How do Reverse Mortgages Work?
How do Reverse Mortgages Work?
First and foremost, a reverse mortgage is a loan. Homeowners age 62 and older who have considerable home equity can borrow against the value of their home and receive the funds as a lump sum, fixed monthly payment, or line of credit.
What’s unique about a reverse mortgage is that it doesn’t require the homeowner to make any loan payments. Instead, the entire loan balance comes due and must be paid when the borrower passes away, moves away permanently, or sells their home.
Federal regulations require reverse mortgage lenders to structure the deal so that the loan amount doesn’t exceed the home’s value. It is also a requirement that the borrower or borrower’s estate won’t be held responsible for paying the difference if the loan balance becomes larger than the home’s value.
The home is the collateral for a reverse mortgage. When the homeowner dies or moves, the proceeds from the home's sale go to the lender to repay the reverse mortgage’s principal, interest, mortgage insurance, and fees. Any proceeds left after the lender is paid will go to the homeowner’s estate or their heirs.
The proceeds from a reverse mortgage are not taxable. Though they can feel like income to the homeowner, the IRS considers the money a loan advance.
Receiving the Proceeds From a Reverse Mortgage
When you take out a reverse mortgage, you choose how you would like to receive the proceeds. There are six options for you to make a selection from:
- Lump sum: get all of the proceeds at once when your loan closes.
- Equal monthly payments (annuity): will be made by the lender as long as at least one borrower lives in the home.
- Term payments: the borrower receives equal monthly payments for a specific period of time, such as ten years.
- Line of credit: Money sits in an account, and the homeowner can borrow when the need arises. The homeowner pays interest only on the amount borrowed from the credit line, not the entire reverse mortgage payout.
- Equal month payments plus a line of credit: as long as one borrower occupies the home as a principal residence, they will receive monthly payments from the lender. If the borrower needs more money at a later date, they access their line of credit.
- Term payments plus a line of credit: the borrower receives equal monthly payments for a set period of years (such as ten years), and the borrower can also access the line of credit if needed.
The payout amount will depend on your interest rate, the value of your home, and your lender. In any case, owners will typically need at least 50% equity in the home based on its current value, not what you paid for it.
”43,000---the number of reverse mortgages issued in the U.S. in 2020, an increase of 23% from the previous year."
NTREIS data last updated August 11, 2022.
Reverse Mortgage Interest Rates
Only the lump sum reverse mortgage has a fixed interest rate; the other five options have adjustable interest rates tied to the London Interbank Offered Rate (LIBOR).
In addition to your base rate, the lender adds their profit margin of 1% to 3%. So, if the LIBOR is 3.5% and your lender’s margin is 3%, then your reverse mortgage interest rate will be 4.5%.
Your credit score does not affect your interest rate or ability to qualify.
Would You Benefit from a Reverse Mortgage?
Once you’re age 62 and older, a reverse mortgage is a good way to get cash when the equity in your home is your biggest asset, and you don’t have another way to meet your basic living expenses. You do get to continue living in your home as long as you stay current with property taxes, maintenance, and insurance.
As good as receiving the money from the lender sounds, you will be spending a significant amount of the equity you’ve accumulated over the years on interest and loan fees. Also, you likely won’t be able to pass your home down to your heirs.
Sell With David Pannell
If you have a desire to cash out the equity in your home and a reverse mortgage isn’t for you, David can sell your home for you quickly, and often above the asking price.
David has been a realtor since 2007 and has been part of thousands of successful real estate transactions for both buyers and sellers. Call him today at (817) 797-9047.