You can see how a reverse mortgage works by comparing it to a “forward” mortgage — the kind you use to buy a home. Both types of mortgages create debt against your home. And both affect how much equity or ownership value you have in your home. But they do so in opposite ways.
“Debt” is the amount of money you owe a lender. It includes cash advances made to you or for your benefit, plus interest. “Home equity” means the value of your home (what it would sell for) minus any debt against it. For example, if your home is worth $150,000 and you still owe $30,000 on your mortgage, your home equity is $120,000.
Falling Debt, Rising Equity
When you purchased your home, you probably made a small down payment and borrowed the rest of the money you needed to buy it. Then you paid back your “forward” mortgage loan every month over many years. During that time:
- Your debt decreased; and
- Your home equity increased.
As you made each repayment, the amount you owed (your debt or “loan balance”) grew smaller. But your ownership value (your “equity”) grew larger. If you eventually made a final mortgage payment, you then owed nothing, and your home equity equaled the value of your home. In short, your forward mortgage was a “falling debt, rising equity” type of deal.
Rising Debt, Falling Equity
Reverse mortgages have a different purpose than forward mortgages do. With a forward mortgage, you use your income to repay debt, and this builds up equity in your home. But with a reverse mortgage, you are taking the equity out in cash. So with a reverse mortgage:
- Your debt increases; and
- Your home equity decreases.
It’s just the opposite, or reverse, of a forward mortgage. During a reverse mortgage, the lender sends you cash, and you make no repayments. So the amount you owe (your debt) gets larger as you get more cash and more interest is added to your loan balance. As your debt grows, your equity shrinks, unless your home’s value is growing at a high rate.
When a reverse mortgage becomes due and payable, you may owe a lot of money and your equity may be very small. If you have the loan for a long time, or if your home’s value decreases, there may not be any equity left at the end of the loan.
In short, a reverse mortgage is a “rising debt, falling equity” type of deal. But that is exactly what informed reverse mortgage borrowers want: to “spend down” their home equity while they live in their homes, without having to make monthly loan repayments.
Reverse mortgages don’t always have rising debt and falling equity. If a home’s value grows rapidly, your equity could increase over time. So your equity would grow as your home’s value increases. But most home values don’t grow at consistently high rates so the majority of reverse mortgages end up being “rising debt, falling equity” loans.
If you decide to pursue a reverse mortgage, we invite you to call us toll-free today at 1-800-486-8786 and experience the difference working with America’s Most Trusted Reverse Mortgage Company.