It probably seems like the advertisements for reverse mortgages are never-ending and it is clear they are aimed at seniors. If you are a senior, and you are living on a tight budget or you need an influx of cash to pay for unexpected expenses, you may be wondering if a reverse mortgage is the answer. A Los Angeles estate planning attorney at Schomer Law Group, APC explains how a reverse mortgage works.
Reverse Mortgage Basics
A reverse mortgage is a loan for senior homeowners that allows a homeowner to access a portion of the home’s equity and convert it into cash using the home as collateral. Initially, the concept of a reverse mortgage was conceived to help retirees with limited income use the accumulated wealth in their homes to cover basic monthly living expenses and/or pay for costly health care; however, the proceeds of a reverse mortgage can be used for anything you wish. Instead of you paying the bank for the term of the mortgage, the bank pays you. You can receive the proceeds from a reverse mortgage in several different ways, including:
- Lump sum – a lump sum of cash at closing.
- Tenure – equal monthly payments as long as the homeowner lives in the home.
- Term – equal monthly payments for a fixed period of time.
- Line of Credit – draw any amount at any time until the line of credit is exhausted.
By way of illustration, imagine that you own your home outright and its current market value is $750,000. You might decide to take out a reverse mortgage for $250,000. You could choose to take the entire $250,000 as a lump sum at the closing or you might prefer to receive monthly payments. Once you take out the reverse mortgage, the equity in your home decreases by $250,000 to $500,000 and that $250,000 mortgage loan must eventually be repaid. The actual amount you will be eligible to receive in a reverse mortgage will depend on several factors, including the age of the youngest borrower, current interest rate, appraised value of the home, and government-imposed lending limits.
Am I Eligible for a Reverse Mortgage?
To be eligible for a Home Equity Conversion Mortgage (HECM), which is a reverse mortgage that is insured by the Federal Housing Administration (FHA), the youngest borrower on title must be at least age 62. If the home is not owned free and clear, then any existing mortgage must be paid off using the proceeds from the reverse mortgage loan at the closing. Beyond those two important criteria, there are additional financial eligibility criteria established by HUD that you must meet.
Repaying a Reverse Mortgage
Generally, a reverse mortgage does not become due until the death of the borrower or until the borrower is no longer living in the home as his/her primary residence. You must abide by the terms of the loan by paying the required property taxes, keeping homeowners insurance current and maintaining the home according to Federal Housing Administration requirements.
Estate Planning Considerations
At the time of your death or if the home ceases to be your primary residence for more than 12 months, a reverse mortgage loan will usually become due. Consequently, you (or your estate) must either repay the reverse mortgage or put the home up for sale to pay for the mortgage. If the home is sold, and the equity in the home is higher than the balance of the loan, the remaining equity belongs to you or to your estate. On the other hand, if the sale of the home is not enough to pay off the reverse mortgage, the lender (not the borrower) must take a loss and request reimbursement from the FHA. No other assets are affected by a reverse mortgage. This is important because it means that even if the sale of your home, after you are gone, fails to cover the amount owed to the reverse mortgage, your other assets (such as vehicles, investments etc.) are not at risk of being sold to repay the loan.
Reverse Mortgage vs. Home Equity Loan
Because a reverse mortgage is based on the existing equity in your home, it may sound a lot like a home equity loan. Unlike a Home Equity Line of Credit (HELOC) though, the HECM does not require the borrower to make monthly mortgage payments. Instead, the entire loan is paid off when the borrower no longer lives in the home or after the borrower’s death. In addition, with a reverse mortgage, any existing mortgage or mandatory obligations must be paid off using the proceeds from the reverse mortgage loan which is not typically a requirement for a home equity loan.
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