Reverse Mortgages: How Do They Work?
A reverse mortgage is a loan provided to a homeowner by a lender. Like a traditional home mortgage, a reverse mortgage is secured by the underlying home. However traditional mortgage borrowers are required to make monthly payments that reduce the loan, eventually paying off the balance. Conversely, reverse mortgage holders make no payments, and the loan balance grows larger over time due to the accrual of interest charges and fees. Homeowners may borrow a portion of the home’s equity determined by a combination of factors, including the age of the youngest borrower, the current value of the home, and prevailing interest rates.
Repayment of a reverse mortgage is not expected until the final homeowner has moved away or is deceased. Borrowers may continue to live in their home until that time, but must pay property taxes and homeowner’s insurance, as well as maintain the home in keeping with Federal Housing Administration (FHA) requirements. Bear in mind that you may need to set aside funds to cover those obligations.
Reverse Mortgage In Action
Imagine this hypothetical scenario: An FHA authorized appraiser values a couple’s home at $450,000, and they owe $100,000 on the existing mortgage. The pair is 69 and 72 years old respectively, and are in need $40,000 to complete a home renovation project. Based on those numbers and an initial total loan rate of 4.925%, their loan principal rate would be approximately $228,000. Fees and closing costs would round up to $20,000. After paying off the balance of the original mortgage, the homeowners would be left with available proceeds of about $108,000*, which they may take in increments or in one lump sum.
*It is important to note that the amount of proceeds available to the borrower may be limited in the first year following the origination of the loan, and may be reduced to allow for insurance and property tax payments.