Reverse Mortgage is a general term. There are proprietary reverse mortgages and the FHA Home Equity Conversion Mortgage (HECM) reverse mortgage. It is a financial product that when used correctly with a plan in place can be the fourth bucket of money in retirement planning.
It can be confusing because there is a lot of incorrect information floating around out there. The bank doesn’t own your home, you retain Title. Your family will not have an inheritance. That could happen with a traditional loan or a Reverse. It’s all how you structure a loan and the plan you put in place and stick to how much you want to leave for your family.
There is a lot of controversy about this loan, much of its old news, financial gurus such as Dave Ramsey or Suze Orman are against these loans because they are debt adverse in general.
They don’t like the cost of the loan; however, they don’t take into account the organic value that increases your equity without you doing a thing except purchasing the home in the first place.
They are afraid that if you don’t manage your money properly and don’t pay your taxes, homeowners’ insurance, and keep up with the property maintenance the Reverse Mortgage bank will foreclose. A Conventional bank will do exactly the same.
Lastly, they do not like the compounding interest. As I mentioned earlier, with the right plan and structure of the loan, there is a way to reduce that. Amazing how many Financial Advisors nationwide are incorporating the Reverse Mortgage in their client’s asset plans.
With Ramsey and Orman, however; if you have no pension, and social security isn’t enough to pay utilities, groceries, property taxes and homeowners’ insurance, then what can you do? Sell the home and rent? Sell the home and downsize to a smaller home? Sell the home and move in with family?
How do you want to live your life is the question that you must answer. Look ahead five years from now with nothing changing. Is that the life you want? Family and friends can give you advice, but it is your choice in the end, and you must be happy with that choice.
First let me explain that a Reverse Mortgage whether a refinance on your current home or a purchase money loan on a new home is exactly the same as having a traditional conventional mortgage lien on your home.
Your home is not a liquid asset. In order to make the equity in the home liquid you need to use the home as collateral to get “cash out” in the form of a loan.
The way the loan amount is determined is by the value of your home, your age, and an algebraic formula like life insurance accuracy tables. It is not based on the current equity you have in your home. There is no LTV or loan to value percentage that traditional banks use. A traditional loan LTV can be as high as 90%. With a Reverse Mortgage loan, we want at least 60% of your equity to remain in the home.
Minimum age for the FHA government insured loan is 62 nationwide, and minimum age for the proprietary (private) reverse mortgage is 55 in most states. If a spouse is younger than 62, the loan can still be done, but the loan amount will be based on the younger spouse. Hence, even more equity retained in the property, for your heirs.
So, how does it work? Basically, it is a cash out refinance. With a traditional loan, you go to your bank and say you’d like to refinance your current loan to take “cash out” of your equity, the bank determines a new loan amount. As an example, you owe $200,000, and you need $100,000. The bank determines that the new loan amount will be $300,000. They pay off the existing loan from the new loan amount and the remaining $100,000 of the loan are proceeds or cash-out which goes to you. Exactly the same with a Reverse Mortgage.
You sign a promissory note, and a Trust Deed (or Mortgage) lien is recorded against the home and released once the “monies” are paid back in full.
The difference between a Reverse Mortgage loan and a Conventional loan is making a monthly payment and when the loan becomes due. In the end both loans need to be repaid.
With a Conventional loan you must make a monthly payment. Interest accrues on the balance each month and you receive a statement to pay the interest due + any monies that go towards the principal balance. Very little is applied to the principal balance in the first 9-11 years. The loan balance decreases over time.
With a Reverse Mortgage loan, you are not required to make monthly payments. The interest accrues on the balance; you receive a statement showing the interest due. You can pay the interest due if you like, but if you do not want a mortgage payment, then each month the interest due is added to the balance; therefore, the balance increases.
In a nutshell you either pay monthly on the loan until it is paid in full or sell the property and pay off the loan at that time. In the case of a Reverse Mortgage all monies due are paid upon death of all borrowers on Title, refinance of the loan or sale of the property.
With either loan upon sale any equity/monies left over after repayment of the loan is kept by the property owner, estate or the heirs.