The term Reverse Mortgage is causing confusion among many regarding its meaning and scope. This section, reverse mortgage explained, tries to solve this issue. Reverse Mortgage or Equity Release is a way to secure a loan by using the customer’s primary asset, usually his/her home. This is a sort of ‘rising equity, falling debt’ type of deal.
Before looking into the intricacies of reverse mortgage, let us see how the common type of mortgage – forward mortgage – works. In the case of forward mortgage, one qualifies for the loan on the basis of his/her income from a job or business. The bank ensures further security by securing the loan on the customer’s asset – mostly his/her house – so that should there be any default on the repayments, the bank can make up for the lost money by taking over the asset attached with the loan. Now to the technicality of economics, the equity is calculated as the difference between the mortgage value issued and the amount the customer have paid back till date. The house belongs to the customer when he/she makes the last payment on the mortgage availed.
A reverse mortgage, on the contrary, does not need any proof for income or credit checks, but is issued against the primary asset – usually home – of the customer. It is so because, in reverse mortgage, interest payments are added to the loan amount and not repaid. Over a time period, this starts eating into the equity as each interest payment is contributed to the original loan such a way that interest get charged on the previous interest as well. This is a sort of cumulative process in a way. Reverse mortgages require the prospective customer to have a minimum age as specified by the bank. Further, the older the person, the more will be the issued loan amount. Also it is mandatory that the reverse mortgage must be the only debt existing against the customer’s primary asset.
Famous with senior citizens, reverse mortgages are often structured such that the loan becomes repayable only on the death of the home owner. And in many cases, there may not be any equity left when the loan is completely paid. But this depends on the current market conditions and the loan amount. Keep in mind that as with all other loan schemes, you need to be very careful not to default on any additional charges, such as insurance, property tax or rates. This is because these could lead to the loan being reclaimed early. In most cases, your bank will have an option built in to the contract so as to raise your debt by paying such charges on your behalf. Remember this is not a choice you need to take, as you need to pay interest on those charge also.
In short, reverse mortgages are a good choice for all, but before sticking into any of the schemes it is better to study all its advantages and the features of a reverse mortgage.