What is a reverse mortgage? Here’s what you need to know

Buying a home often seems like a promising strategy for building wealth, as your monthly mortgage payments can help you build equity, and home values ​​generally appreciate over time. However, sometimes due to housing market conditions, the value of your home may actually depreciate – and the value of the home may fall below the amount of money you borrowed to pay for it.

This phenomenon is actually known as “underwater mortgage”, which can also be called reverse mortgage.

“A reverse mortgage is when the principal exceeds the value; in other words, you owe more than the actual value of the house,” says Christopher Rotio, executive vice president of Town Title Agency.

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How do you end up with a reverse mortgage?

A reverse mortgage is usually the result of short-term fluctuations in the housing market. So in a market with higher home values, for example, a home buyer will likely need a larger loan to cover the cost of the home.

But if the home’s value plummets for some reason, the loan amount you borrowed doesn’t plummet with it; you will still owe what you borrowed, even if the house is worth less.

“As the economy changes, you find yourself in a situation where home values ​​normalize and come down to earth,” Rotio says. “So it’s not worth the same as it was when purchased.”

Is a reverse mortgage a bad thing?

Market volatility can always be uncomfortable and many people tend to feel inclined to act during this time. But just like dealing with stock market volatility, the best way to deal with real estate market volatility is to do nothing, because the tides will turn again and your home’s value will likely recover over time.

However, you can run into real trouble if you have an upside down mortgage and are trying to sell your home. According to Rotio, if someone in this situation sells their home for an offer that is still less than what they owe on their mortgage, the seller of the home will have to pay the difference to their lender out of pocket. Depending on the situation, this could cost the seller tens of thousands or even hundreds of thousands of dollars.

“I don’t recommend selling if you have an upside down mortgage, but due to extenuating circumstances some people have to sell anyway,” Rotio says. “They should be prepared to pay the difference in this situation.”

What should you do if you have an upside down mortgage?

“Sometimes the best action is inaction,” Rotio says. That sentiment certainly applies here.

Simply avoiding a drastic action like selling your home when the value has dropped will allow your home’s value to rebound over time until you no longer have a reverse mortgage. Rotio also recommends being strategic during this time and making extra mortgage payments so you can pay down the principal faster.

“The beauty of doing this is that once the market stabilizes and values ​​go back up, you’ll have accumulated a lot more equity in your home,” he says. Making extra payments even if you have an upside down mortgage can also ensure that you pay your lender less out of pocket if you were to sell the home before values ​​have had a chance to fully rebound.

Is there a way to avoid an upside down mortgage in the first place?

Before you buy your home, you need to make sure you get an appraisal that makes sense, says Rotio. An appraisal is an assessment of the fair market value of a home. They can be based on a variety of factors, including property condition, home improvements, square footage, number of bedrooms, and other things.

“Generally, an appraisal is the purchase price, but you don’t want to pay too much,” says Rotio. “So negotiating upstream is more important than ever.”

Home appraisals cost more, but some mortgage lenders may waive the fee, so it’s always worth asking if this is something your lender can do. And if you can’t get the fee waived, you can try finding other ways to save on upfront costs. Some lenders, like Ally Bank, do not charge certain lender fees. Other lenders, like SoFi, offer deep savings and cashback offers to eligible homebuyers.

SoFi

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed and adjustable rate mortgages included

  • Types of loans

    Conventional loans, jumbo loans, HELOC

  • Terms

  • Credit needed

  • Minimum deposit

Allied bank

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed and adjustable rate mortgages included

  • Types of loans

    Conventional Loans, HomeReady Loan and Jumbo Loans

  • Terms

  • Credit needed

  • Minimum deposit

    3% if you continue with a HomeReady loan

Advantages

  • The Ally HomeReady loan allows a down payment of just under 3%
  • Pre-approval in just three minutes
  • Submission of the application in less than 15 minutes
  • Online support available
  • Existing Ally customers are eligible for a discount that applies to closing costs
  • Does not charge lender fees

The inconvenients

  • Does not offer FHA, USDA, VA or HELOCs loans
  • Mortgages are not available in Hawaii, Nevada, New Hampshire or New York

Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff alone and have not been reviewed, endorsed or otherwise endorsed by any third party.

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