Ever wander how does a reverse mortgage work? Well you are not alone. With so many baby boomers approaching the retirement age many seniors simply do not have the financial resources that they had hoped for. The economy has taken its toll on many and retiring in comfort is simply not an option for many seniors. However the reverse mortgage loan may be just the thing to ease the financial stress that comes with retirement. In the next couple of paragraphs we will answer what is a reverse mortgage and how it works.
How Does a Reverse Mortgage Work for You?
So how does a reverse mortgage work? Well a reverse mortgage loan is not much different than a regular mortgage. The main difference is the reverse home loan is designed for seniors of the age of 62 or older and is structured in a way that lets seniors access the equity in there home. So instead of paying a monthly mortgage you can actually receive a monthly payment from the equity in your home. Simply put, a reverse mortgage is exactly what it sounds like. Instead of paying the bank each month for your home, the bank pays you each month for your home; it’s a mortgage in reverse. How a reverse mortgage works is that you convert the equity in your home to cash that you can use for retirement or other expenses that you might have. Lets take a closer look at how a reverse mortgage works. So lets say you’ve paid off your home and now it is worth $250,000. As a home owner of the age of 62 or older you would be able to tap into a portion of the home value and receive either a lump sum or monthly payments. The important part to remember is that you must live in your home. The loan does not have to be paid back until you are no longer living in the home as your primary residence or you have become deceased. At that point, the loan must be repaid or the bank will take ownership of the property. So in a nutshell the benefits of the reverse mortgage is that you get to stay in the comfort of your own home while tapping into the equity and not worrying about paying it back monthly like a traditional mortgage.
Different Types of Reverse Mortgages
There isn’t just one reverse mortgage loan type out there. There are actually three different types, and while Home Equity Conversion Mortgages (HECM) are most commonly used by homeowners, it’s important to understand what the other two offer.
A single purpose equity mortgage allows you to convert your equity into funds for one single purpose. Examples include home renovations, a utility bill, etc. This loan has a very low starting cost and does have some income restrictions. Because it is limited to only paying off one expense, it may not give you all the funds you need to truly enjoy your retirement.
A proprietary reverse mortgage is usually tied to a private company. Although it has very few qualifications, it does require the highest fees, such as those for origination, credit reports, appraisals, and other closing costs.
The HECM, as I said above, is meant to cover any needed expenses and is the most popular of the three types of reverse mortgages. These are insured by the Federal Housing Administration and afford far more reliability and less risk. This is the type of reversed mortgage that I’ll focus on.
Reverse Mortgage Costs Explained
When you’ve reached retirement but you have to pay high medical bills and additional expenses, your home becomes your biggest asset. But does turning your equity into cash sound a little too good to be true? Keep in mind that a reverse mortgage is a loan, so there is a cost associated with it. To find out if a mortgage reverse would be beneficial for you in your situation, calculate the cost and benefits. Here’s a simple list of what you pay the bank in exchange for the reverse mortgage loan:
What You Pay the Bank
- Origination fees
- Mortgage insurance premium
- Title fees
- Credit report
Actual costs will vary depending on what type of loan you choose and which lender you’re doing business with. For the most part, however, reverse mortgages come with a lot of fees, making them more expensive than traditional home loans in most cases.
Taking a look at each fee independently, the HECM origination fee cannot be any higher than $6,000 and costs 2 percent of the home’s value. The cost of the mortgage insurance premium depends on how much you withdraw during the first year. So if you take out less initially, you pay less initially. The mortgage insurance premium costs 2.5 percent of the home value when you withdraw over 60 percent of what is available to you. However, if you take out 60 percent or less, that fee is cut to just 0.50 percent. An annual mortgage insurance premium is also charged, and unlike the initial premium, this one accrues over time and must be paid when the loan is due (when the owner no longer lives in the home).
To get an appraisal on the home (determining its value) you must pay another fee, which usually comes out to $450 on average. Other closing costs usually add up to around $1,000, though this varies greatly depending on your loan and lender.
How Much Can You Borrow?
Unlike traditional home loans, reverse mortgages increase over time. Because of this, no one can borrow 100 LTV (loan to value). Otherwise, you would very quickly owe much more than your home was worth. Lenders determine how much each homeowner can borrow through a principal limit factor (PLF). The PLF is calculated based on these factors:
- Current mortgage rates
- Age of youngest borrower
- The borrower’s ability to manage debts
- The amount of the initial mortgage insurance premium
A reverse mortgage calculator is also a helpful tool to help you determine how much you can borrow. If you would like to get a more accurate number on how much you can borrow give us a call now at (855) 667-9290 our reverse mortgage experts are here for a no obligation FREE consultation for tailored for your situation.
Reverse Mortgage Example
If the explanations above don’t paint a clear enough picture of a reverse mortgage, how it works, take a look at this reverse mortgage example:
Betty, 65, owns a home that is appraised at $250,000. With a PLF of .50, she can borrow $125,000 of that amount. She chooses to take out the money over the course of a term worked out between her and the lender. In other words, she gets paid $1,000 each month for 10 years. She lives quite comfortably with those added funds and gets the retirement she always dreamed of. After 10 years have passed, Betty decides to live with her only son, David, and at the end of those 10 years, Betty now owes $120,000 (the principal amount) on her home. Since she no longer lives in the home, she must sell the reverse mortgage home, and the funds go towards paying off that principal amount and the added interest rates and fees.
Could you benefit from a reverse mortgage loan? Give us a call now at (855) 667-9290 for more information on how does a reverse mortgage work?. Click here to take a look at some of the Reverse Mortgage FAQ’s