Let's learn about how reverse mortgages work. Reverse mortgages allow for you to borrow on the equity of your home and not make any monthly payments. Why would any lender do this? It is not a trick or scam. It is basic math called compound interest. Everyone loves earning compound 
interest, but what happens when you pay it? Let's use an example of $100,000 as the starting loan amount on your. We will use the current interest rate of 5.56% fixed for life.
$100,000 after one year at 5.56% interest = $5,560 in interest owed to the lender. since you don't make any payments, the lender will add that amount to your loan amount. Now you owe $105,560.
$105,560 after one more year at 5.56% interest = $5,869.14 in interest that is now owed. You will notice that the amount of interest that you owe on year 2 is a little more than year one. This is because the bank earned interest on the interest. This is compound interest. Earning interest on interest. If you ever had a savings account or retirement account, you have earned it. Now instead, you are getting the loan and being charged the compounding interest.
We are talking about how does a reverse mortgage work, and phew, we made it through the math. Now you might be thinking what happens as this interest is accruing and compounding and using up my equity? Will I run out of equity and get kicked out of my home? The answer is no. This is one of many reverse mortgage misconceptions. These loans are designed to allow you to live there for as many years as you are able. No one can kick you out because of what you owe them. Not only that, but the banks don't want to. Remember they are earning (compound) interest, and they are willing to wait to get paid.
What happens when it is time to sell?
So what happens if you need to sell or your heirs have inherited the home and they plan on selling it? There is nothing different about how does a reverse mortgage work, than any other mortgage. Take the amount you borrowed, add the interest owed (and any other fees) and that's what will need to be paid back to the lender. In the above example, that would mean you need to pay back $111,429. Now if several years have passed and the balance owing is more than the home is worth, I have great news. One of the fees you paid, called mortgage insurance, covers you. You (or your heirs) only have to pay back an amount equal to the market value at the time of the sale. Now there are some exceptions to this, but as long as it is a legitimate sale, you won't have to worry. If you are reading this because you are needing to sell and are looking for a real estate agent, consider visiting Redwood Real Estate Sales.
What are the reverse mortgage disadvantages? Click the link and lets address them now. If you would like to see what you are eligible to receive, visit our reverse mortgage calculator.
If you have questions or comments you may find the answers on our reverse mortgage blog. Alternatively, if you just want information in a printable article, see our reverse mortgage article page.