How Does a Reverse Mortgage Work?
A reverse mortgage is a home loan available to seniors aged 62 and older that does not have to be repaid as long as the borrower continues living in the mortgaged home. The interest typically accrues on the principle, such that the loan balance may be several times the original loan amount. This is a nonrecourse loan, meaning the borrower is not personally liable for repayment. Rather, the home's initial equity along with its appreciation over the loan term are the expected source of repayment funds. The borrower pays for mortgage insurance that will be used to repay the lender if the home's equity is not enough to fully repay the loan.
There are only two basic qualifications for a reverse mortgage borrower: age and home equity. The minimum required home equity, however, is not a specific figure applicable to all cases. Rather, it is one of several interrelated factors that go into determining your maximum loan amount. These factors are home value, up to a maximum cap; age; interest rate; and loan type, which include a lump sum, monthly payment over a specified term, monthly payment over your entire life, line of credit, or some combination of these options.
The formula for determining the maximum loan amount you would receive, according to a lengthy study by the Federal Reserve Board, is complex and may be amended by the Department of Housing and Urban development periodically. It starts with your home's value, up to a national limit set at $625,500 as of 2011. In the second step, your age and the current interest rate charged for the loan type you would like are compared to arrive at value between 0 and 1 that is multiplied by your home's value or maximum cap, whichever is less. The resulting figure is the maximum loan amount for which you are eligible. From that figure, you subtract any existing debt you have on the house. This is the amount of money you can receive, less the loan's closing costs.
Because the formula is so complex and loan rates change daily, there are online reverse mortgage calculators you can use to determine how much money you would be eligible for and therefore how much equity you must have to qualify. For example, a 62-year-old single homeowner, with a $300,000 home, who wants a lump sum reverse mortgage would be eligible for a loan of $157,000 at a fixed rate of 6.4 percent, which includes mortgage insurance. If the homeowner has 50 percent equity in the home, that would mean she also owes $150,000 on an existing mortgage. The mortgage would have to be paid off with the reverse mortgage, leaving $7,000 to pay the closing costs. A homeowner of the same age, wanting the same loan and getting the same rate would not be eligible if he had an LTV of more than 50 percent. As a borrower ages, his loan amount would rise and therefore his LTV would as well. At age 90, the same borrower would receive $210,000, resulting in an LTV of about 67 percent.