A reverse mortgage is a loan facility, which is available to homeowners who are 62 years or above in age. This kind of loan enables them to transform a part of their home equity into cash. The facility was developed with the objective to help cash-strapped retirees who have restricted income to use the accumulated money in their homes. This can then be used to take care of their monthly living expenditure as well as pay for healthcare.

However, there is no limitation as to how one can use the reverse mortgage proceed:

1. Traditional vs. reverse mortgage

In case of a traditional mortgage, the borrower pays money to a lender on a monthly basis. However, in the case of a reverse mortgage, the lender pays money to the borrower. The loan is so-called because it works the other way round. In case of such a mortgage, it is not mandatory for the borrower to repay the loan until he/she does not vacate or sell the house. Until the borrower continues to reside in the home, they need not pay any monthly amount for the loan balance. Instead, the complete loan balance amount becomes payable and due if the borrower sells the house, relocates permanently, or passes away.

2. Federal norms

As per the Federal norms, lenders need to formulate the transaction so that the amount of the loan does not surpass the home’s value and the borrower’s estate. The borrower will not be liable to pay the difference if the loan balance becomes greater than the value of the home. One way wherein the loan balance exceeds the home value could be if there is a fall in the market value of the home. Another way is if the borrower survives for a long duration.

3. How does a reverse mortgage work?
As explained above, in the case of a reverse mortgage, a lender pays money to the borrower. The homeowner (borrower) can choose how to receive the money. The different payment options include a lump sum, equal monthly payments, line of credit, term payments, term payments plus a line of credit, and equal monthly payments plus a line of credit. The homeowner pays interest only on the money received. The interest is then rolled into the loan balance. Hence, the homeowner does not pay any amount upfront. Also, the homeowner retains the home’s title. During the tenure of the loan, the homeowner’s debt rises and home equity falls.

4. Collateral

Home is the collateral in case of a reverse mortgage. When the homeowner passes away or relocates, the sale proceeds go to the lender for the repayment of mortgage insurance, the principal interest of reverse mortgage, and fees. Any sale proceeds beyond the borrowed amount go to the homeowner’s estate if they are no more or to the homeowner if he/she is alive. In certain cases, the heirs can opt to pay off the mortgage so they can retain the home. Reverse mortgage proceeds are tax-free. The homeowner may consider this as an income. However, the Internal Revenue Service (IRS) views the proceeds as a loan advance.