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When an older homeowner has significant equity in his or her residence and needs funds, but lacks the resources to make monthly payments on a conventional mortgage, a reverse mortgage might provide a solution. A reverse mortgage is so-called because the mortgage balance normally increases over the term of the loan, rather than decreasing as the balance of a conventional mortgage does. A reverse mortgage allows a homeowner to receive loan proceeds over a certain period (by borrowing against equity in the home) while continuing to live in the house. (Other loan distribution options are available.)
An older homeowner may be motivated to obtain a reverse mortgage for many reasons. These include paying off an existing mortgage; purchasing a new residence; paying taxes, medical expenses, insurance, and household upkeep costs; covering financial emergencies; supplementing monthly income; paying nursing home expenses; and providing rainy day funds.
The amount a lender will advance depends primarily on the borrower’s age, equity in the home, and the interest rate. The older the homeowner, the larger the advances can be because there will probably be fewer advances than a younger homeowner would receive. Also, the more equity in the home, the larger the monthly advances can be. Finally, a lower interest rate can lead to larger advances.
In a typical case, the house will be sold at some point (normally after the borrower dies) to pay off the mortgage. Since the loan typically defers all repayment until the house is sold or the borrower dies, lending decisions may be based primarily on the home’s value rather than on the borrower’s creditworthiness and ability to make monthly payments as in the typical loan underwriting process.
In most cases, to qualify for a reverse mortgage, the homeowner must be at least 62 years old. He or she must also own the home outright or be able to pay off any balance with a portion of the reverse mortgage proceeds. To avoid default, the homeowner must maintain the home, pay property taxes, and provide insurance.
Caution: The expenses associated with reverse mortgages are high. Homeowners could pay as much as 7% to 8% of their home’s value in closing costs as well as a higher interest rate than with a regular mortgage or home equity loan.
For more tax tips and information, visit our website at http://www.hermancpa.com, or call us to speak directly with experts at our White Plains accounting firm, 914.400.0300.