Reverse Mortgages: The Rising Loan
The purpose of a reverse mortgage is unique from that of a traditional
"forward" mortgage loan. The intent of a forward mortgage is to buy a house;
the design of a reverse mortgage is to extract cash from your home.
In a forward mortgage, your loan balance (the total you owe) would be
smaller with every monthly repayment to the mortgage lender. Meantime the
value of your house ordinarily increases. So your home equity continues to
grow larger through time as your debt decreases. So conventional or forward
looking mortgages are "falling debt, rising equity" loans.
Your loan balance (debt) increases each time you get money from the
lender with a reverse mortgage, as loan interest is added to the outstanding
loan balance, but don't forget you'll make no repayments to the mortgage
lender. Unless the properties value increases very quick, the mortgage loan
balance begins "catching up" to it. So reverse mortgages are typically
"increasing debt, decreasing equity" loans.
Table 1 compares a forward mortgage to a reverse mortgage on a
step-by-step basis.
Table 1: Comparing "Forward" & Reverse Mortgages
| |
"Forward" Mortgage |
Reverse Mortgage |
| Purpose of loan |
to buy a home |
to take cash from you home |
| Before closing, borrower has… |
no equity in the house |
large amount of equity in the home |
| At closing, borrower - |
owes a large amount, and |
owes little on the mortgage, |
| |
has very little equity |
and has a large amount of equity |
| After closing of the loan, borrower -
|
will make monthly payments to the
lender |
will receive payments from the lender
|
| |
loan balance goes decreases |
loan balance increases |
| |
equity increases |
equity decreases |
| At end of mortgage loan, borrowers |
balance is zero |
balance is huge |
| |
has significant equity |
has much less, little, or no equity
|
| Type of mortgage loan |
decreasing debt, increasing equity |
increasing debt, decreasing equity |
|
A Simplified Reverse Mortgage
Table 2 points to the "increasing debt, decreasing
equity" features of reverse mortgages in general. The example
simplifies the reverse mortgage because the table doesn't
include the many fees and/or closing costs that are
often charged by a lender. The costs of selling a
your home is also NOT included, which will almost always
reduce the amount of equity leftover
at the end of the reverse mortgage.
Potential borrowers can see that the $1,000 monthly loan
advances in column 1 are added to the yearly interest of 7.0% in column 2 to equal the loan balance in column 3. Over
the years, the loan balance increases. You can also see we
subtracted the loan balance from the properties appraised
value (we include an assumption of 3% per year appreciation)
in column 4 to create the amount of remaining home equity in
column 4-3.
Table 2: Simplified Reverse Mortgage Example*
Assumptions: Monthly Loan Advance.........$1,000
Yearly Interest Rate...….....7.0%
Original Home Value......…...$200,000
Appreciation Rate.........…….3% per year
| |
1 |
2 |
3 |
4 |
(4 - 3) |
| End of Year |
Principal Advances |
Interest
@7.0%
/Year
|
Loan Balance |
Home Value |
Home Equity |
| 1 |
$12,000 |
$465 |
$12,465 |
$206,000 |
$193,535 |
| 2 |
12,000 |
1366 |
25,830 |
212,351 |
186,521 |
| 3 |
12,000 |
2,332 |
40,163 |
218,810 |
178,647 |
| 4 |
12,000 |
3,368 |
55,531 |
225,466 |
169,935 |
| 5 |
12,000 |
4,479 |
72,010 |
232,323 |
160,313 |
| 6 |
12,000 |
5,671 |
89,681 |
239,390 |
149,709 |
| 7 |
12,000 |
6,948 |
108,629 |
246,671 |
138,042 |
| 8 |
12,000 |
8,318 |
128,947 |
254,174 |
125,227 |
| 9 |
12,000 |
9,786 |
150,733 |
261,905 |
111,172 |
| 10 |
12,000 |
11,361 |
174,094 |
269,871 |
95,777 |
* illustrative example only; doesn't include loan closing
costs, mortgage insurance, fees, or the cost of selling your home.