A reverse mortgage loan is a deviation from the conventional credit perception. Both conventional and reverse mortgages are lawful entitlements against a property, usually a house, as collateral for securing a loan. In other words, a reverse mortgage is a credit where the lender pays the monthly instalments to you instead of you making any payments to the lender. For this reason the name reverse mortgage, as the payment stream is reversed. In addition, a reverse mortgage facilitates the home owner to alter equity (the worth of a property besides any mortgage or other liabilities relating to it) into ready money even without selling the home or refund the arrears instantly. In this case, the owner of the house keeps hold of both the proprietorship as well as possession of his home and, at the same time, is able to access and utilize the equity in the asset.
In the case of reverse mortgage, the owner of the house collects the equity payment on his property in any of the three different options - single payment of the total amount, in regular instalments or an arrangement that includes both the alternatives. The home owner does not make any refund of the money to the lender up to a precise point in time in the future. The repayment of the loan may be made in any of the four alternative situations - death of the home owner, when the proprietor sells his property, when the home owner moves out of the place for ever or when the pre-decided period of five or 10 years expires. Significantly, a reverse mortgage allows the senior citizens to translate their home equity to tax-free income. Reverse mortgages are basically planned to reinforce the senior citizens' personal and economic liberty by making available funds without a monthly payment encumbrances during their lifetime in their home.
It may be noted here that though the traditional and reverse mortgages have many aspects in common, the differences between the two modes are far more significant. The main differences between the two mortgage schemes are elaborated below, with emphasis on the benefits and downsides of both - reverse mortgage and traditional mortgage.
In this mortgage system, the borrower, who is the owner of the property or home, recurrently pays a part of the principal and interest to the lender. As a result of this, in traditional mortgage the arrears due to the lender reduce progressively. Simultaneously, the equity stake of the home owner regularly swells. Usually, a traditional mortgage is over after a period of approximately 10 to 25 years when the borrower has prepaid the entire principal amount, mounting up interest charges as well as the penalties, if any, to the lender. As a result, when the proprietor of the home has made the complete payments due to the lender, their equity on the property becomes 100 per cent.
In this case, the mortgage is done in converse to the traditional mortgages and hence the term reverse mortgage. In reverse mortgage, the home owner or the borrower collects money from the lender and hence the owner's equity share in his property decreases gradually. As mentioned above, a reverse mortgage comes to an end when in any of the five conditions - when the current term of the mortgage finishes, when the home owner dies, when the home owner moves out of his property eternally, when the home owner sells his property or when the borrower makes the full and final repayment of the loan amount with the accumulated interest fees and penalties if any to the lender.
It may be mentioned here that the equity or the worth of the property minus the mortgage or other liabilities may well be totally exhausted much earlier than the expiry date of the reverse mortgage as the interest builds up against the loan. In such a situation, the amount taken on mortgage credit as well as the accrued interest on the principal amount will surpass the worth of the property itself. Nevertheless, if the borrower or home owner is normally restricted to paying back the part of the loan or credit equivalent to the worth of the property, the lender has to take in the additional arrears. In this case, the home owner or borrower needs not sell his property to refund the reverse mortgage liabilities. Even after saying this, it is normally found that the borrower sells off his property or home to repay the reverse mortgage arrears. And in case the borrower is left with any excess funds from the sale of the home even after completely repaying his reverse mortgage that sum remains with him.
The most important pre-requisite for obtaining a traditional mortgage is the capability of the borrower to repay the loan amount along with the interest charged on it. Hence, it is essential that the borrower has a steady income to meet this expense. In most cases, the lenders lay down a condition whereby the total payment for the principal amount, interest as well as the taxes does not surpass more or less 30% of the borrower's family's combined income. Normally, the credit in traditional mortgages is fixed on a specific fraction of the evaluation of the property. Normally, in traditional mortgage, the evaluation price of any property stands for the 100% of the lending value. Therefore, the home owner is entitled to obtain a loan of maximum of 90% of the assessed value of the home or property from nearly all the mortgagees. In some special cases, it is also possible to acquire loans up to 100% or even above of the assessed value of the property. However, such cases are very rare.
Contrary to the traditional mortgage, income of a borrower is not an important pre-requisite while seeking finance under the reverse mortgage scheme. The fact is that a home owner who does not have even a single penny income is also eligible for finance under the reverse mortgage policy. However, the eligibility for securing credit under reverse mortgage is primarily dependent on the home owner age and sex. This is besides the most important aspect in any mortgage - the assessed value of the property.
In instance of reverse mortgage, it is the creditor who decides the maximum amount of money that may be lent against a property. Although the maximum limit to be lent to the borrower is fixed on the appraisal worth of a property, different financers or mortgagees have different policies in this regard. In reverse mortgage, the majority of the creditors maintain the maximum lending amount below 50% of the appraisal value of the property. Normally, they prefer to keep the maximum lending amount between 30% and 40% of the assessed price of the property. By doing so, the mortgagees make certain that even as the interest builds up, it never goes beyond 75% of the appraisal value of the house or property. Therefore, going by the creditor's policy, a specific lending ceiling is fixed for a particular borrower or home owner and usually this is at par with the lender's norm or lesser than that.
As mentioned above, the most important pre-requisite to obtain a traditional mortgage is the borrower or home owner's capability to pay off the loan along with the accumulated interest; it is a shortcoming for the older home owners to secure a traditional mortgage. In fact, the older home owners even find it difficult to apply for a traditional mortgage as mortgagees are conscious of the fact that the income of an individual decreases with old age or retirement. The inadequate scope for employment for people beyond a certain age is also a crucial factor for elderly property proprietors for not easily availing a traditional mortgage.
Contrary to the traditional mortgage, advanced age is a plus point while securing a reverse mortgage. In fact, reverse mortgage has been planned for the senior citizens and with a view to strengthen their personal as well as economic freedom by making available funds to them minus any monthly payment encumbrances during their lifetime in their home. Therefore, people who are 60 years old or above are most eligible for securing finances under the reverse mortgage plan. In fact, in reverse mortgage, the mortgagee's payment to the home owner greatly depends on the prognosis of the borrower's supposed life span. Hence, it may be said that the reverse mortgage payment from the financer will be better if the home owner is older.
In the instance of traditional mortgages, the obligation to make recurring payments, which is normally made once in a month, may prove to be a disadvantage for most home owners. Unless the payments are made regularly every month, the interest amount will pile up to such an extent that it may eventually become the undoing for the borrower. In fact, many borrowers or home owners have been found to spend some chunk of the loan money in paying the monthly instalments of the credit.
As mentioned earlier, one of the basic as well as tempting differences between the traditional mortgages and reverse mortgages is that in the latter case, the borrowers receive monthly payments from the lenders, while in the former instance, the borrowers need to make monthly payments to the creditors to end the mortgage. In the instance of reverse mortgage, the home owner's stake in the property is translated into ready money. The home owner or borrower may get this money in three different alternates - a single payment of the total amount, in instalments or in a permutation of both the choices. Varying on the clauses of the mortgage agreement in reverse mortgage, the length of time of payment to the home owner may range from a few years to his or her life time.
In most instances of traditional mortgages, the borrower makes payments every month and it comprises a part of the principal amount and the accrued interest. Since, the traditional mortgage requires blended payments, the Federal Interest Act curbs the lender in charging frequency of compounding interest in semi-annual or annual interest computation. It is important to mention here that in the instance of the majority of traditional mortgages, the interest is compounded somewhat yearly and priced against declining arrears.
Unlike in traditional mortgages, semi-yearly compounding interest is very widespread in reverse mortgages and the worst part of the entire aspect is that there is no lawful constraint for the occurrence of such compounding interest. Therefore, it is not surprising to note that contrary to the interest cost in traditional mortgages, in reverse mortgages, the interest keeps growing progressively escalating the arrears. For example, if a home owner receives a one time payment against his stake in the property, the interest grows in progression on the principal amount as well as the mounting interest since the date of signing the mortgage contract.
The failure by a borrower to make timely and required payments for the principal amount and interest charges is the most widespread reason that makes a borrower defaulter or lead to a infringement of the mortgage contract. Hence, in order to protect the interests of the creditors, the National Housing Act has made it mandatory that all loans over 75% of the property's assessment value to be termed as high-ratio mortgages and they need to be insured against all types of non-payment by the borrower. As this Act lessens the burden or risks of the creditors, they are now more free and amenable to proffer high-ratio mortgages. It may be mentioned here that the federal housing agency offers mortgage cover to creditors against borrower default and when any borrower fails to repay the arrears on mortgage, it clears the liability. However, the borrower is still required to pay the premiums.
In the instance of reverse mortgage, the payment is made on a mutually agreed date in the future. Therefore, even if there is an instance of default, it would be at the time of the concluding date of the mortgage agreement if the borrower either declines to pay the amount at the end of the period or he is found to be not capable of paying off the debt. In this case, the home can be sold off to collect money to pay the arrears. Here, the lender has two options to recover the money he has credited to the borrower. Either the creditor can take the power of sale action against the borrower to compel the home owner to sell his property or the lender can even file a law suit for foreclosure and take over the possession of the house. In addition to the above, non-payment may also take place in the condition when a borrower does not maintain the home in good condition, repair the property when necessary, and insure the house or fails to pay the property taxes. The lender may also adopt the same measures to recover his money in this case as in the other cases of default, but is likely to be less severe in his actions. The creditor may also step in on behalf of the house owner to resolves each of the cases mentioned above and then add up the cost incurred by him in the process or even more to the mortgage arrears.
All said and done, the creditors may still face an unusual hazard in reverse mortgages. In reverse mortgage, with the interest charges compounding, the mortgage arrears continue to build up all the time and hence if the value of the property reduces or even remains the same, the mortgage liabilities are likely to surpass the value of the property itself. On the other hand, if the home owner lives longer than the creditor's approximation of his or her life expectancy, the reverse mortgage could even devour all the stake of the home owner in the property during his or her life time. It is evident from the above mentioned conditions that if both take place at the same time, the mortgage liability will surely surpass the worth of the home increasing the risks of the lender. In case the mortgage agreement includes a clause that restricts the home owner's legal responsibilities, the home owner will have to settle up only a part of the mortgage equivalent to the appraised price of the property. In this case, the lender will have to take in the arrears that surpass the value of the home. However, the creditor may protect himself from such unforeseen risks as well as any impending or latent losses by insuring the reverse mortgage.