Interest accrual is a critical aspect of reverse mortgages that can significantly impact your financial situation. In this article, we’ll delve into how interest accumulates on a reverse mortgage and what it means for borrowers.
Understanding Interest Accrual:
In a reverse mortgage, the borrower receives funds from the lender based on the home’s equity. However, unlike traditional mortgages where you make regular payments to reduce the loan balance, reverse mortgages typically involve no monthly payments. Instead, the interest on the borrowed amount accumulates over time.
As you receive funds from your reverse mortgage, the loan balance increases. The interest calculation depends on the outstanding balance and the loan’s interest rate. This accumulation of interest adds to the loan balance, leading to its growth throughout the loan’s duration.
Compound Interest Effect:
The accumulation of interest on a reverse mortgage can result in compound interest. This means that not only is interest calculated on the original borrowed amount, but also on the previously accumulated interest. Over time, this compounding effect can lead to a significant increase in the total amount owed.
Impact on Home Equity:
The growing loan balance due to interest accrual can gradually reduce the home equity available to borrowers. Although reverse mortgages enable seniors to access their home equity, it’s crucial to recognize that borrowing more and extending the loan term will result in retaining less equity.
Loan Repayment and Consequences:
Interest accrual continues until the loan is repaid. When the borrower moves out of the home or passes away, the loan becomes due. Borrowers or their heirs have the option to repay the loan, typically by selling the property. If the loan balance exceeds the home’s value, borrowers or heirs can choose to pay 95% of the home’s appraised value or allow the lender to take possession of the property.