Many people consider putting their most valuable asset ― their home ― to work for them. It is possible to use the value built up in your home to get some cash, but it should be done very carefully.
Second mortgages can be helpful when it comes to getting the money needed to consolidate debt, pay for a wedding, fund college tuition, or make home improvements. For those who are retiring (or retired) and are interested in receiving income based on their home equity, reverse mortgages can be quite beneficial.
Second Mortgages and Reverse Mortgages
A second mortgage is a loan that’s secured by the value (or equity) in your home. The amount of your equity is calculated by having an appraiser determine the market value of the home. Your equity is the difference between the amount that you still owe on the house (on the first mortgage) and the market value of the home.
For example, if your home’s market value is $200,000 and you owe $50,000 on the original mortgage, you have $150,000 of home equity. That equity can be used to finance a second mortgage, which will provide you with cash.
If you are a retiree, one type of second mortgage that you may consider is a reverse mortgage. A reverse mortgage converts a percentage of your home’s equity into tax-free cash. For this type of second mortgage, most lenders require that the homeowner is at least 62 years old ― however, some lenders will issue reverse mortgages to homeowners who are at least age 60.
A reverse mortgage basically “reverses” the flow of payments, so that the lender is paying the borrower. Reverse mortgage loans were first introduced in 1989 to allow senior citizens (aged 62 or older) to access a portion of their home equity without having to move. Prior to the development of reverse mortgages, retirees seeking to withdraw that equity had to sell their house or take out a Home Equity Loan (HEL). There are conventional reverse mortgages as well as government-insured products (e.g., the FHA’s Home Equity Conversion Mortgage) available.
Reverse mortgages have special terms that make them attractive to senior citizens. First of all, there are no income requirements for a reverse mortgage, and usually no credit requirements. Additionally, you do not have to make payments on your reverse mortgage as long as you’re living in the home ― reverse mortgages are repaid to the lender when the borrower passes away, permanently moves out, or sells the home.
With a reverse mortgage, the lender makes payments to the borrower/homeowner based on a percentage of the accumulated equity in their house. You may choose to receive the money through installment payments (monthly, quarterly, or annually) or in one lump sum. The typical amount for a reverse mortgage is based on 50% of the value of the home. Reverse mortgages are often used by retirees to supplement their income, help pay off debt accumulation, finance home improvements, or pay for health care expenses. However, a reverse mortgage can be used for any reason the borrower chooses.
Some of the drawbacks of reverse mortgages can include high fees (in some cases) and high interest rates (compared to some other types of second mortgages). Also, with a reverse mortgage, you cannot leave the home to your heirs because it must be used to repay the lender.
Reverse mortgages can be very useful, but like all second mortgages, it’s a good idea to evaluate your financial situation and make a decision based on what is best for you (and your family) in the long run.