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Is a Reverse Mortgage Right for You? Monetize Your Home Equity

Anuradha Garg - Author
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May 31 2022, Published 9:56 a.m. ET

Older people are often looking for ways to monetize the equity in their homes. According to National Reverse Mortgage Lenders Association, homeowners aged 62 and older held a record $10.6 trillion in home equity in the fourth quarter of 2021. They have various options such as refinancing the home, selling it, or taking out a reverse mortgage. Some people aren't very familiar with the concept of a reverse mortgage and often wonder how a reverse mortgage works.

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A reverse mortgage is a type of loan that enables homeowners older than 62 years old to borrow money using their home as a security for the loan. In a way, it helps them monetize their home value and they receive the funds as a lump sum, a fixed monthly payment, or a line of credit.

How does reverse mortgage work?

A reverse mortgage works in the opposite way as a forward mortgage or simply a mortgage. In a mortgage, you borrow money to buy a home. In a reverse mortgage, instead of the homeowner, the lender makes payments to the homeowner. The homeowner only pays interest on the proceeds received. The homeowner tends to keep the home’s title. However, as the life of the loan increases, the homeowner’s debt increases while the home equity decreases.

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reverse mortgage interest
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Since the home works as a collateral for the loan, when the homeowner moves or dies, the home sale proceeds go to the lender. These mortgages usually charge an "origination fee," closing costs, and service fees for the entire duration of the mortgage.

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The proceeds from a reverse mortgage aren't taxable. In fact, the IRS considers this money to be a loan advance.

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It's important to understand the interest on a reverse mortgage.

For the money received, interest is tacked on to the balance owed every month, which translates to higher interest on the loan as time passes. Reverse mortgages could have fixed interest rates or adjustable interest rates, depending on the type of loan. While single disbursement loans have fixed interest rates, other loans have adjustable rates, which are tied to a benchmark index. The interest isn't tax-deductible until the loan is paid in full.

When does it make sense to go for a reverse mortgage?

Reverse mortgages could be one of the feasible options for seniors who have limited income and few other options to fall back on during their non-earning years. A reverse mortgage isn't taxable, which makes it an attractive option for some people.

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However, reverse mortgages aren't for everyone. The loans can be costly, complex, and prone to scams. Overall, reverse mortgages can be risky. If a person isn't able to keep up on the fees incurred, they run the risk of their home being foreclosed. Also, given a potentially lucrative opportunity and a vulnerable section of the population, these mortgages are also prone to scams. Contractor scams and scams that target veterans are popular in this space.

You have three business days after the closing of loan to cancel the loan, which could be for any reason, without any penalty.

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