Eli5: What is a reverse mortgage?
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You sell your house to the bank but they agree to let you live there rent free until you die.
(Be extremely careful of the fine print. It will include exactly what circumstances will allow them to kick you out before you die.)
You agree with a bank for them to lend you money based on your house as collateral. But with no intent to pay it back, except by selling your house. Usually the house is sold when you die, or when you move to a retirement home.
You’re effectively selling off your home equity for cash in monthly installments.
Loan is due at time of death (no sooner unless there’s a sale or a specific clause).
Interest is compounded monthly based upon the amount of money in total that the bank has given you.
You give someone your house. How nice of you. They give you a couple bucks a month to make it feel like you are getting some magical deal. You eventually pass away. They keep the house you gave them. End of story.
For simplicity sake, say you have paid off the mortgage on your house and own it outright. Taking out a reverse mortgage is just a loan, but your house is the collateral. However, as opposed to a Mortgage or a HELOC, the point of a Reverse Mortgage is essentially that you get “Free money” and never pay the loan back. You default on the loan and the bank takes your collateral instead (Your house).
In general a Home Equity Loan is a better option – you still get a loan collateralized by your home, but payments are scheduled and you’re expected to pay the loan back with interest rather than lose your house. Your kids would vastly prefer the latter
With an ordinary mortgage, you borrow money and buy a house, then pay monthly to pay off the debt.
With a reverse mortgage, someone buys your house a bit at a time, paying you monthly to be allowed to have your house when it is either paid off or you either die or go to a nursing home.
They are tricky and you need to make certain you understand both the reverse mortgage and your long-term needs. Sometimes they are a great way to use your house to fund your retirement. Other times they are a great way to lose your house in your twilight years.
They’re for old people who can’t afford their monthly expenses. Instead of dying and leaving a home to their heir(s), they slowly sell it to the bank and use that money now.
Upside is that someone can maintain their standard of living even after spending all of their savings.
Downside is that their children will have a much smaller inherence since they were selling off their biggest asset and spending it before death.
If someone is considering a R-Mortgage, you may consider moving in together instead to save money and preserve their wealth.
It lets you borrow money at high interest rates, but in theory you do not have to pay it back until you are dead.
Pros:
1) If you live for a long time, the money you borrow plus interest might be more than the value of the house. You win!
2) Even if you die before the borrowed amount exceeds the value of the house, you never worried about the borrowed value exceeding the value of the house.
Cons:
1) If you have to sell the house, then you just took a very high interest loan over many years.
2) The companies that offer reverse mortgages are not idiots, it is unlikely that the value of your loan will ever exceed the value of your house. That means that you rarely “win”, and most likely just take a high interest loan.
Remember that not everyone gets to die in their own home. If you have to move to an assisted care facility, then you might have to sell to fund it, which means you lose. If your spouse dies early and you remarry and want to move, then you might sell your house and you lose. There are many many many life events that might prompt somebody to sell their house, more than people expect.
A better plan would be to take out home equity line of credit, the interest rate is usually substantially lower.
A reverse mortgage is usually a FHA loan. You have to be a certain age (62). If married, the borrower only has to be 62. Based on the current value, rate and your life expectancy. If you have enough equity, you can take out a lump sum up front or take monthly payments. If the rate is say 6%, that’s the monthly interest you would be paying anyhow, but because you are not, that gets added to the loan balance. At the time of her death, if there is equity, her kids can finance the home, pay back the bank and keep it. They will do a new appraisal and based on her balance at the time, you have options. This is how it’s determined. Not the bank! Sell the home and keep the equity. If there is no equity, great! You can still buy it to keep it or let the bank deal with it. As we age, if I don’t make enough to get by, you bet I’m doing a reverse mortgage. No way I’m going to suffer the last 10-20 years of my life.
A lot of wrong answers here. A reverse mortgage is a loan in which the payment stream is reversed. Instead of making payments to a lender, the lender issues you distributions based on your equity. Usually they cap at 50-60% or your homes value (mostly to ensure it doesn’t go underwater with negative amortization). With that 50-60% you can set up either a lump sum payment, term payments (payments for a set amount of time like 10 or 20 years), life payments (for the rest of your life) or a line of credit (pretty unique in that the credit lines scales up as your homes value increases). In addition you never are obligated to make a mortgage payment however you must reside in the home more than half of the year and maintain the prop taxes and insurance. Obviously if you don’t ever make payments your principal balance is going to continue to increase, but the idea is that your homes value will increase alongside it, and if you or your heirs decide to sell you’ll still have a decent chunk of equity. Additionally, it’s backed by HUD so you never owe more than the home is worth at maturity of the loan. Very unique product that actually benefits a lot of homeowners.
I always say if you have heirs you intend to leave you home to then it’s best to exhaust all other options prior to considering a reverse mortgage. On the other hand, if you don’t, and you have a substantial amount of equity and are coming across hard times it is a double whammy. You eliminate the need for a mortgage payment (potentially for the rest of your life) and can also set up distributions (again potentially for the rest of your life).
There is a lot of fear and negative connotations surrounding reverse mortgages as there were some pretty poorly designed programs back in the day. Nowadays the majority are HECM loans which are backed by HUD and are hardwired to avoid the homeowner “losing their home” (including required homeownership counseling prior to even applying). You always remain on title, you can always refinance out of a reverse mortgage back into a conventional mortgage and you can always sell. At any time.
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