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How does a Reverse Mortgage work?

The following pie depicts the Reverse Mortgage:

Reverse Mortgage Fees Pie Chart

 

At closing of the Reverse Mortgage
Value of the Home
The whole pie symbolizes the value of the home. Remember, as long as you or your spouse live in your home, you are the owner of the home.
Costs for the Loan
The costs for a Reverse Mortgage are financed through the Reverse Mortgage itself. The closing costs are symbolized by the red and orange segments: Financing Fees and Insurance Fees.
Lump Sum Upfront
The lump sum that you receive upfront is symbolized by the dark green segment.
Line of Credit
The remainder of the Reverse Mortgage will remain at your disposal as a Line of Credit. This is symbolized by the light green segment.
Funds for Monthly Income
If you would like to receive a monthly income from your Reverse Mortgage, then a part of the Reserve Mortgage will be reserved for monthly income. This is symbolized by the blue segment.
Reserves
The Reverse Mortgage does not cover the whole value of the home. There remain reserves that are not used for the Reverse Mortgage. These reserves are yours. These are symbolized by the grey segment.
Your Equity
Your equity is the balance of what you own and what you owe. You own the whole pie, but you owe the red, orange and dark green segments. Thus your equity is the light green (Line of Credit) plus the blue (Funds for Monthly Income) plus the grey reserves.

During the course of the Reverse Mortgage

Income

Over time you will enjoy the benefits of the Reverse Mortgage. It will provide you income. If you have set up the Reverse Mortgage to provide you a monthly income, you will receive this amount of income every month. Additionally, as long as you have a Line of Credit, you can always draw cash from the Line of Credit.

Reverse Mortgage Income Received
Income received from the Reverse Mortgage

Liquidity

Unexpected things happen. Liquidity is the amount of cash that you may access, if needed. Liquidity is provided by the Line of Credit in a Reverse Mortgage. Keeping part of the Reverse Mortgage as a Line of Credit is a wise decision when setting up a Reverse Mortgage. It helps you to manage unforeseen financial difficulties. In most Reverse Mortgages the Line of Credit, if left untouched, grows over time.

Reverse Mortgage Line of Credit
Development of the Line of Credit over time
Equity

Whenever you use cash, your net worth is affected. With a Reverse Mortgage you continue to own your home; it is yours. Eventually you or your estate will have to pay back the cash and interest that you have been drawing from the Reverse Mortgage. The Equity represents the net balance in your favor at any time. These are the proceeds that you or your estate would receive at any given time, in the event you sell the home and pay off the Reverse Mortgage. Your repayment of the Reverse Mortgage will never exceed the value of the home.

Reverse Mortgage Equity Chart
Equity is the net value of the Reverse Mortgage in your favor
Cost of the loan

The cost of money (Interest Rate) is measured with the Annual Percentage Rate (APR). Other things equal, the lower the APR the better it is for the borrower. In order to calculate the APR, estimations have to be made about how much cash you draw from the Reverse Mortgage.

Reverse Mortgage APR Chart
A Reverse Mortgage is costly in the short term, but a very good deal in the long term.
Your Reverse Mortgage in the Future

To understand how the Reverse Mortgage looks in the future, you can view the same pie you did at closing:

Reverse Mortgage 2014 Fees Pie Chart
Value of the Home

Again, the whole pie depicts the value of the home, and the value may have increased.

Costs for the Loan
The costs for a Reverse Mortgage are still there. Because you do not have to make any payments during the course of a Reverse Mortgage, all interest accrues. Each month the interest expense is added to the balance of the loan. This is symbolized by the purple segment.
Income Received
This is the total of all the income you have received from the Reverse Mortgage.
Line of Credit
Unless you use up all the Line of Credit, you will continue to enjoy the Line of Credit.
Funds for Monthly Income
As you receive cash from the Funds for Monthly Income. Over time these Funds shrink. Thanks to the mortgage insurance Monthly Income would even continue if the funds eventually become exhausted.
Reserves
Depending on the interest rates and the change in value of your house, the Reserves may increase, decrease, or run out.
Your Equity
Again, the whole pie symbolizes the value of your home. When you terminate the Reverse Mortgage you have to pay back the red, orange and purple segments. These are the costs for the loan. Also, you have to pay back the dark green segment; this is the cash that you have received so far. Thus your remainder is the sum of the light green, blue, and grey segments. Together they make up your equity.