Home buyers often save rigorously for their home, forgoing expenditures and making sacrifices to pay down the mortgage and save for retirement. At retirement they get to enjoy their dream home debt-free. The only problem with this scenario for a lot of retirees is that they live on a fixed, and often not very large, income.
One option is to take a reverse mortgage – a loan against the home, which brings you money while you still live in your home. You can usually borrow between 10 to 40 percent of the value of your home depending on your age. A reverse mortgage loan requires no repayment for as long as you live in your home and you will never owe more than the value of your home.
This loan is different from a traditional mortgage in two ways. In order to qualify for a traditional mortgage, the bank checks your income to see how much you can afford to repay each month, but with a reverse mortgage there are no monthly repayments. With most loans, if you fail to make your repayments, you are in trouble. With a reverse mortgage, you don’t have any repayments. Thus, the debt grows larger as you keep getting cash advances and the interest is added to the amount you owe. This is why a reverse mortgage is called a “rising debt, falling equity” loan. As the amount you owe (your debt) grows larger, your equity (the value of your home less debt) is getting smaller.
You can receive income from your reverse mortgage in two ways. You can take the loan and invest it in an annuity. In turn, this annuity will provide you with income until your death. The second alternative is to receive monthly income from your reverse mortgage provider. Here you simply increase the size of your loan on a regular basis in order to receive income.
There is one big downside to all of this – you still owe money on your home. The total amount you will owe at the end of the loan will equal the loan plus all the interest accrued. All the interest can be a substantial amount of money.
Before you apply for a reverse mortgage, discuss your options with your family. Remember that a reverse mortgage will reduce the size of your final estate.