It’s no wonder the reverse mortgage is one of the most misunderstood mortgage products around. That was fine when reverse mortgages were an exotic loan product that few people purchased. However, more than 1 million have been sold since the government program that insures them started in 1990.
So, what is a reverse mortgage? A reverse mortgage is a loan that uses a primary residential home as collateral. In that sense, it’s like a traditional mortgage. However, unlike regular mortgages, the amount a borrower owes on a reverse mortgage increases over time, and payment is only due when the homeowner no longer lives in the property.
There are three main types of reverse mortgages. Most of them – around 90 percent – are insured by the Federal Housing Administration. There is the standard HECM, which you can use as a line of credit, a monthly installment or a lump sum. There is also an HECM for Purchase, which borrowers use to buy a home and finally there’s an HECM Refinance, which allows you to convert an existing HECM into a new HECM, to either benefit from lower rates or borrow more money.
What are the benefits and disadvantages? The main benefit of a reverse mortgage is that the borrower’s credit is not a deal breaker when it comes to approval. The key factors are the value of the house, the loan amount and the age of the borrower.
In 2018, senior home equity hit $6.8 trillion and it continues to grow. This makes reverse mortgages a particularly attractive option for some senior homeowners. Note that even if the value of your home drops, the homeowner’s heirs will never owe more than the value of the home when it is sold.
If the value of your home holds or rises, the homeowner or the heirs could be left with some equity when the house is finally sold. As long as property taxes and insurance is paid, they can never be forced to leave the home. These are attractive benefits for elderly homeowners who are struggling to make ends meet.
However, there are serious disadvantages to consider. For example, reverse mortgages reduce the inheritance you leave for your heirs. Unless they pay off the reverse mortgage, they will not inherit the house. Also, HECMs are not cheap. They are expensive when compared to home equity lines of credit and second mortgages, particularly when you consider the mortgage insurance premium.
Something important to consider is that fees and costs vary significantly from one reverse mortgage to another. Homeowners can save a great deal of money by shopping around and comparing terms. It pays to shop around and get quotes before choosing a lender. You are also restricted from leaving your home for more than a year, and there is no annual tax deduction for interest.