Both regular and reverse mortgages are types of loans. However, since reverse mortgages are only about 60 years old and still relatively unknown, many people wonder how a reverse mortgage works.
Well, you’re in luck, as in today’s article, we’ll be comparing the two to see the difference between them.
Standard Mortgage – How it Works
The standard mortgage is a very simple, straight-up agreement between a person needing a loan (usually to purchase a home) and an institution granting that loan – a bank or a credit union.
After agreeing on the price of the property, you’ll need your bank to finance that house. To qualify for a mortgage, you must check a few boxes.
How to Qualify for a Mortgage
Firstly, you have to have enough money for a down deposit. A lot of banks stick to the 20% rule – you need to be able to pay off at least 20% of the property’s value immediately, while the mortgage will pay for the remaining 80%. Some banks agree to less than 20%.
It’s usually a good idea to pay as much as you can upfront. Obviously, you shouldn’t spend all your life’s savings as you have to have something for a rainy day. However, the larger your initial down payment, the smaller your mortgage is!
Another thing you have to qualify for is your credit score – simply said, it has to be good. A credit score tells the bank the likelihood of you paying the mortgage off successfully.
The debt-to-income ratio has to be lower than 43% (in ideal cases), and you’ll also need proof of stable income.
After all that paperwork, you can get a mortgage approved. There are different types of mortgages, but they all follow the same rule – the bank pays for your property, and you pay the bank back with interest.
Types of Mortgages
Depending on your financial status, you could choose longer or shorter loans. Shorter loans give you less time to pay the loan back, and you have to make larger monthly payments. The good thing is – you save money on the long run as the interest is lower.
Longer loans work the opposite way – you make smaller monthly payments over a longer period. In the end, though, this costs more as interest is greater.
When paying your mortgage, you pay for the principal loan (the worth of the property), the interest, and home insurance (after all, your home is technically the bank’s property until you pay off the loan, and you have to keep it safe), while you also have to pay your property taxes.
Once you pay off the loan after a decade or two, your property is only yours!
In short, and with no further complications, this is how a regular mortgage works. Now let’s take a look at reverse mortgages.
Reverse Mortgage – How it Works
Unlike a regular mortgage, a reverse mortgage agreement starts with the bank paying off your property without you owing them anything. However, this is only the beginning.
The idea behind a reverse mortgage is that you’ll pay off the debt once you sell the property, or if you die – once your heirs sell the property.
During your time owning the property, you don’t owe the bank any monthly payments – you just have to pay the taxes and home insurance. During that time, the lender (the bank) will give you advance payments on your home equity.
This money is added to your debt (usually with interest). Once you sell your home, you have to pay off that debt and interest.
Essentially, your lender is paying you money in your home‘s equity, and you have to pay off the debt once you sell the home or die. If you die, your heirs do it for you.
How to Qualify for a Reverse Mortgage
The first and most important qualification is that you have to be 62 years old or older. Although the idea of a reverse mortgage is to finance your life with the home you already own, you can also use a reverse mortgage to buy a home.
Types of Reverse Mortgages
There are three types of reverse mortgages.
The single-purpose reverse mortgage is only found in some states, and the lender can only use the loan granted to them for a single purpose – taxes, for example.
The proprietary reverse mortgage is a private loan backed by a company, usually used for higher-value homes.
Lastly, the Home Equity Conversion Mortgage is a reverse mortgage insured by the government, and you can use it virtually for anything.