What is a Reverse Mortgage?

Reverse Mortgage Basics

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A reverse mortgage is a type of loan that provides cash using your home equity. This isn’t the most flexible (or the least expensive) way to borrow, so it’s worth evaluating alternatives before using one. In the right situation, these loans provide a powerful way to tap into the value of your home.

The Basics

Like a standard mortgage, a reverse mortgage is a loan that uses your home as collateral. However, these loans are different in several ways, leading to the “reverse” part of the name.

  1. You receive money instead of paying money to your lender each month
  2. The amount of your loan grows over time, as opposed to shrinking with each monthly payment

The concept is similar to a second mortgage or home equity loan. However, reverse mortgages are only available to homeowners aged 62 and older, and you generally don’t need to repay these loans until you move out of your house.

Reverse mortgages can provide money for anything you want. As long as you meet the requirements (see below), you can use the funds to supplement your other sources income or any savings you’ve accumulated. However, don’t just jump at the prospect of easy money – these loans are complicated (especially to unwind), and they reduce assets for your heirs.

There are several sources for reverse mortgages, but we’ll mainly cover the Home Equity Conversion Mortgage (HECM) available through the Federal Housing Administration.

A HECM is generally less expensive for borrowers due to government backing, and rules for these loans make them relatively consumer-friendly.

How Much Can you Get?

The amount of money you get depends on several factors and is based on a calculation that makes certain assumptions about how long the loan will last.

Equity: the more equity you have in your home, the more you can take out. For most borrowers, it works out best if you’ve been paying down your loan over many years and your mortgage is almost completely paid off.

Interest rate: lower interest rates mean you can get more from a reverse mortgage.

Age: the age of the youngest borrower on the loan will also affect how much you get, and older borrowers can take more. If you’re tempted to exclude somebody younger to get a higher payout, be careful – a younger spouse would have to move out at the death of an older borrower if the younger person is not included in the loan.

Your choice of how to get the money is also important. You can choose from several payout options.

Lump sum: the simplest option is to take all of the money at once. With this option, your loan has a fixed interest rate, and your loan balance simply grows over time as interest accrues.

Periodic payments: you can also choose to receive regular payments (monthly, for example). Those payments can last for your entire life, or for a set period of time (10 years, for example). If your loan becomes due because all borrowers have moved out of the house, the payments end. With lifetime payments, it’s possible to take out more than you and your lender expected if you live an exceptionally long life.

Line of credit: instead of taking cash immediately, you can opt for a line of credit, which allows you to draw funds if and when you need them. The advantage of this approach is that you only pay interest on the money you’ve actually borrowed, and your credit line could potentially grow over time.

Combination: can’t decide? You can use a combination of the programs above. For example, you might take a small lump sum up front and keep a line of credit for later.

To get an estimate of how much you can take out, try the National Reverse Mortgage Lenders Association’s calculator. However, the actual rate and fees charged by your lender will differ from the assumptions used.

Reverse Mortgage Costs

As with any other home loan, you’ll pay interest and fees to get a reverse mortgage. Fees have historically been notoriously high, but things are getting better.

Still, you need to pay attention to the costs and compare offers from several lenders.

Fees can be (and often are) financed or built into your loan. In other words, you don’t write a check – so you don’t feel those costs, but you’re still paying them. Fees reduce the amount of equity left in your home, which leaves less for your estate (or for you, if you sell the home and pay off the loan). If you have the funds available, it may be wise to pay out of pocket instead of paying interest on those fees for years to come.

Closing costs: you’ll pay some of the same closing costs required for a home purchase or refinance. For example, you’ll need an appraisal, you’ll need documents filed, and your lender will review your credit. Some of these costs are beyond your control but others can be managed and compared. For example, origination fees vary from lender to lender, but your county recording office charges the same no matter who you use.

Servicing fees: you may get sticker shock when you see monthly fees that eat into your monthly income from a reverse mortgage. There are maximum limits on HECM fees, but it’s always worth shopping around.

Insurance premiums: because HECMs are backed by the FHA (which reduces the risk for your lender), you pay a premium to the FHA. Your initial mortgage insurance premium (MIP) is between 0.5 percent and 2.5 percent, and you’ll pay an annual fee of 1.25 percent of your loan balance.

Interest: of course, you paying interest on any money you’ve taken through a reverse mortgage.

Repayment

You don’t make monthly payments on a reverse mortgage. Instead, the loan balance is due when the borrower permanently moves out of the home (typically at death or when the home sells). However, you are taking on debt that needs to be repaid – you just don’t notice it.

Your total debt will be the amount of money you take in cash plus the interest on the money you borrowed. In most cases, your debt grows over time – because you’re borrowing money and not making any payments (you might even be borrowing more each month).

When your loan comes due, it must be repaid. The loan is generally due when all borrowers have “permanently” moved out. However, reverse mortgages can also come due if you fail to meet the terms of your agreement – if you don’t pay your property taxes, for example.

Most reverse mortgages get repaid through the sale of the home. For example, after your death, the home goes on the market, and you receive cash that can be used to pay off the loan. If you owe less than you sell the house for, you get to keep the difference. If you owe more than you sell the house for, you don’t have to pay the difference with a HECM (in other words, you “win”).

In some cases, your heirs will decide to keep the home. In those cases, the full loan amount is due – even if the loan balance is higher than the home’s value. Your heirs will need to come up with a large sum of money to keep the house in the family.

Requirements

To get a reverse mortgage, you’ll need to meet some basic criteria.

Basic rules:

  • The home is your primary residence (you can’t use a rental property, for example)
  • You are at least 62 years old
  • You are not delinquent on any debt owed to the federal government

Sufficient equity: since you’re taking money out of your house, you need a substantial amount of equity in your home to draw from. There’s no loan to value calculation like you’d have with a “forward” mortgage.

Ongoing expenses: you must have the ability to continue paying ongoing expenses related to your home (you’ll need to prove that you’re capable of keeping up with expenses). This ensures that the property keeps its value and that you retain ownership of the property. For example, you’ll have continual maintenance expenses, and you may need to pay property taxes and insurance premiums.

Income: you don’t need income to qualify for a reverse mortgage because you’re not required to make payments on the loan.

Counseling: before your HECM is funded, you must attend a “consumer information session” with a HUD-approved HECM counselor. This is supposed to provide unbiased information about the product.

First mortgage: if you still owe money on your home, you can still get a reverse mortgage (some people do it in order to eliminate the existing monthly payments). However, the reverse mortgage will need to be the first lien on the property. For most borrowers, that means paying off your remaining mortgage debt with part of your reverse mortgage. This is easiest if you have roughly 50% equity in your home (or more).