How Do Reverse Mortgages Work

Turn on the television or open up your internet explorer and chances are you'll see ad after ad for reverse mortgages, all of which are targeted toward senior citizens.  With so many scams these days that revolve around mortgages, and those geared toward senior citizens, you do well to want to explore all the details of mortgages before ever signing on for such a deal.  So, what are they and how do they work?  And why are these ads only geared toward seniors?

First of all, it's important to understand that reverse mortgages are advertised to seniors not because they are some type of scam but because they are only available to those 62 and over in the United States.  Sorry, but you must be a senior to be eligible.

It's also good to understand how a typical mortgage works.  For a regular mortgage, the homeowner borrows a certain amount of money at a certain interest rate and pays monthly payments to the bank.  Because of the way the loan is amortized, much of those payments go toward interest, but as the principal of the loan is paid down, the homeowner builds equity in the home.  This equity is an important factor in mortgages.  Equity in a home simply refers to the fact that the home is now worth more than what the homeowner owes on it; if he or she were to sell the house, that excess amount they would receive over and above the loan amount is equity.

In many cases, a person may buy a home when they are younger and as they pay over the life of the loan, by the time they are a senior citizen the mortgage may be entirely paid off.  When they are in their 60's, it's assumed by many that they don't have a mortgage or have very little of the mortgage balance left.  The home by this time should have quite a bit of equity in it.  This type of mortgages tap into that equity of the home by giving it to the homeowner by way of a monthly "allowance" or one lump sum.  Rather than needing to be paid back to the bank every month, however, the mortgage do not become due until the homeowner dies, sells the home, or leaves the home permanently (such as to move to a nursing home or other full-time facility).  If there is no payment arrangement at that time, the bank would then seize the home the way they would with a typical mortgage foreclosure.

The Pros and Cons of Reverse Mortgages

You might immediately be thinking of some drawbacks of reverse mortgages.  For example, if the homeowner is getting this loan as monthly payments and then he or she dies, chances are there will be no cash reserves with which to pay back the loan.  This means the bank is likely to seize the home.  For those who had been looking to leave their home to their children or grandchildren as part of an inheritance, this can be a complicated problem.  When the home is sold, monies owed for the mortgage get paid first; any and all equity above and beyond that go back to the estate, but this often takes time and of course there are always added fees and costs tacked on when the bank needs to seize a home.

However, reverse mortgages might work for seniors that need cash for their health care or other reasons.  If they only take a small amount and leave other cash reserves, such as their 401(k), then there may be a cash reserve from which to repay any mortgage when they become due.  Or, seniors who do not have children or do not plan on leaving the home to the children can tap into this money while they are still alive and may need it.

Examining all these details of reverse mortgages is the only way to really be sure if such an arrangement is appropriate for you.