You should have just finished reading lesson 1 where we gave a general description of what a reverse mortgage is. If you have not, please go back and read it first. We will build on our reverse mortgage knowledge from that article.
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 me give you an example using $100,000 as the loan amount on your reverse mortgage. We will use the current interest rate of 5.56% fixed.
$100,000 after 1 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 the lender $105,560.
$105,560 after one more year at 5.56% interest = $5,869.14 in interest owed to the lender. 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 lender 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, the lender is loaning to you and charging the compounding interest.
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. Reverse mortgages 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.
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 a reverse mortgage 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.
Want some more information? Then continue on to the next lesson where we talk about loan programs and how to interpret what they mean.