Reverse Mortgage: Types, Pros, Cons, Eligibility, Downside, Cost

A product aimed at using your home to supplement your income during retirement. 

There is a financial product dedicated to transforming the value of a property or home into income . It is known as a reverse mortgage. But what is a reverse mortgage? It is a very common type of mortgage loan for people over 65 years of age, although the age may vary depending on the entity with which it is negotiated. We see the keys:

Unlike in the case of normal mortgages, with reverse mortgages it is the owner of the property who receives a monthly rent offered by the bank in exchange for the home . The main advantage of the reverse mortgage is that the owner can continue to use the property until his death and at no time loses ownership of the habitual residence. 

Therefore, it is when the owner dies that the entity becomes the new owner of the property. However, in the event that the heirs of the home want to get it back , they can return the money loaned by the bank to the deceased owner and pay off the debt incurred. 

Despite how attractive it may seem for an older person to take out a reverse mortgage to supplement the pension, it is convenient to know all the aspects of this resource: requirements to request it, alternatives before the death of the owner, how is the settlement, common questions, etc. We see it below: 

Index 

Requirements to apply for a reverse mortgage

To apply for a reverse mortgage it is necessary to be at least 65 years old , although this may vary according to the requirements established by the financial institution with which it is negotiated and by the Bank of USA. The limit is frequently around 70 years of age, for life expectancy. Although it also depends on the personal conditions of the applicant and there are different limits for dependents. 

In addition, it is also necessary to be the owner of the home . And in the case of being a habitual residence we will be exempt from Taxes on Documented Legal Acts. The income that we will receive will also be exempt from personal income tax, regardless of whether it is a first or second residence. You can subscribe more than one owner of the property without losing ownership and use and enjoyment of it. 

Finally, if we have a mortgage loan , it will be necessary to cancel it before hiring. In this type of case, the financial institutions are the ones that give the capital in advance to cancel the mortgage that is in force. 

Therefore, the main requirements to request it are: 

  • Be at least 65 years old, although age may vary. 
  • Be the owner of the property, although more than one owner can subscribe.
  • Cancel any other mortgage loan that we have in force before contracting the reverse mortgage.
  • There may be some additional provision, which will vary depending on the entity.

Types of Reverse Mortgages

Although it is currently the only one available in the Spanish market, there are the following modalities or types of Reverse Mortgages that we explain very briefly and simply:

– Lifetime Modality: the mortgage loan is complemented by a lifetime annuity insurance that comes into operation in the event that the Elderly Person survives the credit granting term. That is to say, it is guaranteed that the collection of the fixed amount will be received regardless of what the Senior Person lives. In addition, you may request a capital advance or initial disposal.

– Temporary Modality: the monthly amount is charged only during the term set by the bank based on the age of the customer.

– Single Payment Method: the total amount of the credit would be received in a single provision.

How are reverse mortgage rents calculated?

The rent depends on:

  1. Of the value of the house . The higher the appraisal, the higher the rent.
  2. The age of the owner or beneficiary . And this because tables for calculating life expectancy are used.
  3. From the form of perception . For example, if a life annuity is agreed, it will be lower than a temporary one. And it is that when the bank has paid the full price of the mortgaged home, it will stop paying rents.

How much is a reverse mortgage cost?

The cost of the reverse mortgage includes:

  • Interest, which is usually agreed at a fixed rate.
  • Management expenses, notary, registration and commissions. It should be noted that the law prohibits banks from charging cancellation fees.
  • Generally, an annuity insurance in case the applicant survives the agreed term.

Is it worth applying for a reverse mortgage?

While some people are better off applying for a reverse mortgage, others are more interested in other solutions to supplement the pension. For example, there are those who take out life annuity insurance. There are also those who opt for the liquidation of their patrimony or for the donation to enter residences. Each case is different, and it is best to have legal and financial advice.

Advantages of the reverse mortgage

The advantages of a reverse mortgage have to do, mainly, with the maintenance of home ownership and there are tax benefits .

  1. You benefit from tax incentives. For example, the income received is not taxed on personal income tax, in addition to having discounts in notary and registry expenses and in the IAJD.
  2. As the guarantee is the home itself, it will not be necessary to provide guarantees or prove income.
  3. Whether or not to return the mortgage money is a choice that is left to the heirs. But you can also cancel early without paying commissions.
  4. The beneficiary of the income maintains ownership of the home. Therefore, you can live in it, rent it or sell it. Of course, in this case you would have to repay the loan or offer another guarantee.
  5. Therefore, unlike what happens in the case of sale of the bare property , the home can be monetized without losing its property or possession. This allows the heirs to rescue her by taking over the loan.

Disadvantages of the reverse mortgage

But the reverse mortgage also has a series of disadvantages, mainly associated with the costs of the operation and the non-updating of the rents .

  1. The mortgage constitution expenses are paid at the initial moment.
  2. When the beneficiary has collected the maximum value, his pension will end.
  3. The mortgage conditions the disposal operations. For example, the rent does not revalue, so if the house does, it will be charged comparatively less. Furthermore, it cannot be sold without previously paying off the loan. On the contrary, if the house is devalued, the heirs will not be interested in rescuing it.
  4. The fact that income is not updated together with inflation means that the pension has less and less value.
  5. Hiring rental insurance makes mortgage expenses more expensive.

Is a reverse mortgage or an annuity better?

As we have pointed out, the rents that are charged for the mortgage have a limit : the value of the house. When the beneficiary has collected this amount, they can continue to enjoy their home. However, you will not collect more rent on the mortgage.

That is why another product is quite popular, which is annuity insurance . This insurance also provides a periodic income, but its duration is not determined by any financial limit. The amount received depends on the capital contributed to the insurance.

Reverse mortgages are usually combined with annuity insurance , in case the beneficiary survives the amortization of the property’s value. However, hiring this type of linked services makes the mortgage more expensive.

When choosing between these instruments, different factors must be taken into account. From interest rates to the state of the real estate market. So it is advisable to consult specialists in the field before constituting the reverse mortgage .

Reverse mortgage settlement

Once the subscribing owner dies, we would find ourselves facing several possibilities or scenarios, since it will be the heirs who will receive the property and the debt linked to it (which has been generated with the money that the owner has received monthly). The heirs may:

  • Pay off the debt . 
  • Hiring a new mortgage to deal with the debt and can also rent the home to pay for it. 
  • Or sell the property to pay the debt and be able to keep the benefits, if there is a difference between what is owed to the entity and the sale price. 

It is common for questions to arise around reverse mortgages. We briefly answer the most common ones below:

Is I have Reverse Mortgage, Am I still the homeowner?

Yes. With the contracting of a reverse mortgage you do not lose the ownership of the home at any time . The house is used only as a guarantee for the financial institution, but the property is still yours. 

If I have a mortgage, can I take out a reverse mortgage?

Yes. However, if you want to take out the reverse mortgage you will have to cancel your mortgage previously . In these cases, the entities advance an amount of initial capital at the time of signing to cancel the mortgage that the owner in question has in force.

Can I cancel the reverse mortgage early?

Yes. Reverse mortgages can be canceled at any time . Of course, we will have to return the income received so far . To pay the debt, the amount of the amounts received must be returned; the initial expenses that the entity would have paid; and the interests that have been generated until the cancellation, which will depend on the interest rate that has been agreed at the time of signing. This process does not involve commissions in most banking entities. 

Can I rent my apartment with a reverse mortgage?

Yes. The home is still yours, so this decision is yours alone . However, financial institutions usually ask that we give part of it to ensure that it is not a life rental (valid until the person dies) or a minimum income.

Can you apply for a reverse mortgage on a home with a mortgage?

Is it possible to contract a reverse mortgage with a home that is already mortgaged? The answer is negative with a “but”. The bank will require you to cancel the loan first, but in most cases it will advance you the money to do so. 

If the bank grants you a reverse mortgage it is because it is interested and it will also continue to be interested even if you receive less money as rent and something more as an advance to pay the mortgage still pending. 

Are taxes paid on the reverse mortgage?

The money received in this way has tax advantages. These amounts are not subject to personal income tax because they are dispositions of a credit and not income for the purposes of making the personal income tax return.

In other words, you will not have to pay taxes for the reverse mortgage . 

Things change when the income insurance money is received . This would occur when the housing money runs out because the elderly person has exceeded the life expectancy with which they worked the bank. 

How the reverse mortgage money is paid back

The retired person who signs the reverse mortgage does not have to pay back any money. Unlike a normal loan in which the amount to be repaid is reduced, with the reverse mortgage this amount only increases. Those who will pay in the end will be the heirs, although in reality they will not have to loosen their pockets if they do not want to.

Upon the death of the owner, the heirs will be able to choose between returning the money to the bank to keep the house , sell the house and pay the debt and even sign a new mortgage to pay off the debt generated little by little. Most entities will give them one year to face the debt, which will usually be much less than the value of the house. So much so that it is normal that only 50% of what the mortgaged home is worth in the market is consumed.

And could the rest of the loan be collected and the bank keep the house? This solution can be presented to the bank, but no entity will accept it. And is that the bank usually has little interest in keeping the home. Moreover, if it does, one should be suspicious because then its market value would be much higher than the remainder of the loan.

What does the bank charge for making a reverse mortgage?

The bank is one of the parties interested in signing this type of loan. The financial institution charges an interest rate for the money it lends to the person who signs the reverse mortgage. This interest rate will be reflected at the end of the loan, when it is time to recover the home, that is, to cancel the loan.

When you cancel the reverse mortgage loan, the entity will do the math. To the money that the older person has received, the initial expenses and the interest generated will be added. That will be the amount borrowed and that will have to be repaid to keep the house. 

What are the risks of a reverse mortgage?

The main risk of the reverse mortgage  is in the contracting of the derived annuity insurance. If it is paid in the form of a single premium, it will make the final price go up a lot. As an example: for a loan of $664,526 contracted in 2013 by an 85-year-old and that would be activated after 93, the single premium was $211,000.

The other big risk of the reverse mortgage is that the rent to be collected is not updated, so the capital will lose value due to the effect of inflation. Also, it could be the case that, when the time comes, the home is worth less than the loan. This burden would be assumed by the heirs.

Alternatives to a reverse mortgage

In addition to the reverse mortgage, there are other operations that allow us to use our home to obtain income that complements our pension. In the following list we show the best known alternatives:

  • Housing, pension or real estate life annuity : consists of selling the home to an insurer, which will allow us to continue using the property and will pay us a higher rent than with the reverse mortgage until death.
  • Insured life annuity : it is similar to the previous operation, although this product can include both real estate and others such as shares, investment funds, etc; with a maximum amount of 240,000 euros. In this case, the capital gain derived from the transfer of the house is exempt from taxation.
  • Sell property : it is to sell our property in exchange for being able to continue living in it in usufruct until we die (it can also be agreed that it has a specific term). The buyer, for his part, will have to pay us a lump sum. 
  • Sale with guaranteed rent : it also consists of selling the house, although in this case we would become tenants. We can keep a part of what we get from the sale and another part will go to a rental pool, with which the rental income will be paid (if it runs out, we will not have to continue paying).

In all these cases, we would transfer our home to an entity, so we could not bequeath it to our heirs.

What happens if you outlive your reverse mortgage?

If you outlive the Reverse Mortgage, you can still continue living in the house. Only that you will not continue to receive income.

What is the difference between a reverse mortgage and a traditional mortgage?

A traditional mortgage is used to buy or refinance a home. A reverse mortgage is often used to get money from your home. 

In a traditional mortgage ; the lender loans you the money to buy or refinance the home. In return, you promise to pay the lender the money you borrow, plus interest, over many years.

In a reverse mortgage;  Instead of borrowing to buy a home, you borrow against the home you already own. This allows you to use cash for expenses on the spot and pay off the loan when you die or sell the home. 

Reverse mortgages are designed for older homeowners who want access to home equity (the value of their homes). To obtain a reverse mortgage , you must be at least 62 years old and have paid most, or all, of your mortgage.

Unlike traditional mortgages, reverse mortgages do not require monthly mortgage payments. Interest and mortgage payments are added to your loan balance each month. Over time, your home’s equity decreases as your loan balance grows. It is the opposite of a traditional mortgage. 

If you are interested in buying a new home (for example, to reduce the size of your home or move closer to family members), you can sometimes use a reverse mortgage for this. You will need a higher down payment than with a traditional mortgage, but you will not have to make monthly mortgage payments. Learn more about the HECM program  for purchasing .

Tip: It is your home. Be aware that you could put her at risk. Before you borrow against your home, make sure you understand how the loan works. A good way to test if you understand the loan is to explain to a friend or family member how this type of mortgage works in your own words.

Be careful when considering a reverse mortgage. There are many factors to consider, including your age, your needs, your financial goals, and how long you expect to stay in the home. If you decide it makes sense for you to get the loan, know the rates and compare the interest rates before signing anything. For more information:

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