A reverse mortgage is a type of home equity loan that allows you to convert some of the existing equity in your home into cash while you retain ownership of the property. Equity is the current cash value of a home minus the current loan balance.
A reverse mortgage works much like a traditional mortgage, except in reverse. Instead of the homeowner paying the lender each month, the lender pays the homeowner. As long as the homeowner continues to live in the home, no repayment of principal, interest, or servicing fees are required. The funds received from a reverse mortgage may be used for anything, including housing expenses, taxes, insurance, fuel or maintenance costs.
To qualify for a reverse mortgage, you must own your home. You may choose to receive the reverse mortgage funds in a lump sum, monthly advances, as a line-of-credit, or a combination of the three, depending on the reverse mortgage type and the lender. The amount of money you are eligible to borrow depends on your age, the amount of equity in your home, and the interest rate set by the lender.
Because the borrower retains ownership of the home with a reverse mortgage, the borrower also continues to be responsible for taxes, repairs and maintenance.
Depending on the plan selected, a reverse mortgage is due with interest either when the homeowner permanently moves, sells the home, dies, or the end of a pre-selected loan term is reached. If the homeowner dies, the lender does not take ownership of the home. Instead, the heirs must pay off the loan, typically by refinancing the loan into a forward mortgage (if the heirs meet eligibility requirements) or by using the proceeds generated by the sale of the home.
Value of the Home
The whole pie symbolizes the value of the home. Remember, as long as you or your spouse live in your home, you are the owner of the home.
Costs for the Loan
The costs for a Reverse Mortgage are financed through the Reverse Mortgage itself. The closing costs are symbolized by the red and orange segments: Financing Fees and Insurance Fees.
Lump Sum Upfront
The lump sum that you receive upfront is symbolized by the dark green segment.
Line of Credit
The remainder of the Reverse Mortgage will remain at your disposal as a Line of Credit. This is symbolized by the light green segment.
Funds for Monthly Income
If you would like to receive a monthly income from your Reverse Mortgage, then a part of the Reserve Mortgage will be reserved for monthly income. This is symbolized by the blue segment.
The Reverse Mortgage does not cover the whole value of the home. There remain reserves that are not used for the Reverse Mortgage. These reserves are yours. These are symbolized by the grey segment.
Your equity is the balance of what you own and what you owe. You own the whole pie, but you owe the red, orange and dark green segments. Thus your equity is the light green (Line of Credit) plus the blue (Funds for Monthly Income) plus the grey reserves.
Unexpected things happen. Liquidity is the amount of cash that you may access, if needed. Liquidity is provided by the Line of Credit in a Reverse Mortgage. Keeping part of the Reverse Mortgage as a Line of Credit is a wise decision when setting up a Reverse Mortgage. It helps you to manage unforeseen financial difficulties. In most Reverse Mortgages the Line of Credit, if left untouched, grows over time.