What The Heck Is A Reverse Mortgage? – Part 1 of Reverse Mortgages

I don’t do Reverse Mortgages, however I do get a lot of questions regarding them. While not a Reverse Mortgage specialist, I have studied and learned a lot about them over the years. Hopefully this series will prove to be both helpful and informative. It is based on the most common questions my clients have asked over the years.

What Is a Reverse Mortgage?

It’s for:

• Individuals age 62 or older.
• Own the home they live in (property in which reverse mortgage will be attached).
• Owe either a minimal amount on their mortgage balance (or)
• Own it free and clear. 

For homeowners fitting this criteria, a reverse mortgage program can be a powerful financial vehicle one can use to receive extra income. A reverse mortgage allows an individual to leverage (borrow) the equity they’ve accumulated in their home without repaying the loan for as long as they live in the property. Instead of making monthly payments, qualified individuals receive monthly payments from their lender! That’s the “reverse” part.

Cash Flow During Your Retirement!

A reverse mortgage can be a powerful way to make the equity acquired in a home work for you. Today, there are more homeownership options for retired individuals and couples than ever before. Whether you’re looking to pay off bills, or would just like additional income to enjoy retirement, a reverse mortgage may be the answer for you!

Why Get a Reverse Mortgage?

Income received through a reverse mortgage can be used for a variety of purposes. Just like a regular refinance, you are not restricted in how to use the funds.

Below are a few examples of the potential uses for funds received through a reverse mortgage:

• Supplement retirement income
• Medical expenses
• Invest in CDs, annuities, long-term care insurance
• Make much needed home repairs or improvements
• Pay for in-home care
• Pay property taxes
• And more…

Reverse Mortgage vs. Traditional Mortgages or Home Equity Loans

A reverse mortgage is the opposite of a traditional mortgage. With a traditional mortgage or home equity loan, you borrow a large amount of money and make monthly payments. You must also have a sufficient debt-to-income ratio to qualify and make monthly mortgage payments.

A reverse mortgage pays you and is available regardless of your current income or debt-to-income ratio. With a reverse mortgage, you borrow small amounts – monthly or at other intervals through a line of credit. Payment is required only once, at the end of the loan, typically when you no longer occupy the home as your principal residence.

Benefits

For many older homeowners, a reverse mortgage is an effective way to convert home equity into flexible, tax-free (consult your tax adviser) income. The benefits are numerous:

• Continue to live in and own the home.
• Obtain immediate cash advances in addition to monthly income.
• Receive tax-free income from the cash advances.
• Adjust your payment option to meet your current circumstances.
• Enjoy the flexibility of determining how you wish to receive your cash disbursements: fixed monthly payments, a line of credit, a lump sum cash advance, or a combination of the plans.
• Have peace of mind knowing that you and your heirs have no personal liability for the repayment of the loan since it is secured solely by your home.
• Repay the loan at any time without penalty.
• Relax knowing that you owe nothing until after you no longer occupy the home as your principal residence.

Disadvantages

• Reverse mortgages tend to be more costly than traditional loans because they are rising-debt loans. The interest is added to the priprincipal loan balance each month. So, the total amount of interest owed increases significantly with time as the interest compounds.
• Reverse Mortgages are typically more costly to set up than other types of loans 
• Reverse mortgages also use up all or some of the equity in a home. That leaves fewer assets for the homeowner and their heirs.
• The vagaries of age might make such cash availability dangerous. Families should be prepared to monitor draw downs and/or expenditures if this is a risk
• Interest on reverse mortgages isn’t deductible on income tax returns until the loan is paid off in part or whole.
• Because homeowners retain title to their home, they remain responsible for taxes, insurance, fuel, maintenance, and other ho housing expenses.
• Although the proceeds are tax-free, a Reverse Mortgage may affect your eligibility for certain “need based” public benefits.

It’s A Good Day To Have Your Mortgage Adjust

When the Federal Reserve lowered the Fed Funds Rate by 0.75% yesterday, it was in response to economic weakness that mounted since its last meeting December 11, 2007.

By contrast, the mortgage markets meet every day. 

Because of this, mortgage rates had already “priced in” the weakness to which the Fed was reacting. 

This is why mortgage rates did not fall by the same 0.75% yesterday — they only fell slightly.

Two important rates that did fall, though, were the 6-month LIBOR and the 1-year constant maturity treasury (CMT). 

These are two popular interest rates used in adjustable-rate mortgages.

When an ARM adjusts, it adjusts according to a simple math formula:

(New Interest Rate) = (Index) + (Margin)

Where:

Index: A variable, usually 6-month LIBOR or the 1-year CMT.
Margin: A constant, usually ranging from 1.500% to 6.999%

So, if the indices move lower — as we saw yesterday — the adjusted interest rate on a mortgage is going be lower, too.

As an example, LIBOR fell  percentage point over the last month from 4.83% to 3.83%.  This means that mortgage rates tied to LIBOR will adjust 1 percent lower than they would have in December 2007.

For every $100,000 in a principal + interest loan, this yields $65 per month in savings.

Of course, each mortgage has unique index, margin and rate characteristics so talk to your loan officer about how your ARM operates.