Once we’ve paid off most of the debt pertaining to our house, our home equity equates to considerable net worth, but here’s the thing…all that wealth is tied up in the house itself.
To access any of our home’s inherent value, we have to apply for something known as a reverse mortgage, but the terms of such an agreement can be confusing.
For instance, when you take out a reverse mortgage, you aren’t required to make the monthly payments that you are with a regular, forward mortgage.
So, how exactly are you paying for this loan? Are you essentially selling your home to the lender, or do you somehow retain ownership?
Well, to answer your question as efficiently as possible….you own your home. When you take out a reverse mortgage on a house, ownership of the property never changes hands, and your John Hancock will always be on the deed.
I know that probably raises more questions about the parameters of a reverse mortgage than it answers, but don’t worry; all will be addressed in this brief yet informative article.
What Is A Reverse Mortgage?
To figure out what a reverse mortgage is, we first need to understand what home equity means. Equity is the value of your property minus any withstanding debts you still owe on it.
At its core, a reverse mortgage is a simple trade-off between home equity and its cash value equivalent. Let’s say, for example, your home is worth $500,000, and you still owe $25,000 on the mortgage you took out to pay for it.
Your home equity would be $475,000, which means that’s the sum you’d be entitled to when applying for a reverse mortgage, minus interest.
Unlike traditional loans that require you to pay off debt in order to build equity, a reverse mortgage involves building debt by reducing equity. Simply put, it’s a loan taken out against your house. Does that mean the bank owns your home? No.
In that regard, it’s the same as a regular mortgage, as when you buy a house, it’s the bank paying, but it’s your name on the documentation.
Why Doesn’t A Reverse Mortgage Grant Ownership Of The Property To The Lender?
In a reverse mortgage, the home is used as collateral, just as it is with a regular mortgage. Lenders never own collateral, and they can only take action to claim collateral if the terms of the loan aren’t being met.
So, now you’re probably wondering what you owe during a reverse mortgage if not the property itself.
Well, it’s really quite simple. You just owe the sum of money that you borrowed against the equity of your home, which is the same as any collateral-based loan agreement.
In fact, the last thing the lender wants is to claim your property, as there are a number of restrictive obligations that come part and parcel with ownership, including paying property taxes and maintenance bills.
When Do You Pay Off A Reverse Mortgage?
The next thing we need to unpack is the repayment process. If you’re not making repayments, how are you paying off your debt, right?
It’s not that you don’t owe the debt, it’s just that you don’t have to pay it off for a long time, and unlike forward mortgages, it needs to be paid off in one lump sum rather than in installments.
Now, I know what you’re thinking…how long is a long time? And the answer is…it depends. The full lump sum is due back either when you move out of your home or (rather grimly) when you die.
Even then, ownership of the property doesn’t transfer to the bank, it will belong to your heirs. The lenders still don’t technically want to claim your property. They’re just looking for their investment back.
Will A Reverse Mortgage Leave My Heirs With Debt?
The heirs of the borrower do indeed inherit the debt of a reverse mortgage after their passing, but it’s not quite as irresponsible as it seems.
Reverse mortgages are non-recourse loans, which translates in Layman’s terms to a debt that never exceeds the value of the collateral it’s taken out against. So, basically, as long as the heirs sell the house, and give the money to the bank, the debt is repaid.
Even if over the years the value of the property has fallen below the borrowed amount, the heirs are not obligated to supplement the difference themselves. The lender only has the right to claim the sum from the property that was used as collateral.
In the event that the property has appreciated in value, the lender may only recoup the borrowed sum. They do not get access to the surplus-value. Instead, the inheritors of the property may keep the excess for themselves.
Of course, there’s nothing to prevent the inheritors from finding alternative means of paying off the reverse mortgage.
They might have the funds to pay it off outright, or will perhaps negotiate refinancing the debt with the same or a different lender. If this is the case, the house doesn’t have to be sold at all.
In What Circumstances Would the Lender of a Reverse Mortgage Foreclose on the Property
The only reason a lender of reverse mortgage would claim the collateral property by force is if they have absolutely no other recourse. This is usually only done in a scenario where the deceased borrower has no heirs to claim ownership of their property.
Reverse mortgages can seem daunting at first, and there are scams to be aware of, but as long as you stick with a reputable lender and talk everything through with your family, they can be a great way to supplement your pension and enrich your golden years.
At no point during the agreement will you or your heirs ever give up ownership of your property to the bank. The lender will only foreclose on the property if absolutely necessary in order to reclaim their investment.