Reverse mortgage
What is reverse mortgage?
Reverse mortgages are particularly used by the senior citizen that has no specific term of maturity. Reverse mortgage is a type of loan available to senior citizens and is primarily used in releasing the home equity either in the form of lump sum payment or periodic payments. The obligation of the homeowner to pay back the loan is delayed till the time the owner dies, sell the property or otherwise leave the house by shifting to aged care centre.
In the traditional mortgage, the mortgagor makes monthly payments to the mortgage holder that are amortized and at the end of the term of mortgage, the entire mortgage is paid and the pledged property is discharged from the lien of mortgage holder. However, in case of a reverse mortgage, like the name suggests, it is totally opposite where the monthly payments are not there and all the interest is added to the lien on the property that the mortgage holder owns.
If the market value of the pledged property increases over the period of time since the first reverse mortgage is taken out, the mortgagor can acquire a second or even third mortgage on the appreciated value of the property. But in some countries the law enforce reverse mortgage to be the first and only reverse mortgage.
Another name used for the reverse mortgage in United Kingdom is lifetime mortgage.
Payments or loan advances in reverse mortgage:
The amount of loan that any person can receive from the reverse mortgage depends on certain factors; the age of the mortgagor, the regulations lay down by the legal authorities, the market value of the home or property and the interest rate at the start of the mortgage that will be effective upon finalization of the loan, also the geographical location of the property can also cast an impact on the reverse mortgages’ rate.
There are various ways in which the mortgagor can be paid. If we talk about United States in particular, borrower can be in the form of some lump sum amount, periodic payments of the advances, extending the line of credit or some combination of all the three options. These loan advance payments are not taxable under US laws.
Costs associated with reverse mortgages:
In the private sector, the costs associated with reverse mortgage are higher than that of other mortgages and equity conversion loans. The exact costs and interest rates are specific to the type of reverse mortgage acquired by the borrower. In United States, generally the reverse mortgage has 2 per cent insurance premium together with 2 per cent origination fee over and above the normal closing costs. The closing costs also vary depending upon the third party costs like appraisal fees. This means that a reverse loan of US $2,000,000 will result in cost of US $80,000 over and above the normal closing costs. Some reverse mortgage loan does not require the insurance premium, but the closing costs and origination fees cannot be avoided. However, there are certain programs that waive off the initiation fees if the borrower exhausts the maximum limit of loan provided to them. As of the other charges, there are certain monthly dues that range between US $25 to $35 and is generally added to the total amount of mortgage loan.
Interest rates associated with reverse mortgages:
The interest rates charged on the reverse mortgage loans depends on the type of program the borrower is opting for, but the rates on these mortgages are very much similar to the adjustable rate mortgages. Thus, most of the reverse mortgages charge adjustable rates that are adjusted over a period of time that can be annual, semi annual or monthly, the fixed rates are not there because of the prime reason that the tenure of the reverse mortgages is not fixed. But with the development of financial services, now there are certain reverse mortgages that have fixed interest rates. To further elaborate on the interest on reverse mortgages, since the interest is not paid on periodic basis, it is added to the principal and accrued with it.
Governments of several countries rate taking initiatives to offer low rate reverse mortgages to the senior citizens.
Tax treatment of loan advances and interest:
Different government lay down different provisions for loan advances and interest. American bar Association guide have the following provisions for the treatment of loan advances and interest:
- The loan advances are not considered as a part of income by the Internal Revenue Service.
- The advances of annuity are partially taxable.
- Interest is not deductible till the time the interest is actually paid, that is till the tenure of loan lapses.
What happens when the loan tenure is over?
The tenure of the loan depends on events like the death of the homeowner, selling of house or other events spelled out the loan agreement like vacating house for 12 or more consecutive months. At that time, the reverse mortgage can be paid off from the proceeds of the sale of house or can be refinanced by the heirs of the homeowner. If the house is sold at a price higher than the amount owed to reverse mortgage lender, the difference is reimbursed to the homeowner or the heirs if the person has died. In the event when the proceeds of sale of the house fall less than the amount owed to reverse mortgage lenders, the difference is absorbed by the insurance company or the bank, whichever is applicable.
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