According to a 2010 survey of American senior citizens applying for a reverse mortgage, 48% said they were forced to do so due to their financial troubles. So what is a reverse mortgage loan and how can it help someone that might have a shaky cash flow?
If money is tight and you can’t afford your typical mortgage rate, applying for a reverse mortgage loan gives you access to your home equity as a means of cash flow, which is used to cut down expenses like bills every month. Available only to the elderly, this type of loan helps people keep their home and the rest of their financials in check despite having lower income than they once had.
Reverse Mortgage: What Does It Mean?
The concept of a reverse mortgage is a fairly complicated and obscure. One easier way to think about a reverse mortgage is that it’s a loan in which someone cedes the home equity they’ve accrued over the years in exchange for immediate cash.
Due to certain requirements, it’s restricted to the elderly who might not be making as much money as they once were prior to their retirement. Instead of forcing someone to spend most of the little money they have left on mortgage payments every month, they’re able to use this home equity for other things and in exchange, the money they’ve already paid into their initial mortgage is given to the lender.
For example, let’s pretend that John Smith has spent years sinking over $150,000 into his home, but he still has $75,000 left to pay. While his original payments were totally feasible on his working salary, he has since retired and various problems have put a huge dent in his savings, restricting what he has to spend each month. What he might do is turn to the reverse mortgage, giving him access to some of that $150,000 that he’s already invested in his home, allowing him to maintain a steady cash flow once again.
Once he has the loan, he’ll get some cash or some sort of credit line that covers his expenses, even though the cash wasn’t originally in his pocket. Of course, the lender will own more and more of his home as time goes on.
Who Can Get A Reverse Mortgage?
Every country has different requirements when it comes to who can apply and obtain a reverse mortgage loan. In the United States, the first major component of the application is that the person seeking the money must be at least 62. This individual must also be using the home that needs the reverse mortgage as their principal residence.
Another big requirement is that the existing mortgage must be low enough to be covered by the equity already held in the home. Sometimes market values can change, making homes more expensive than they were when the reverse mortgage was applied for and approved. Typically the lendees will not have to pay for this shift. While this type of loan can cover the mortgage payments, the homeowner will still have to pay for things like property tax and hazard insurance on the property.
When Is A Reverse Mortgage Loan Due?
These loans operate on the assumption that the elderly person receiving the reverse mortgage will pass away prior to when their home equity runs out. At this point, there are multiple options for whoever is put in charge of their estate. This person can choose to either sell the home getting cash for the remaining equity, refinance the home and keep it, or to simply turn the home over to the lender to cover final payments. If the latter option is chosen or forced, the estate holders will lose any stake they have in the home.
Is A Reverse Mortgage Really A Good Option?
The Consumer Financial Protection Bureau doesn’t really seem think so. Due to the complex concept of the reverse mortgage and misleading advertisements often coupled with poor counseling, some experts say that many people taking advantage of this service can get quickly in over their heads.
This lack of understanding also opens the door for scams. The accepted “benefit” of a reverse mortgage is to help elderly people manage their finances as they enter a part of life where income might not be as stable, though this sometimes leads to more problems. A reverse mortgage can be a great tool when used for the right reasons, but it has the potential to hurt everyone involved, sometimes even the lenders.
Reverse mortgages can also be expensive and interest is often high, forcing people to devalue something they’ve put so much time and money into already. This can result in a significant loss of assets. Plus, thanks to the use of a compound interest system reverse mortgages tend to use, interest is calculated on both the principal loan and the interest previously assessed on that loan each month, meaning interest grows quickly making it very likely all home equity will eventually be gone.
The Bottom Line
A reverse mortgage can be a great thing, but it comes with a cost. If someone is at serious risk of defaulting on their mortgage payments, it can help prevent someone from losing their home, something that can be detrimental to one’s livelihood when finances are tight at this later point in life. Like any loan though, it has its downsides as it means someone’s saving will be drastically cut down, and like any other type of loan, it’s important to proceed with caution and to plan ahead by learning exactly what to expect in years to come prior to signing any paperwork.
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