Episode 21: How Does a Reverse Mortgage Work?

Thank you for joining us for Episode 21 of our Money Wisdom Question Series, where we film answers to common financial and retirement investment questions. Today’s question is, “What is a reverse mortgage?”

A few years back, there was a lot of confusion on reverse mortgages. I remember talking to my mom and dad and them thinking that if I go get a reverse mortgage, the bank will just take my house. Well, that’s not how it works. To better understand this, let’s compare a reverse mortgage to a traditional mortgage.

A Traditional Mortgage

Let’s talk about a traditional mortgage. If you go to buy a house and it’s $500,000, you can put down $100,000 of your own money and borrow the other $400,000 from the bank.

The bank gives the seller the $400,000 and you give the seller your $100,000. Now, you owe the bank $400,000. Well, what do you do to pay the bank back? You make monthly payments to the bank. If you don’t make the payments, the bank can come in and force you to sell your house so they can get all their money back.

Pretty simple, right? You make the payments and if you do, there are no problems. If you stop making the payments the bank can force the sale of the house to get their money back.

A Reverse Mortgage

A reverse mortgage is the exact opposite of that. You can take your house, let’s say for instance it’s paid off and you can go to the bank and say you want to borrow $400,000 against your home. The bank can look at the valuation of the home and say, “OK we’ll loan you the $400,00.” But you don’t have to make the payments. It’s a reverse mortgage. Instead, the payments just accrue to the loan.

Again, you start owing $400,000. If your first month’s payment was $2,000 and you don’t make it because it’s a reverse mortgage. Now you owe $402,000. In the second month, you don’t make a payment. Now you owe $404,000, but you get to keep the $400,000 and use it for retirement.

There’s no risk to you as long as you stay in the house. The bank can’t kick you out of your house. The bank simply gets the first amount of money when your kids sell the house if you die and leave it to them to pay the bank back.

How A Reverse Mortgage Works

A reverse mortgage doesn’t have to be a scary thing. It can be a great tool for retirees to get additional income in retirement or pay off other debt. It’s certainly not for everybody, but this whole idea that the bank is going to kick you out of your house is not valid. As long as you’re living in the house, the bank can’t kick you out.

If they underwrote the reverse mortgage, they’re at risk. If that house is no longer worth what is owed to the bank, that’s the bank’s problem. That’s how the product works. It can be a good tool but be cautious. Do your research before you go ahead and get a reverse mortgage.

Thanks for joining me and I hope you found this information helpful!

P.P.S. Feel free to submit questions here for a chance to have them answered!