Many people do not fully understand what a reverse mortgage is. In fact, the concept is quite simple. A senior homeowner borrows against the equity in his or her home in almost the same fashion as in a conventional home equity financing. Once the reverse mortgage transaction closes, the borrower never has to make any interest or amortized principal payments to the lender.
Of course, it is quite wrong to think that the homeowner never pays interest or does not repay the principal borrowed. In actual fact, the borrower has to pay back the principal and interest borrowed, but in a reverse mortgage all such payments are deferred – in effect, capitalized into a lump-sum payment due when the borrower dies or sells the property.
In return for never having to make any mortgage payments in his or her lifetime, the borrower pays for a rapidly growing mortgage debt and a drain of his/her remaining home equity. This is in contrast with a conventional mortgage where the owner must make monthly mortgage payments of principal and interest, but knows that his or her mortgage debt will never grow.
Reverse mortgages are typically marketed to senior borrowers – the last time we looked, in Canada, the minimum age for a reverse mortgage was around 55 years old.
With conventional mortgage lending, a 75 per cent loan-to-value ratio is common. In contrast with reverse mortgages, the homeowner can only borrow up to 50 percent of the value of the property. This extra “equity buffer” gives the reverse mortgage lender some comfort that there will be enough equity left over to pay off the accrued interest and principal when the homeowner finally dies or sells.
Some advisors criticize reverse mortgages on the grounds that reverse mortgages can end up by luring seniors into rash borrowing decisions with the appeal of “no payments ever” only to see them left with small loan proceeds, depleting home equity, and an overall higher net cost of borrowing.
Despite this, demand for reverse mortgages continues to grow. Before entering into such a transaction, as a safeguard, it is only prudent to have your family lawyer give you advice on the proposed transaction beforesigning up. As always, CAVEAT EMPTOR (let the buyer beware) is the best policy.
© The foregoing provides only an overview and does not constitute legal advice. You are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained in the context of your own particular circumstances.
