A reverse mortgage is a loan with no regular payment required, but equity may be cashed out through regular payments from the lender to the borrower. Contrast this to a traditional mortgage, in which there is one large principal advance at the beginning and many (usually monthly) payments over the life of the loan. In a reverse mortgage, the advances are small and periodic, and all repayment occurs upon the sale of the property or the death of the owner.
The reverse mortgage usually involves a line of credit for an amount equal to some percentage (80% for example) of the available equity. Depending on the terms of the loan, the borrower may take advances as needed, or may have a set monthly automatic advance. This second situation, which makes the loan look like a standard mortgage in reverse, is the reason these are called reverse mortgages. Interest, which accrues, is generally capitalized into the principal on a monthly basis, and this can have an effect on how much can ultimately be borrowed before the loan hits its cap based on the available equity. The borrower can usually pay down their balance at will with no penalty, but this does not generally happen.
In the United States, the following qualifications are required for a reverse mortgage:
- Borrower must be 62 years old or older.
- Borrower must occupy the property as his or her personal residence.
- Any existing loans on the property must be small enough to be paid off by the proceeds of the reverse mortgage.
- Applicant must take an approved credit counseling course to help them to understand the unique terms of the reverse mortgage.
The proceeds of the reverse mortgage may be disbursed in one of the following ways:
- Lump sum
- Monthly fixed payment to borrower (monthly fixed principal advance)
- Upon request by borrower (like a Home Equity Credit Line of Credit)
- Combination (Example: Lump sum to pay off existing loan followed by either monthly fixed payment or credit line on request.)
The general ledger accounting for the various transactions would be:
Principal Advance (Regardless of the method of disbursement)
- Debit Loan Asset
- Credit Cash
Daily Interest Accrual
- Debit Accrued Interest Receivable
- Credit Interest Income
Interest Capitalization (Generally Monthly)
- Debit Loan Asset
- Credit Accrued Interest Receivable
Principal Payment (Usually payoff only)
- Debit Cash
- Credit Loan Asset
Because all interest and fees are capitalized into the principal, there will never be any interest payments (except for possibly an un-capitalized portion of one month's interest upon payoff). From an accounting point of view, these loans are fairly simple and easily set up in a loan servicing system. In the Nortridge Loan System, one of these loans could be easily configured as a line of credit. If the advance to the borrower was for a fixed monthly amount, this can be automated with a Recurring Transaction. The capitalization of the interest can be automated the same way. No special customization of the system is required. So, for any lender using a flexible loan system like NLS, if you do reverse mortgages or you want to start doing reverse mortgages, you're good to go.