How Is Interest Calculated on a Reverse Mortgage?
A reverse mortgage lets you convert the equity in your home into cash. You won't need to have a certain level of income, make regular payments or take on any foreclosure risk. However, the interest associated with a reverse mortgage is usually high and not eligible for any tax deduction.
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Amount of Loan
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The amount of money you can borrow with a reverse mortgage depends on various factors, including your age, the value of the home and interest rates. You can choose to get your reverse mortgage funds as a single lump sum of cash, regular withdrawals of a specific amount or unscheduled withdrawals in the amount of your choosing. Once you get the money, the lender adds it to the principal amount of the loan. Because you don't make payments toward the loan, the principal amount increases over time.
Compounding
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The lender calculates interest based on the outstanding balance and adds it to the principal amount every month. This means that your total debt increases as the lender adds more interest to the amount you owe. For example, if your reverse mortgage has an interest rate of 7 percent annually and you withdraw $3,000, then your interest for the month is $3,000 X (0.07/12) = $17.50. The lender adds this to your principal amount, making it $3,017.50. The lender will base next month's interest calculation on the new principal amount.
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No Tax Deductions
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With conventional loans, you get tax deductions that are calculated based on the amount you repay throughout the year and you receive as income tax returns. You don't get tax deductions with a reverse mortgage because you don't make repayments toward the loan. You only get tax deductions when you or your estate pay off the loan in part or whole. This may result in higher overall costs over the life of the loan.
Other Costs
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The lender charges various costs on the reverse mortgage, including upfront costs, insurance premium and servicing fees. While these fees can significantly increase the total amount owed, the lender does not usually add them to the principal amount. As such, these costs don't increase the interest charges of the reverse mortgage loan.
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References
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