What is a Reverse Mortgage?
A reverse mortgage is a loan available to homeowners, 62 years or older, that allows them to convert part of the equity in their homes into cash.
The product was conceived as a means to help retirees with limited income use the accumulated wealth in their homes to cover basic monthly living expenses and pay for health care. However, there is no restriction how reverse mortgage proceeds can be used.
The loan is called a reverse mortgage because instead of making monthly payments to a lender, as with a traditional mortgage, the lender makes payments to the borrower.
The borrower is not required to pay back the loan until the home is sold or otherwise vacated. As long as the borrower lives in the home he or she is not required to make any monthly payments towards the loan balance. The borrower must remain current on property taxes, homeowners insurance, and homeowners association dues (if applicable).
Features of Reverse Mortgages
With a reverse mortgage, the borrower always retains title or ownership of the home. The lender never, at any point, owns the home even after the last surviving spouse permanently vacates the property.
The amount of funds that a borrower is eligible for depends on the person's age (or age of the youngest spouse in the cast of couples), home value, interest rates and upfront costs. The older someone is, the more proceeds he or she may receive.
There is a limit on the amount of funds a borrower can access during the first 12 months after closing. If a borrower is eligible for a $100,000 loan, for example, no more than $60,000, or 60 percent, can be accessed. In month thirteen, a borrower can take as much or as little of the remaining proceeds as he or she wishes. There are exceptions to the 60 percent rule. A borrower can withdraw a bit more if there is an existing mortgage, or other liens on the property, that must be paid off. A borrower can withdraw enough to pay off these obligations, plus another 10 percent of the maximum allowable amount. That's an extra $10,000, or 10 percent of $100,000.
Lenders must conduct a "financial assessment" of every reverse mortgage borrower to ensure the person can afford to live in the property and pay future property taxes and homeowners insurance, over the life of the loan. Lenders look at all of the borrower's income streams, including Social Security, pensions and investments. Reverse mortgage borrowers must also provide tax returns and bank account statements to help document income and expenses. Any credit trouble (i.e., late payments) must be explained. The lender determines whether the explanation qualifies as an "extenuating circumstance" in getting the reverse mortgage approved.
The lender subtracts what the borrower pays for taxes and insurance, debt obligations and other living expenses from the borrower's income and assets. The resulting "residual income" is the amount of money left over each month. This figure is compared to a government threshold amount (based on region and family size) that determines whether a borrower has enough monthly residual income to pass the assessment.
If the borrower passes the financial assessment, they can proceed with the getting the loan. If, however, the lender determines that the borrower does not have adequate cash flow, the borrower's loan application can be declined, or all (or most) of the available loan proceeds will be placed in a Life Expectancy Set-Aside and used specifically to pay property taxes and homeowners insurance for as long as those funds last.
