How a reverse mortgage loan works using a home's equity.
How a reverse mortgage loan works and how to apply.
Whether seeking money to pay for medical treatment, finance a home improvement, buy long-term care insurance, or supplement income, many older Americans are turning to a "reverse mortgage." A reverse mortgage allows older consumers to convert the equity in their homes to cash while retaining home ownership.
With a "regular" mortgage, you make monthly payments to the lender. But with a reverse mortgage, you receive money from the lender and generally do not have to repay it for as long as you live in your home. In return, the lender holds some — if not most or all — of your home's equity.
Introduced in the late 1980s, reverse mortgages can help homeowners who are "house-rich-but-cash-poor" remain in their homes and still meet their financial obligations. The proceeds of the loan are tax-free, there are no minimum income requirements, and for most reverse mortgages, the money can be used for any purpose.
If you're considering a reverse mortgage, it's important to understand how the loans work and what your rights and responsibilities are.
Types of reverse mortgage loans:
the federally insured Home Equity Conversion Mortgage (HECM), administered by the Department of Housing and Urban Development (HUD)
single-purpose reverse mortgages, usually offered by state or local government agencies for a specific reason
proprietary reverse mortgages, offered by banks, mortgage companies, and other private lenders and backed by the companies that develop them.
To qualify for a reverse mortgage, you must be at least 62 and have paid off all or most of your home mortgage. Income is generally not a factor, and no medical tests or medical histories are required. If you seek an HECM, you also must undergo free mortgage counseling from an independent government-approved "housing agency." Financial institutions offering proprietary reverse mortgages may require similar counseling or homeowner education.
The amount you can borrow depends on your age, the equity in your home, the value of your home, and the interest rate. If it's an HECM, federal law limits the maximum amount that can be paid out.
You can be paid in a lump sum, in monthly advances, through a line of credit, or a combination of all three.
Section 226.33—Requirements for Reverse Mortgages
33(a)Definition.
1.Nonrecourse transaction. A nonrecourse reverse mortgage transaction limits the homeowner's liability to the proceeds of the sale of the home (or any lesser amount specified in the credit obligation). If a transaction structured as a closed-end reverse mortgage transaction allows recourse against the consumer, and the annual percentage rate or the points and fees exceed those specified under § 226.32(a)(1), the transaction is subject to all the requirements of § 226.32, including the limitations concerning balloon payments and negative amortization.
Paragraph 33(a)(2).
1.Default. Default is not defined by the statute or regulation, but rather by the legal obligation between the parties and state or other law.
2.Definite term or maturity date. To meet the definition of a reverse mortgage transaction, a creditor cannot require any principal, interest, or shared appreciation or equity to be due and payable (other than in the case of default) until after the consumer's death, transfer of the dwelling, or the consumer ceases to occupy the dwelling as a principal dwelling. Some state laws require legal obligations secured by a mortgage to specify a definite maturity date or term of repayment in the instrument. An obligation may state a definite maturity date or term of repayment and still meet the definition of a reverse-mortgage transaction if the maturity date or term of repayment used would not operate to cause maturity prior to the occurrence of any of the events recognized in the regulation. For example, some reverse mortgage programs specify that the final maturity date is the borrower's 150th birthday; other programs include a shorter term but provide that the term is automatically extended for consecutive periods if none of the other maturity events has yet occurred. These programs would be permissible.
Subordinate
loans, or a second
mortgage, can be difficult if the loan goes into default. It this happens, the
first mortgage gets paid off, before the second one. That makes second mortgages
more of a risk for lenders, and they can have a higher interest rate. Term lengths of a 2nd mortgage
varies, and could last up to 30 years. Yet, the repayment may be required in a year, depending on the
payback structure. These are secured mortgages, making them subordinate to another loan against the same property.
Real
estate property can have multiple mortgages or liens, and the mortgage, when it
is registered with the county or city registry, it is called the first mortgage.
A lien registered second, is called the 2nd mortgage. Properties can have three
or four mortgages even though it is rare. When a homeowner defaults on a loan,
the second lien holder could purchase the primary mortgage. They could then
foreclose and the homeowner would lose their home to the second mortgage lender.
Examples
of what a lender may look for from 2nd mortgage applicants:
*
Equity in the first mortgage.
*
Small debt-to-income ratio.
*
Good credit scores.
*
Good employment history.
People
take out second mortgages usually to finance something expensive they want, but
they do not have the money. It may be for a college education, to remodel or
repair a home, for a boat, an auto or any other thing the borrower chooses. The
money could even be used to get out of debt. Home equity lines of credit, a HELOC,
is a revolving credit line that uses a home for security. When a home already has a first mortgage, the HELOC will take second
place and lacks an amortization schedule, most are recourse loans. This means the lender can pursue the borrower personally for the amount of the loan
if there is a default. If the lender is not made whole after a foreclosure sale, they have the right to take further
action.
Don't want a
reverse mortgage loan?
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Reverse mortgage - Information about the benefits of a reverse mortgage.
Home equity loan - Refinance your first mortgage and take cash out at closing.
Home remodeling loan - Use your home's equity to finance a remodeling project and increase home value.
Mortgage refinance loan - For a home equity line of credit, you may want to think about a traditional second mortgage loan.
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