum – then you could secure a fixed-rate reverse mortgage.
You can see that it is important to understand what you’ll need the reverse mortgage for, in order to figure out which payment option is going to work best for you. You can use them for paying off specific items, education, medical expenses and more – or you can use them as an additional income stream when the earning years are creeping behind you.
Because they are federally sponsored, HECMs will typically offer you bigger loans at better rates than any proprietary offer can match. There is however, a limit to how much you can borrow in the first year, called your “initial principal limit.” This limit is calculated by the lender, based on your age, financial assessment, the home’s value and the applied interest rate…usually about 60% of the loan’s borrowing limit is available the first year.
Your counselor will walk you through all of the fees, limits and restrictions, and necessities that stand between you and your reverse mortgage. You also have a three-day right to rescind the deal, protected by law, in case you start having second thoughts, as many borrowers will.
The Pros and Cons
There are certainly benefits and challenges to weigh in about a reverse mortgage.
Some of the pros might include the fact that you can blend your payment options and create a nice income stream based on your equity to help in later years. You can use it to pay off an existing mortgage. You can stay in your home with a spouse and eliminate monthly mortgage payments. You retain the title to the home.
Your heirs are not responsible for anything greater than the appraised value of the home if you pass away or the loan reaches maturity in another way (like selling the home). If you use a line of credit as your payback option, you are charged interest on only what you spend, not what is available.
Understanding what you will need the money for will help you to determine if there are more benefits to enjoy with this type of a loan compared to others available.
Some of the drawbacks associated with a reverse mortgage will definitely include the costs. There are closing costs to consider, as well as ongoing costs to help protect the lender. While these costs tend to be higher than with a traditional loan, they are not typically going to come out-of-pocket. Instead, you can typically roll your closing costs into the reverse mortgage.
Annual mortgage insurance premiums of .5% of the loans’ balance are also part of the ongoing costs to consider. You must maintain all taxes and keep the house in good repair.
Another risk is the idea of leaving the home before you plan to, say for an illness. If you were to be admitted to a full-care facility, you would have one year before you or your heirs/estate would need to settle the balance of the loan.
Similarly, if you should decide to move, or make the home less than your primary residence you would be required to pay-off your balance in full. If you have family members not named specifically on the reverse mortgage, they would be forced to move or settle the loan in either case.
Losing equity is also a big concern, because it means you will have less to leave your heirs when you die. In many cases, surviving family members need to sell the home to meet the obligation. However, they can also pay off the balance and retain the property as well.
Is It Right for YOU?
Whether or not a reverse mortgage makes sense to you is going to depend on a lot of personal factors. These will include, but are not limited to:
- Your age;
- The amount of equity built int the home;
- The amount you need (and why);
- The number of heirs to your estate;
- Other options available to you.
You can pay off the balance of a reverse mortgage, and in some cases the interest you pay might even be tax deductible. It is important to talk to a qualified tax professional to understand the range of your possibilities and also your responsibilities with each decision made.
The counselor you talk to at HUD will help you to see the full picture of what a reverse mortgage will mean to you, as well as your estate. It is important to ask questions and try to get a full understanding of the implications your decision will make.
When used in the right situations, reverse mortgages can certainly allow older citizens a flexible and responsive income source when there may be less opportunity for other income streams. They are not without risk, but they do provide another opportunity for savvy borrowers to increase their options.
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