Now that you know the basics on how a typical mortgage works, you may be wondering what on God’s great Earth a reverse mortgage is. According to lenders on this market segment, reverse mortgages are financial instruments that seek to provide additional welfare to retirees. This article seeks to answer a few questions regarding this allegedly efficient type of loan. These questions include, “what is reverse mortgage?” and “how does reverse mortgage work?”, but the post also addresses criticism against reverse mortgages and warns against their pitfalls. If you’re interested in taking out a reverse mortgage loan, we advise you to seek out independent counseling beforehand – just to make sure you reduce the risk of walking head-first into a scam. Earlier, we have provided an FAQ on this type of mortgage. This article addresses more general issues.
What is a reverse mortgage?
In a nutshell, a reverse mortgage is a home-secured loan, which turns home equity into cash. Usually, the owner of the home will postpone paying back the loan until they pass, sell the property, or move away. Most such loans are marketed at seniors, whose heirs then relinquish property rights over the home, or refinance the home to buy back the property title from the reverse mortgage lender. While these rules apply by and large, they vary from one jurisdiction to the other, based on local laws.
The best known reverse mortgage provider in the United States is One Reverse Mortgage, headquartered in San Diego, CA. Their claim to seniors is that the option of turning mortgage equity into cash will help them enjoy a happier, financially carefree old age. They offer what is typically known as non-recourse loans, i.e. loans which never make the debtor owe the lender more than their home is worth. Their process is that a senior only needs to repay the reverse mortgage when the last surviving borrower sells the home or leaves it, in order to relocate for good. Until then, debtors are allowed to live in their homes without making any payments, save for the typical maintenance, taxes, and insurance bills.
How does a reverse mortgage work?
If you’re a senior past the age of 62, or if you are planning on eventually becoming one, you’re probably wondering ‘how do reverse mortgages work?’, since they seem to be such a perfect solution to your quest for happy retirement. Reverse mortgages are promoted as the end to credit card debt, or financial woes that put a dampen on what are supposed to be one’s golden days. They work by reversing the process: the equity of one’s home is turned into cash provided by a lender. Unlike conventional mortgages, reverse ones don’t entail making monthly payments to the lender. However, by not making any regular payments, homeowners increase the balance of the loan.
As you may assume, this progressive increase in loan balance can lead to a point where the borrower owes more money to the debtor than the home is actually worth. This, however, is a fairly rare case, at least according to most reverse mortgage providers. In some markets, there are specific limitations placed on reverse mortgages: in Canada, for instance, the overall loan balance cannot legally exceed the ‘fair market value’ of a home.
In view of the above, reverse mortgages have been met with substantial criticism, both from market regulators, as well as from academics in the field of finance. While some genuinely believe that reverse mortgages can be beneficial for seniors and allow them to reach a happy medium in regulating their income and expenditure habits, not all agree. According to other opinions, including that of the Consumer Financial Protection Bureau, reverse mortgages work according to complicated mechanisms, which might prove difficult to grasp for average consumers. The situation is further confounded by aggressive and ambiguous marketing, poor financial counseling services provided by lenders, as well as a risk of fraud and scam.
Reverse Mortgages are sophisticated financial instruments that can be the best solution in a particular situation or a complete disaster in a different one. As with any major financial decision, it is prudent to get educated, understand and weigh all pro’s and con’s and only then proceed and take action.