A reverse mortgage is a type of loan that is used by homeowners at least 62 years old who have considerable equity in their homes. By borrowing against their equity, seniors get access to cash to pay for cost-of-living expenses late in life, often after they’ve run out of other savings or sources of income. Using a reverse mortgage, homeowners can get the cash they need at rates starting at less than 3.5% per year.
Think of a reverse mortgage as a conventional mortgage where the roles are switched. In a conventional mortgage, a person takes out a loan in order to buy a home and then repays the lender over time. In a reverse mortgage, the person already owns the home, and they borrow against it, getting a loan from a lender that they may not necessarily ever repay.
In the end, most reverse mortgage loans are not repaid by the borrower. Instead, when the borrower moves or dies, the borrower’s heirs sell the property in order to pay off the loan. The borrower (or their estate) gets any excess proceeds from the sale.
In the U.S., most reverse mortgages are issued through government-insured programs that have strict rules and lending standards. There are also private, or proprietary, reverse mortgages, which are issued by private non-bank lenders, but those are less regulated and have an increased likelihood of being scams.
The process of using a reverse mortgage is fairly simple: It starts with a borrower who already owns a house. The borrower either has considerable equity in their home (usually at least 50% of the property’s value) or has paid it off completely. The borrower decides they need the liquidity that comes with removing equity from their home, so they work with a reverse mortgage counsellor to find a lender and a program.
Once the borrower picks a specific loan program, they apply for the loan. The lender does a credit check, reviews the borrower’s property, its title and appraised value. If approved, the lender funds the loan, with proceeds structured as either a lump sum, a line of credit or periodic annuity payments (monthly, quarterly or annually, for example), depending on what the borrower chooses.
After a lender funds a reverse mortgage, borrowers use the money as provided for in their loan agreement. Some loans have restrictions on how the funds can be used (such as for improvements or renovations), while others are unrestricted. These loans last until the borrower dies or moves, at which time they (or their heirs) can repay the loan, or the property can be sold to repay the lender. The borrower gets any money that remains after the loan is repaid.
In the U.S., in order to qualify for a government-sponsored reverse mortgage, the youngest owner of a home being mortgaged must be at least 62 years old. Typically only certain types of properties qualify for government-backed reverse mortgages. Eligible properties include:
- Single-family homes
- Multi-unit properties with up to four units
- Manufactured homes built after June 1976
- Condos or townhomes
There are two primary costs for U.S. government-backed reverse mortgages:
- Interest rates: These may be fixed if you take a lump sum (with rates starting under 3.5%—a rate comparable to conventional mortgages and much lower than other home equity loan products). Otherwise, they’ll be variable based on the London Interbank Offered Rate (LIBOR), with a margin added for the lender.
- Mortgage insurance premiums: Federally backed reverse mortgages have a 2% upfront mortgage insurance premium and annual premiums of 0.5%.
Reverse mortgages aren’t good for everyone. Only certain borrowers qualify, but their structure also only makes them appropriate for certain borrowers. A reverse mortgage may make sense for:
- Seniors who are encountering significant costs late in life
- People who have depleted most of their savings and have considerable equity in their primary residences
- People who don’t have heirs who care to inherit their home
Most people who take out reverse mortgages do not intend to ever repay them in full. In fact, if you think you may plan to repay your loan in full, then you may be better off avoiding reverse mortgages altogether.
As Malaysia becomes an ageing society by 2030, this product may make sense to some. Otherwise, workout a scheme with a family member that actually performs like a reverse mortgage. In this case, the house remains with the family even if one dies.
Source: https://www.aarp.org
References:
Reverse mortgages: How they work and who they’re good for, Dock David Treece, July 24, 2020 (www.forbes.com)
Selling versus reverse mortgage: which should you use? (www.99.co)
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