The Rising Debt 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: 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.