The Mechanics of a Reverse Mortgage require Equity Reserves to protect the homeowner, bank, and FHA.
Reverse Mortgages are negative amortization loans. Therefore, if payments are not made, the balance of the mortgage will increase. This happens because the homeowner is given the option of not making a payment. Like any other mortgage or loan, interest is charged on the balance of the money borrowed. But when payments are not made, that interest is added to the balance of the mortgage.
The benefits of this feature are pretty straightforward. The homeowner can live in a home they own for the rest of their life. Likewise, they’re not required to make a monthly mortgage payment and only cover basic property expenses like taxes and insurance. The bank is repaid in the future when the homeowner either passes away or sells the home.
Risks to the Bank
We don’t have a crystal ball to predict how long people will live. This is why the Reverse Mortgage must have an equity reserve. This means is that a portion of the home’s equity (usually 35%-55%) is held in an equity reserve. That money/equity is left in the home. The homeowner isn’t forfeiting this money to the bank. The equity is used to offset the interest charges that will be added over time.
What happens later?
When the homeowner sells the home or passes away, any remaining equity still belongs to them and their heirs. Thus, the home is sold, the mortgage is paid, and the remaining equity reserves go back to the family.
The New Reverse Mortgage
Before changes in 2017, a small equity reserve requirement caused a lot of issues for homeowners, banks, and FHA. By not putting enough into reserve most Reverse Mortgages ended up going upside down before the homeowner passed away.
The New Reverse Mortgage requires more equity to be set aside and allows the homeowner to borrow less, but the benefit is that the vast majority of new Reverse Mortgages will likely never go upside down. Now banks and FHA face less risk and homeowners and their families have more equity left when the home is no longer needed.
If you or someone you love is considering a Reverse Mortgage please let us know how we can help.
President – Reverse Mortgage Specialist
Heritage Reverse Mortgage
Heritage NMLS #1497455 Trevor’s NMLS #: 267962
1060 South Main Street Bldg. A Suite 101B
St George Utah 84770