What is a Reverse Mortgage, and How Does it Work?

A new form of loan has gained prominence in recent years among homeowners who have a lot of equity in their home, but need cash on hand. Known as a ‘reverse mortgage,’ this type of debt instrument has existed for a few decades now, but has exploded in popularity in the 21st century. If you’re in need of a loan, and you own your own home, then this may be a good option for you. It’s recommended that you consult with your lawyer first, though, to ensure that a reverse mortgage really is the best way for you to go.

Reverse Mortgages Defined

Most people are familiar enough with the concept of a mortgage. When you want to buy a house, you go to a bank or other lender and take out a loan for the purchase price (minus your down payment). The loan is debt, which must be paid back to the lender, plus interest. As you gradually pay off the loan over time, your home equity increases, and when you pay off the loan entirely you own the house free and clear.

A reverse mortgage, as its name implies, works in the opposite way. This type of mortgage allows a homeowner to take out a loan against the value of their home, and is structured in a way that prevents the amount of the loan from exceeding the value of the home. During the life of the loan, the lender makes monthly payments to you in an amount based on the value of your home. It is also possible to receive payment in a lump sum up front. You retain title to your home the entire time, but your debt will gradually increase while your home equity decreases. No payments of the reverse mortgage are due until after the homeowner dies or moves. When you do die or move, though, the lender will recover the money they paid you from the proceeds. Any residual equity will go to you or your heirs.

It’s possible for the property to be foreclosed upon under a reverse mortgage. For example, if you fail to abide by your contractual obligations under the mortgage agreement, the lender can foreclose. Possible breaches include failing to pay property taxes, failing to obtain homeowner’s insurance, or failing to adequately maintain the property.

Types of Reverse Mortgages

There are three main types of reverse mortgage: Single-purpose reverse mortgages, federally-insured reverse mortgages, and proprietary reverse mortgages. A single-purpose reverse mortgage is typically offered by state or local agencies, or sometimes by a nonprofit organization. These types of reverse mortgages are intended for lower-income homeowners to pursue a particular purpose, such as paying property taxes or replacing the roof. The entity making the loan has discretion to approve or deny the use of the reverse mortgage funds.

The federally-insured reverse mortgages, also known as Home Equity Conversion Mortgages (HECM) are issued by private banks and insured by the Federal Housing Administration. There is no income restriction, age requirement, or medical status needed to qualify for this type of reverse mortgage. However, the maximum amount that you can obtain under this type of loan is the residence’s appraised value or $625,500, whichever is less.

Finally, proprietary reverse mortgages provide an alternative for those who would like a loan for an amount higher than the HECM cap. Keep in mind, though, that these mortgages are much more expensive and do not come with the protection of being federally insured like an HECM.

How to Qualify for a Reverse Mortgage

Because HECMs are the most common type of reverse mortgage, we’re going to focus on the process for obtaining one of those. If you would like to apply for a different type of reverse mortgage, contact a real estate attorney, like Adam Leitman Bailey, P.C., for assistance. To qualify for an HECM you must: be at least 62 years old, own your home or have a low mortgage balance, hold legal title to your home and live in it as your primary residence, be current on all federal debt, be able to afford all property expenses, and participate in a consumer information session offered by a HUD-endorsed counselor.

In addition to you meeting the requirements above, your home itself must also be: free of all liens, a single-family home or two-to-four unit home, a HUD-approved condo or townhome, or an FHA compliant manufactured home.

Conclusion

This concludes our basic primer on reverse mortgages. There is more to consider when weighing the pros and cons of whether this type of mortgage is right for you, and these are best discussed with an experienced real estate attorney.

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