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The lender of the reverse mortgage is required to fill out a financial assessment and analyze your parents’ income versus expenses ratio. If this ratio shows they might have a problem paying their home insurance premiums, recurring taxes or other obligations, the lender may set aside money from their loan funds to pay these obligations.
Finally, your parents will have three business days after the loan closing to change their mind and cancel the reverse mortgage. And the lender cannot charge your parents interest during this three-day period.
The downsides of reverse mortgages
The biggest downside of reverse mortgages is their cost. There’s a cost attached to all mortgages and a reverse mortgage is no exception. In fact, the cost of a reverse mortgage can be extremely high as it will include the interest, a mortgage insurance fee, a loan origination fee, a fee to cover the cost of an appraisal, title insurance fees and miscellaneous other closing costs. While these costs vary they can be as much as $40,000. However, this fee is included in the loan so that your parents are not required to pay it.
There can be a problem if your parents move permanently from their home so that the loan immediately becomes due. This may not be a problem now but if your parents ever needed to move to a full-time care facility, their loan would be due. The same is true if they were to leave their home for a year for some reason.
The final negative of a reverse mortgage is how it would affect your parents' estate. It is almost certain that it will shrink the equity in their home so there will be less money left for you and any other heirs.
An even simpler explanation
If you'd like simple explanation of reverse mortgages in video form here it is as presented by a Certified Aging-in-Place Specialist.
Frequently Asked Questions about a reverse mortgage
Q. What happens if your parents have an existing mortgage?
A. While they may still qualify for a reverse mortgage it must be in the first lien position so that any existing mortgage must be paid off. Your parents could pay off the existing mortgage with money from the reverse mortgage, from their savings or with financial help from a friend or family member.
Q. How much money could my parents get?
A. This will depend on several factors including the age of your youngest parent, the home’s appraised value and the loan's interest rate. If the loan is in a government program, the FHA has a lending limit, which is now $625,5000. If your parents’ home is worth more than this then the amount of money they could get will still be based on the $625,500 loan limit.
Q. How does the interest work on one of these mortgages?
A. Your parents will be charged interest only on the money they receive. It may have either a fixed or variable rate. Their interest rate will not be paid out of the proceeds from the reverse mortgage but instead compounds over the life of the loan until it is paid off.
Q. What could my parents do with the proceeds from their reverse mortgage?
A. The money they would get from a reverse mortgage can be used for anything – to supplement their retirement income, repair or modify their home, cover their daily living expenses, pay off existing debts, cover their property taxes – or even to prevent foreclosure.
Q. Could my parents deduct their interest charges for income tax purposes?
A. Your parents can deduct their interest charges only when they have paid them. If they have not made any interest payments on the reverse mortgage they won’t be allowed to deduct any interest charges for income tax purposes.
Q. Will my parents receive statements from the lender?
A. The company that services your loan must issue to your parents a statement of account after each credit activity. It must also provide them with a statement about any impending interest rate charges that may impact their mortgage. Finally, the loan servicer is required by law to provide your parents with an annual statement of account by January 31. This statement will detail all of the account’s activity of the previous year.