Reverse mortgages: How do they work?

Reverse mortgages often are considered a last-resort source of income, but they have become a planning tool for cash-strapped homeowners.

The first FHA-insured reverse mortgage was introduced in 1989. Such loans enable seniors age 62 and older to access a portion of their home equity without having to move.

A type of home equity loan for older homeowners. It does not require monthly mortgage payments. The loan is repaid after the borrower moves out or dies. It is also known as a home equity conversion mortgage, or HECM.

Steven Sass, program director at the Center for Retirement Research at Boston College, said a reverse mortgage makes sense for people who: Don’t plan to move. Can afford the cost of maintaining their home. Want to access the equity in their home to supplement their income or have money available for a rainy day.

Some people even use a reverse mortgage to eliminate their existing mortgage and improve their monthly cash flow, said Peter Bell, president and CEO of the National Reverse Mortgage Lenders Association.

“In some cases, people may have an immediate need to pay off debt, or they may have had some unexpected expenses like a home repair or health care situation,” Bell said.

The bank makes payments to the borrower throughout their lifetime based on a percentage of accumulated home equity. The loan balance does not have to be repaid until the borrower dies, sells the home or permanently moves out. Reverse mortgage basics include: How does it work? The bank makes payments to the borrower based on a percentage of accumulated home equity.

When does it need to be repaid? When the borrower dies, sells the home or permanently moves out.

Who is eligible? Seniors age 62 and older who own homes outright or have small mortgages.

How can the money be used? For any reason. Retirees typically use cash to supplement income, pay for health care expenses, pay off debt or finance home improvement jobs.

Better yet, you can never owe more than the value of your home in a reverse mortgage loan, regardless of how much you borrow. And if the balance is less than the value of your home at the time of repayment, you or your heirs keep the difference.

According to the National Reverse Mortgage Lenders Association, several factors determine the amount of funds you are eligible to receive through a reverse mortgage:

Age (or the age of the youngest spouse in the case of couples). Value of home. Interest rate. Lesser of appraised value or the HECM FHA mortgage limit of $625,500.

To be eligible for a reverse mortgage, you either must own your home outright or have a low mortgage balance that can be paid off at the closing with proceeds from the reverse loan. You must use the home as your primary residence. Generally, the older you are and the more valuable your home, the more money you can get.

There are no restrictions for how the money from a reverse mortgage loan must be used.

The method of payment collection depends on the type of mortgage. Retirees with an adjustable-rate mortgage can collect their payments on a reverse mortgage as a lump sum, fixed monthly payment, line of credit or some combination.

Holders of fixed-rate mortgages receive a lump sum.

Pros and cons of a reverse mortgage

Pros: Does not require monthly payments from the borrower. Proceeds can pay off debt or settle unexpected expenses. The money can pay off the existing mortgage. Funds can improve monthly cash flow. Cons: Fees and other closing costs can be high. Borrower must maintain the house and pay property taxes and homeowners insurance.

A reverse mortgage can complicate one’s wish to keep the house in the family.