Reverse Mortgage

Updated on March 19, 2024
Article byPriya Choubey
Edited byPriya Choubey
Reviewed byDheeraj Vaidya, CFA, FRM

What is Reverse Mortgage?

A reverse mortgage is offered to senior citizens aged 62 years or more in lieu of home equity. The borrowers do not have to pay any monthly repayments. A borrower can choose between a lumpsum amount, fixed monthly payments, or a line of credit.

The loan amount is determined by evaluating the borrower’s age, the estate’s current market value, and the prevailing interest rates. The lender recovers the principal amount and interests when the borrower sells the property, shifts permanently, or dies.

Key Takeaways

  • A reverse mortgage is a loan extended to senior citizens, usually aged 62 or above, in exchange for their home equity. Depending on their choice, borrowers receive a lump sum, fixed monthly payments, or a line of credit. 
  • This loan is availed by individuals who don’t have any backup for meeting financial needs in their old age. They lose property ownership but gain liquidity to take care of immediate expenses.
  • The borrowed amount is tax-free, and the borrower can reside in their property till their last breath.

How Does Reverse Mortgage Work?

A reverse mortgage is the opposite of a conventional loan—the borrower does not repay the loan amount. Here, borrowers are mostly retired senior citizens (aged 62 years or above). The borrowers get a lump sum amount, fixed monthly payments, or a line of credit in lieu of home equity. When the borrower leaves the house permanently or passes away, the lender claims ownership of the property. The interest is added to the loan balance each month. Sometimes the loan balance exceeds the resale value of the property.

Reverse Mortgage

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This loan is availed by individuals who don’t have any backup for meeting financial needs in their old age—no savings or investments. Their net worth is predominantly made up of the property (the house they own). Thus, they will benefit from losing ownership to gain liquidity—they can take care of immediate needs.

Also, if the borrower sells the house, then the sale amount is submitted to the lender as repayment. If the sale amount exceeds loan clearance, the difference goes to the borrower. Most of these mortgages are insured—borrowers do not have to worry about repayment, even if they reside in the property beyond the loan tenure. 

Borrowers’ credit scores play no role in such loans. The only factor that matters is the current market valueMarket ValueMarket Value (MV) is the projected value for which an asset, or liability, would exchange between a willing buyer and seller in an independent transaction, following proper marketing, and where both parties acted with knowledge, caution, and without compulsion.read more of the property. Borrowers do have to take care of timely payment of property tax, HOA fees, and homeowner’s insurance though. Even the Internal Revenue Service (IRS) doesn’t levyLevyA levy is a lawful process where the debtor's property is seized when the debtor cannot pay the outstanding debts. It is different from liens, as a lien is only a claim against a property, whereas a levy is an actual property takeover to fulfill the obligation.read more any taxes on the borrowed amount. The FHA prohibits cooperative house owners from such loans—they don’t have direct ownership of the property.

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Examples

Patricia is 67 years old and lives alone in New York. Her children reside in other countries. She doesn’t have any permanent income—she used to work at a grocery store and is retired now.

Patricia owns a property worth $160,000, against which she takes a reverse mortgage loan for 15 years with mortgage insurance. After 15 years, the property’s value is $240,000, and the lender is owed $200,000.

Following are various possible scenarios:

  • If Patricia dies:
  1. Her children (successors) can take the house and pay $200,000 to the lender.
  2. Else, the lender can sell the house, recover $200,000 and send $40,000 to Patricia’s children.
  • If Patricia sells the house, she can keep the $40,000 difference after repaying $200,000 to the lender.
  • If Patricia permanently moves in with her children, the lender can sell the property. But, after recovering the $200,000, the lender must return the $40,000 difference to Patricia.

Pros and Cons

Now, let us look at its advantages:

  • It can serve as a fixed and regular source of income for retiree borrowers—improves their standard of living.
  • Most such loans are backed by mortgage insurance—no repayment burden on the borrowers.
  • The borrowed amount is tax-free.
  • It is the only loan with nil monthly repayments.
  • Borrowers can acquire funds in lumpsum to repay an existing loan or other expenditures.
  • If the housing market falls and the recovery amount exceeds the home’s value, the borrower or the borrowers’ dependents cannot be held liable.
  • The borrower can reside in their property till their last breath.

But the loan also has certain disadvantages:

  • There are numerous conditions associated with a reverse mortgage. If the borrower spends the majority of a year outside their home, the property can be foreclosed.
  • Reverse mortgage scams are on the rise—borrowers need to research the credibility of the lender.
  • To qualify for such a loan, the borrower has to bear various expenses—HOA fees, property tax, and homeowners’ insurance.
  • Borrower’s successors lose a significant share of home equity.
  • It even deprives borrowers of other government retirement benefits—offered by Supplemental Security Income (SSI) or Medicaid facilities.

Frequently Asked Questions (FAQs)

What are reverse mortgage scams?

Sometimes fraudsters trick senior citizens into a reverse mortgage using complex terms and conditions. These lenders take advantage of borrowers’ dwindling cognition owing to age. Fraudulent loan terms are intentionally framed to steal the property from its owner.

What are the three types of reverse mortgages?

The different forms of reverse mortgages are as follows:
#1-Single-Purpose Reverse Mortgages
#2-Proprietary Reverse Mortgages
#3-Home Equity Conversion Mortgage (HECM)

Are reverse mortgages good?

Reverse mortgages are a source of cash inflow for older individuals lacking liquidity. But such a loan should be analyzed carefully. It can leave the borrower’s successor with no right to claim the property. Also, the piled-up interests can make it highly expensive.

The utility of such loans depends on the terms and conditions. Borrowers should always go for mortgage insurance. Due to the prevalence of fraud, borrowers must take a closer look at the terms and even consult a professional before making the final decision.

This has been a guide to Reverse Mortgage and its Meaning. We explain its definition pros, cons, rates, requirements, & how reverse mortgage loan works. You can learn more about it from the following articles – 

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