reverse mortgage

What It Is

A reverse mortgage is an arrangement whereby a homeowner borrows against his or her home equity and receives regular payments from the lender until the total payments reach a predetermined limit.

How It Works

To qualify for a reverse mortgage, a prospective borrower must be at least 62 years old and own his or her residence. They must also submit an application to the lender and have the property inspected. In some cases, certain repairs may be required before the lender will approve the reverse mortgage.

The size of a reverse mortgage depends on many factors, including the borrower's age, the type of mortgage sought, the value and location of the property, the borrower's equity, and current interest rates. As with a traditional mortgage, lenders typically charge an origination fee, an appraisal fee, and other miscellaneous fees.

Generally, borrowers may elect to receive their payments in one of three ways: through a lump sum payment, a series of fixed payments, or as a line of credit (to be drawn upon only when the borrower needs the money). Occasionally, homeowners will choose some combination of these methods. A reverse mortgage usually comes due when the borrower no longer lives on the property. The lender then either takes possession of the property or is repaid in a lump sum. There are generally three types of reverse mortgages:

FHA-insured reverse mortgages -- Under these arrangements, the borrower receives a guarantee that payments will continue to be made even if the lender defaults. For this reason, FHA-insured reverse mortgages may offer smaller loan amounts than other programs. This type of reverse mortgage remains in effect as long as the borrower lives in the house.

Lender-insured reverse mortgages -- These generally provide periodic payments and a line of credit for as long as the borrower lives in the home. Because the lender must make payments indefinitely, lender-insured reverse mortgages are also referred to as reverse annuity mortgages. Lender-insured reverse mortgages generally charge higher fees than FHA-insured reverse mortgages. They can also stipulate that payments to the borrower will continue even if he or she sells the home and moves. In some cases, payments made under this type of reverse mortgage are considered annuity payments and are therefore taxable.

Uninsured reverse mortgages -- These offer a fixed number of payments, and the loan balance then becomes due at the end of that period.

[InvestingAnswers Featured Article: Is a Reverse Mortgage Right for You?]

Why It Matters

Reverse mortgages can be a useful planning option for elderly homeowners in need of extra cash. Not only do they provide a steady stream of income, but they also remove what is often the largest monthly expense. Typically, no house notes are due while a reverse mortgage is in place. Furthermore, because reverse mortgages are technically considered loan advances, they are generally not subject to taxes. Most importantly, though, they allow borrowers that might have otherwise been forced to move an opportunity to remain in their homes.

Reverse mortgage agreements may also be made between relatives, meaning that a child might agree to provide his or her parents with cash and obtain the depreciation or other tax benefits associated with homeownership in return.

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Source: Investing Answers