Many retirees end up not saving enough to maintain an acceptable quality of life during their golden years. Of course, this can be quite problematic for those finding themselves in this situation. However, there is a creative solution you may want to consider if you are a retiree that has already been able to secure significant home equity. This option is known as a reverse mortgage.
What is a reverse mortgage?
A reverse mortgage is essentially a type of loan which is borrowed against a person’s home equity. Only those who are 62 years of age or older can qualify for a reverse mortgage loan. Also, you need to have accumulated a significant amount of home equity to qualify.
Once you qualify for a reverse mortgage you may either receive a lump sum cash payment, fixed monthly payments or be given a line of credit. It will be at your own discretion as to how the funds from a reverse mortgage will be utilized.
What happens to home equity with a reverse mortgage?
You will not have to make any payments on a reverse mortgage loan. Technically, you are charged interest, but this is rolled into the total amount loaned to you. Instead of requiring payments, the lender will take a portion of equity of the home as your debt amount increases. Like in a traditional mortgage, with a reverse mortgage, the home itself is used as collateral for the loan.
Although you will retain title to your home, you will not keep any equity in the real estate. When you pass away or sell the property the remaining balance owed to the lender is fully paid off.
Selling the home
If you sell the home, the proceeds are required to be used to pay back the loan principal, interest charges, mortgage insurance and other related fees. However, you will be able to keep proceeds leftover after you have paid what you owe to the reverse mortgage lender.
What happens if you pass away?
If you pass away the balance due on the reverse mortgage loan will be taken from your estate. Your heirs may have to sell the home to pay the debt. On the other hand, if your heirs want to keep the home they can choose to pay off the debt themselves. Your heirs can opt to utilize other assets in the inherited estate to pay off the remaining balance on the reverse mortgage loan debt.
Taxes and reverse mortgage
Payments you receive from your lender may seem similar to any regular income, especially if you receive monthly payments. However, technically these payments are not considered income. The Internal Revenue Service (IRS) categorizes these payments like any other type of loan. Therefore, you will not owe any income taxes on reverse mortgage loan payments received.
Advice from a financial professional
If you are considering a reverse mortgage or maybe you have inherited an estate that owes money on a reverse mortgage loan you will want to carefully consider the financial consequences of how you decide to deal with the situation. Talking with a financial advisor who is knowledgeable about wealth management can help you better understand your available options.