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What Exactly is a Reverse Mortgage?

By
Mortgage and Lending with Reverse Mortgage Consultant

What exactly is a reverse mortgage? (Technically known as a HECM - Home Equity Conversion Mortgage).House on Coins

It is simply a loan against a home, just like a "forward" mortgage, in many respects.  Let's say you buy a home and get a mortgage from Moneybags Lending for $200,000.  Now Moneybags Lending has a lien against your home for that amount.  You now have to start making monthly payments to the lender until the loan is paid off or you either sell the home or refinance it (which has the effect of paying off the loan).  We are all familiar with these types of loans.

A reverse mortgage is very similar.  You borrow X amount of money from Reverse-R-Us Lending Company.  The lender now has a lien against your home and will expect repayment.

Here's where the difference between a "forward" loan and a "reverse" loan gets interesting.  Both loans are debts against the property and both loans must be repaid.  However, the reverse mortgage does NOT have to be paid back while the borrowers (or one borrower) live in the home.  In other words, there are NO monthly payments to be made to the lender as with a regular "forward" mortgage.

This is where most folks get "that" look on their face and they say:  "Sylvia, what is the catch?  This sounds too good to be true".   And I would reply to them that the lender WILL eventually get paid.  In fact the lender will get paid the principal AND the interest, just like in a regular mortgage.  It's just a matter of WHEN the lender gets paid.  With a "forward" mortgage, the borrower is paying back both principal and interest each month (depending on the type of loan).  With a reverse mortgage, the lender doesn't get repaid until the borrowers leave the home permanently, whether through death of the last borrower or if the borrowers sell the home.  At that point, the entire loan balance PLUS interest that has accrued over the years, is due.  So rather than getting the money paid back over time, the lender gets it all at once.

You might be thinking: "Wow - that must be a lot of money someone has to come up with, right?"  Not exactly.  Here is how it works:  Let's say that Mr. & Mrs. Borrower took out a reverse mortgage.  Years later, Mr. Borrower dies. Mrs. Borrower continues to live in her home with no monthly loan payments due (in fact she might have been drawing funds from the reverse mortgage to help supplement the income she lost when her husband died, but that is for another Blog).  Then one day Mrs. Borrower passes away. 

At this point, the lender will want repayment (although in reality, lenders allow the heirs time - from several months up to a year or more - to settle the loan).  Here are a couple of possible scenarios:

1.  The home is worth more than the loan balance.  The kids have some choices.  They could sell the home and pay back the reverse mortgage lender (just as if the folks had a forward loan balance).   Any remaining equity goes to the heirs.  Or, maybe they want to keep the home, in which case they will have to get conventional financing to pay off the reverse loan balance.

2.  The home is worth less than the loan balance (in other words, there is negative equity or the home is "underwater" which has become a popular term recently).  In this case, the heirs could simply walk away and let the lender deal with it.  

How is that?  A reverse mortgage is a non-recourse loan, which means the total amount owed at the end of the loan can never exceed the current value of the property. The borrower and the borrower's heirs are always protected in a situation where the loan value is greater than the property value. Because reverse mortgages are FHA loans, this protection is guaranteed by the Federal Housing Administration (FHA).

I am often asked, "Is a reverse mortgage a good thing"?  And my response is "It depends".  They are neither good nor bad in and of themselves.  That would be like asking "Is water a good thing"?  (It wouldn't be if you were drowning!).  It depends on each person's situation and circumstances. 

The better question to ask is this:

"Is a reverse mortgage appropriate in this situation?"  And, that question cannot be answered without a thorough understanding of the potential borrower's financial situation, goals, health, and lifestyle.

So there you have it in a nutshell - that is how a reverse mortgage works.  It appears simple, and it is.  But there is a lot more to know and understand about reverse mortgages such as:

  • How to qualify
  • Types of reverse mortgages
  • Interest rates
  • Fees
  • Homeowner obligations
  • How to determine the amount of money available
  • Different ways to take those proceeds
  • And more!

We'll save those topics for future Blogs.....Stay tuned!

 

Ed Urbaniak
The Chin Sells Team at Weichert Realtors - Fairfax, VA

Too often, the reverse mortgage has a bad rep and people think that they can lose their home.

Feb 01, 2011 01:18 PM
Sylvia Williams
Reverse Mortgage Consultant - Elk Grove, CA
Ed.D

Ed - You are so right!  I am always amazed at the misconceptions that still abound.  Actually, if you think about it, folks are at LESS risk for losing their homes with a reverse mortgage than with a regular mortgage because they don't have any payments to get behind on!  Lot's of my clients would have been foreclosed on by now had they not paid off their mortgage with a reverse.  Thanks for your comment!

Feb 01, 2011 01:31 PM