Finances

What is a reverse mortgage?

A reverse mortgage is an alternative to traditional home loans, which many retirees find helpful. Learn more about the pros and cons of this unique form of financing here!

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Reverse mortgage: find out the pros and cons

Reverse mortgage written on a memo stick.
Learn what a reverse mortgage is and how it works. Source: Adobe Stock

Are you wondering what a reverse mortgage is? If you’re a senior or retiree looking to take advantage of your home equity, it can be a great option for you!

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This blog post will take an in-depth look at how reverse mortgages work and their various benefits. Keep reading for all the details on this unique financial product!

What is a reverse mortgage and how does it work?

A reverse mortgage is a kind of loan which works differently compared to a traditional mortgage loan. Indeed, it’s treated as a non-recourse loan. But what exactly that means?

In this loan type, borrowers can use the value of their home to apply for funds from a lender and, afterward, pay off the loan in cases of selling, moving, or when the borrower dies.

Furthermore, you get an advance based on your home equity, which cannot be higher or equal to the property’s value. Generally, you don’t have to pay until the terms are met.

Essentially, it works as a loan in which the lender pays you the proceeds in terms previously agreed. But, differently from selling, you still own the property.

You can choose how to receive the amount borrowed, which can be in a lump sum, monthly payments, a credit line, or even a combination of the three.

It seems too simple, but you must be aware that reverse mortgages have some details that must be carefully watched to make the best of it. Let’s see some of their pros and cons!

Pros

  • A reverse mortgage is a non-recourse loan, which means no monthly payments;
  • It can be an alternative for seniors to access equity from their homes;
  • There are different ways of receiving the proceeds from the lender, such as monthly payments or the entire amount borrowed;
  • Usually, the earnings you get from a reverse mortgage aren’t taxable.

Cons

  • It’s not a good option for everyone, and it also has a required age of at least 62;
  • You must be very careful with your finances and strategies to make it worth it for you. There will still be fees and other closing costs from the lender;
  • Once you maintain the property, you still will have to pay fees, taxes, and other costs associated with owning a home;
  • It’s a loan, right? So you’ll have to deal with interests, added to the total amount borrowed over time.

Remember that it’s only worth it in some specific situations. For example, when you do not intend to leave an inheritance property to your heirs or already own a property for this purpose.

Fees

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Learn more about reverse mortgages! Source: Adobe Stock

There are some fees included when contracting a reverse mortgage. Their costs vary from lender to lender, as well as interest rates.

You must be prepared to pay closing costs, monthly service fees, interest, and other fees, which can lower the total amount available.

The most common is that they are added to the loan balance, which, again, will be paid when the terms of the loan are met.

Minimum credit score

A credit score isn’t the main factor in qualifying for a reverse mortgage. Some lenders can close loans for borrowers with mid-600 or even with no credit score requirements.

In most cases, the borrower’s ability to pay their obligations is the most important thing. This is usually checked from your mortgage debt payment history.

Also, a credit check will be performed to confirm the inexistence of any existing debts or federal tax liens, which may affect your eligibility.

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Requirements 

The requirements for both the borrower and the property vary from lender to lender and loan program. First, you need to be at least 62 years old.

Borrower requirements include not being delinquent on any federal debt and owning the property outright or for a substantial amount. The owner must live in the house for at least one year.

Furthermore, the property must comply with the Federal Housing Administration (FHA) standards and other more specific requirements to get a reverse mortgage.

Types of reverse mortgages

Reverse mortgages can be government-backed or offered by banks and mortgage companies. Check out some of their specifications!

HECM

The Home Equity Conversion Mortgages (HECM) are federally insured and backed by the U.S. Department of Housing and Urban Development (HUD).

Before applying for HECM, counseling is required through some government-approved agency. Further, they tend to be more expensive than home loans and don’t have income limitations.

Single-purpose reverse mortgages

As the name suggests, these loans can only be used for one purpose specified by the lender, such as home repairs or to pay property taxes.

Normally they’re offered by local government agencies and non-profit organizations and tend to be one of the least expensive options, with smaller values available to borrow.

Proprietary reverse mortgages

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Find out what are the types of reverse mortgages. Source: Adobe Stock

Private lenders offer proprietary reverse mortgages, and their payments will be the same as in HECM, with a lump sum or a series of monthly payments.

Furthermore, they’re an option when your property is worth more than the limited value for HECMs, in addition to not having a loan amount limitation.

Knowing that, let’s discover next if it fits you!

Is a reverse mortgage the best option for you?

First, you need to know that reverse mortgages aren’t for everyone, but specifically for seniors over 62 years old, normally with considerably good home equity.

In other words, a reverse mortgage is not for those looking to reach their first home. In fact, it is a resource to pay off your mortgage and stop monthly payments.

Although you don’t have to pay until you complete the contractual terms, you must consider the fees and other costs. They’ll be there when it’s time to pay.

With these considerations, you can still count on the guidance of an independent government-approved house counseling agency.

Keep in mind that a reverse mortgage is a loan, although don’t have monthly payments. As such, it can be a great financial tool if used wisely!

Alternatives to reverse mortgages

After all the details discussed, you now know what a reverse mortgage is and how it works. But if you still think that’s not for you, don’t worry!

There are options like evergreen loans, which give you a line of credit and don’t require the repayment of the principal during the loan time.

Keep reading our article to enjoy learning the advantages of an evergreen loan!

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Evergreen loans: how do they work?

Wondering what an evergreen loans are? Look no further! We'll explain everything your need to know, including pros and cons. Read on to learn!

About the author  /  Luis Felipe Regueira

I needed to learn about finances when I was in culinary school and wanted to save money to start my own business. So I haven't stopped because I believe studying and writing about the topic can help more people achieve their goals. Currently, I write about finances and run a small coffee shop.

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