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If you’re an older homeowner seeking extra funds who still owes money on your mortgage loan, you may benefit from a reverse mortgage. This loan option for homeowners age 62 or older allows them to convert a portion of their home’s equity into cash, pay off their existing loan, and pocket extra dollars at closing.
But it’s important to understand how a reverse mortgage works and what’s involved before committing to this new loan arrangement.
How a reverse mortgage works
With a traditional mortgage loan, you borrow money to purchase or refinance a home and then make monthly payments to the lender over a set term, often between 15 and 30 years. But with a reverse mortgage, the lender pays you, the homeowner, by liquidating some of your home’s accrued equity.
You can choose to receive these funds (which are not considered taxable income) either as a lump sum, a line of credit, or via monthly payments provided by the lender.
You aren’t required to pay back what you borrow until you permanently move out of the home, sell the home, or pass away. If the latter occurs, your heirs/beneficiaries will be responsible for repaying your reverse mortgage loan debt, which usually occurs after they sell your residence.
Or, they can opt to refinance into a conventional mortgage or use their personal funds to buy the home for the loan amount due or 95% of the home’s appraised value (whichever is lower), or transfer the title to the lender and disengage from the loan.
With a reverse mortgage loan – including the most common type, a federally insured Home Equity Conversion Mortgage (HECM) – interest and fees are added to the loan balance monthly and the balance grows over time, unlike a traditional mortgage. As your loan balance increases, your equity in the property decreases.
In addition to remaining in your property as your primary residence, you must pay property taxes and homeowners insurance and maintain the home. Ownership of your home remains in your name. To obtain an HECM, you must be at least 62 years old and undergo a financial evaluation to verify your willingness and ability to fulfill the loan’s financial commitments.
Additionally, attending a counseling session is mandatory to ensure comprehension of the loan terms and the eventual repayment obligation.
Say goodbye to your existing mortgage
Numerous borrowers opt for a reverse mortgage because they desire additional funds to cover their expenses during retirement. Many have already paid off their home and no longer have a mortgage loan.
But even if you’re still financing your property, you can qualify for a reverse mortgage, so long as you have paid down at least half of your mortgage loan.
In fact, the reverse mortgage will replace your current mortgage loan. That’s because any existing balance from a primary mortgage loan, meaning a loan in first lien position, is required to be paid off first from your reverse mortgage loan proceeds.
Additionally, any other existing liens, including equity lines or judgments, must be repaid in full to qualify for a reverse mortgage.
The bottom line? You won’t have to worry about paying back two mortgage loans—only the reverse mortgage loan will remain.
» MORE: See today’s refinance rates
Worthy prospects for a reverse mortgage
“Homeowners who might be experiencing difficulties paying bills, funding needed home repairs, or affording health care can be good candidates for a reverse mortgage,” says Neil Christiansen, branch manager and certified mortgage advisor with Churchill Mortgage. “Obtaining one can improve cash flow and enhance the quality of life for someone on a fixed income. And if you have a significant amount of retirement savings in real estate, drawing part of your cash from home equity can help your traditional retirement funds and accounts last longer.”
Let’s say you have a remaining mortgage balance of $100,000 at a fixed interest rate of 4% in a home valued at $300,000. If you take out a reverse more for $150,000, you will pay off your primary mortgage debt, thereby eliminating $4,000 annually in interest.
If you opt to receive monthly reverse mortgage payments, you can count on getting $750 per month tax-free, allowing you to age more comfortably in place with wider financial flexibility.
Noah Gomez, a consumer credit specialist and founder of ThickCredit, says the theoretical perfect candidate “is someone without heirs, 100% ownership in their home, and a high home value. But any cash-strapped retiree with at least 50% home equity may want to consider a reverse mortgage.”
However, if you aren’t planning to remain in your home for an extended period, a reverse mortgage may not be your best option, as it’s more ideal for older homeowners who plan to age in place.
Disadvantages to ponder
“The downsides of a reverse mortgage include the accumulation of interest owed over time, decreasing home equity, and the potential impact on property inheritance for heirs,” says Ryan Zomorodi, COO and co-founder of Real Estate Skills.
Also, homeowners with significant existing debt or who need a swift financial solution should ponder other forms of financing.
“The closing costs involved with acquiring a mortgage, including origination and servicing fees, can be expensive. Potential applicants must carefully analyze their financial condition, consider their long-term housing plans, and ideally consult with a financial professional to determine whether a reverse mortgage is appropriate for their goals and needs, especially if heirs are involved,” Andy Kolodgie, CEO/co-founder of Sell My House Fast, suggests.
Personal finance expert Andrew Lokenauth points out another potential drawback to a reverse mortgage.
“Your home’s value must cover the loan balance upon repayment when you sell the home or pass away. That means there is a risk that you or your heirs may owe more than your home is worth when it’s time to repay the debt,” he cautions.
Weigh the alternatives
Do your due diligence before plunging into the reverse mortgage pool and consider other viable options, the experts agree.
“Choosing a home equity loan, home equity line of credit (HELOC), or cash-out refinance of your existing mortgage can provide quick access to needed funds. Or, consider downsizing to a smaller home, which can release equity by relocating to a more affordable house,” recommends Kolodgie.
If necessary, take on a part-time job or side hustle.
“Odd jobs or gig work can generate additional text income without incurring any further debt,” Lokenauth adds.