A simple way to get stable income or finance a business for “home rich but cash poor” people is to get a reverse mortgage. A reverse mortgage is a loan/mortgage with a primary home as a collateral and repayments postponed until a specific event. In most cases, there are two specific events: a) death of the longest lived owner; b) sale of the primary residence by owners. In some cases, lenders may include other specific events, for example: a) owners move to an assisted retirement home or other places; b) violations of Terms of services, etc.
Reverse mortgages are useful for retired people or people of pre-retirement ages who live in and own their primary residence (home/apartment/etc.). Such people, often do not have enough income to support their life style and will be interested to get an income stream in exchange for giving ownership of their homes to the lender after their deaths.
Sometimes, home owners need urgently big sums of money (unexpected medical expenses, to help children, to buy or start a business, etc.). In this case, reverse mortgages with fixed sum or line of credit can be used.
Another situation when reverse mortgages are helpful is a situation when owners are unemployed and have no income to live on for some time, until they get pensions or social insurance. In this case, term reverse mortgages are useful. A term reverse mortgage gives a stream of monthly income for a specific time interval (term).
The most popular reverse mortgages are tenure reverse mortgages. These mortgages give regular monthly income to owners until they will die or a specific event happen.
Home owners, who want that their children inherited their home, should not use reverse mortgages, because if they take reverse mortgages, the lenders will be owners of their homes after their deaths.
If owners live long enough then the total sum of payments to them exceeds an amount the lender will receive after the property is sold. Therefore, for lenders of reverse mortgages there is a risk that payments to owners will be greater then the repaid amount. To mitigate this risk, governments and insurance companies offer guarantees and insurances for lenders to reduce this risk. The costs of these insurances and government guarantees are passed on borrowers, therefore costs of reverse mortgages are higher than costs of ordinary mortgages. But, the main advantage of reverse mortgages is that during their life time borrowers can live in their homes and do not need to repay the reverse mortgages. The reverse mortgage will be repaid (after the owners will die or a specific event happen and the house will be sold) from proceeds derived from the owners home’s sale after payments of all taxes, fees, … and closing costs.
Main elements of reverse mortgages
In reverse mortgages there are two main parties: owners of a primary residence and lenders. Indirectly, some government agencies, insurance companies or other legal entities can be involved as insurers, guarantors, regulators, etc.
A lender gives to property owners money and after a sale of the property the lender receives the principal plus accumulated interest from proceeds of the sale (after payments of all taxes and expenses). The rest of the proceeds goes to children of the owners or those who is in the owners’ will. In the case, if the proceeds are less than the principal plus interest then the lender has a loss, but the loss is compensated by governments or insurance companies.
Property owners receive money from the lender and pay servicing fees to the lender, according to the Terms of services.
5 main types of reverse mortgages
There are five main types of reverse mortgages (RMs). The first type is a RM with a fixed sum. In this case, the lender gives to the property owners fixed sum of money. The second type is a RM with a line of credit up to a specified limit. In this case, the lender gives to the property owners a line of credit up to a specified limit. Owners can get money any time, in any amount up to the allowable limit. The third type is a RM with a fixed term. In this case, the lender pays to the property owners money regularly during a predefined term. The fourth type is a tenure RM. In this case, the lender pays to the property owners periodically until the death of the longest lived owner. The fifth type is a RM with inheritance fund. In this type of RM, owners specify a guaranteed amount, which will go to their children after their death, as inheritance fund. There are also different combinations from these 5 types of RM.
Examples
Example 1. Fixed sum (or line of credit) RM without an inheritance fund
John and Mary are of the same age 62. An average life longevity for women of this age in the given region is 88. They have a home valued at $600,000. It is expected that an average yearly appreciation of real estate in this place will be 2% per year. John and Mary do not have children, therefore they want a RM with a fixed sum, without an inheritance fund to increase their income. After DYOR (do your own research) on available RMs they found that:
a) an average servicing fee is $35 per month;
b) an average initiation cost is $13,000;
c) an average closing cost (sales tax, sales commissions, insurances, registration, etc.) in % is 33%;
d) an average interest rate on RMs is 5%.
To determine an approximate sum or a limit on a line of credit for them we go to https://dynpass.online/demo/rm/rm_fs.html and enter all information in the input fields.
After clicking on the "Calculate" button we get the result. John and Mary can get about $282,000 in fixed sum or line of credit.
Example 2. Term RM without an inheritance fund
Peter and Helen are unemployed of the same age 62. They will start receive payments from their pension fund at the age of 65, but have no income now. An average life longevity for women of this age in the given region is 88. They have a home valued at $500,000. It is expected that an average yearly appreciation of real estate in this place will be 1% per year. Peter and Helen do not have children, therefore they want a term RM without an inheritance fund to increase their income. After DYOR on available RMs they found that:
a) an average servicing fee is $35 per month;
b) an average initiation cost is $12,000;
c) an average closing cost (sales tax, sales commissions, insurances, registration, etc.) in % is 31%;
d) an average interest rate on RMs is 5%.
To determine an approximate fixed monthly income for them we go to https://dynpass.online/demo/rm/rm_ft.html and enter all information in the input fields.
After clicking on the "Calculate" button we get the result. John and Mary can get about $5,100 in this fixed monthly income, for 36 months.
Example 3. Tenure RM with an inheritance fund
Tom and Betty are of ages 66 and 62. An average life longevity for women of this age in the given region is 87. They have a home valued at $800,000. It is expected that an average yearly appreciation of real estate in this place will be 3.5% per year. They have children and want to give them inheritance fund in the amount of $400,000. Therefore, they want a tenure RM with an inheritance fund to increase their income and guarantees that their children will have $400,000 after the home will be sold. After DYOR on available RM they found that:
a) an average servicing fee is $30 per month;
b) an average initiation cost is $9,000;
c) an average closing cost (sales tax, sales commissions, insurances, registration, etc.) in % is 35%;
d) an average interest rate on RMs is 4.5%.
To determine approximate fixed monthly payments for their life span for them, we go to https://dynpass.online/demo/rm/rm_ls.html and enter all information in the input fields.
After clicking on the "Calculate" button we get the result. Tom and Betty can get about $1,270 in this fixed monthly income during their lifetime and leave to children the inheritance fund of $400,000.
Scams and risks
Reverse mortgage industry is a fast growing industry with big economic and financial potentials, and as any fast growing industry it attracts scammers and fraudsters.
For most common scams see these sources [1-5].
Here are the red flags to watch:
a) a need for argent actions;
b) a very small size text in notes, footnotes, etc. of documents;
c) reluctance to give more detailed information;
d) reluctance for independent expertise;
e) not reader friendly language used in the given documents;
f) missed, incorrect, or unclear information in the documents;
g) exaggerated or incorrect claims, for example that “RM gives you free money”.
Always ask at least five trusted persons (children, relatives, friends) to check, double check, and triple check all documents that you will need to sign, because if you become a victim of a scam or fraud you may lose your home and do not get any money.
References:
[1] Reverse Mortgage: Is It A Rip Off Or A Good Idea?
https://www.forbes.com/advisor/ca/mortgages/is-reverse-mortgage-a-rip-off-or-good-idea/
[2] Watch red flags
[3] RM Scams
https://www.investopedia.com/mortgage/reverse-mortgage/scams/
[4] So, when is a reverse mortgage a ripoff?
https://www.bankrate.com/mortgages/reverse-mortgage-scams
[5] How To Avoid Reverse Mortgage Scams
https://www.aura.com/learn/reverse-mortgage-scams
