Reverse mortgages may seem like a strange product. How can you borrow money without having to pay it back? But it all makes sense, once you understand how they work.
A reverse mortgage is a special type of home loan for seniors age 62 and above. They allow you to borrow against your home equity but not have to make any loan payments as long as the home remains your primary residence. The loan is eventually repaid when the borrowers either die or vacate the property, usually with the proceeds from selling the home.
Because they allow you to continue to enjoy the use of your home without having to make loan payments, reverse mortgages can be an attractive option for seniors on a limited income. But many seniors don't fully understand how they work, so they don't apply for a reverse mortgage, even though it would be a good choice. Others misunderstand how the entire process works, but agree to one anyway.
If you're thinking about a reverse mortgage, here are four common misunderstandings.
1 - It's not a home equity loan
Yes, it is. With both a reverse mortgage and a traditional home equity loan, you turn a portion of your unused equity into cash. But that's where the similarity ends.
With a standard home equity loan, the bank gives you cash and you immediately begin paying it back. With a reverse mortgage, you don't make any payments until you move or pass away.
Also, to qualify for a traditional home equity loan, you must have income, low debt, and a good credit rating. With a reverse mortgage, those factors are largely irrelevant, since you don't have to make loan payments. (You do need enough financial resources to pay your property taxes and home insurance - though those can sometimes be paid out of the reverse mortgage).
2 - Your family can't inherit your home
A common reverse mortgage misunderstanding is that the bank gets your home once you die or move out. Not true. The bank is only entitled to collect the outstanding balance on the loan. If your home sells for more than what you owe, you or your heirs are entitled to keep the difference.
If you or your heirs wish to keep the home in the family, the reverse mortgage can be repaid from other assets. Your home equity only guarantees the loan – it doesn't mean you've signed your home over to the bank.
3 - You can borrow unlimited funds
The amount of money that you can borrow depends on the appraised value of your home, how much equity you have, and your age. Generally speaking, the older you are, the more money will be available to you. If you choose an FHA-insured reverse mortgage (HECM), which accounts for 80 percent of the market, there are limits on how much you can borrow.
In any event, you can't borrow 100 percent of your available equity. Part of it will always be held as a cushion to cover accumulating interest charges and fees.
There is one payment option, called a tenure, where you can arrange to receive regular payments for as long as you stay in the home. Depending on how long it is, it's possible that the amount you receive and your interest charges could eventually exceed the what your home is worth. However your debt obligation is still capped at what the value of your home.
4 - You can't lose your home
One of the attractions of a reverse mortgage is that you can never lose your home for failing to make loan payments, because no loan payments are required as long as the home remains your primary residence. And you can never be obligated to repay more than your home is worth.
However, you can still lose your home if you fail to keep up with your property tax payments or homeowner's insurance. You're also required to properly maintain the home. If you fail to do any of those, the bank can require that you repay the loan. If you can't afford to do that you may have to sell.
Once you understand how a reverse mortgage works, you can decide if it's a good choice for you and, if so, apply for one with confidence.