What Is a Reverse Mortgage?
Reverse mortgages make sense for some homeowners
A reverse mortgage is a type of loan that provides you with cash using your home equity. These loans may lack some of the flexibility or lower rates of other loan types, so it’s worth evaluating alternatives before using one. In the right situation, though, a reverse mortgage can provide a powerful way to tap into the value of your home.
Like a standard mortgage, a reverse mortgage uses your home as collateral. However, these loans are different in a few ways, leading to the “reverse” part of the name. First, you receive money instead of paying money to your lender each month. Second, the amount of your loan grows over time, as opposed to shrinking with each monthly payment
The concept works similar to a second mortgage or home equity loan. However, reverse mortgages are only available to homeowners age 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, from supplemental retirement income to money for a large home improvement project. As long as you meet the requirements (see below), you can use the funds to supplement your other sources of income or any savings you’ve accumulated. However, don’t just jump at the prospect of easy money; these loans are complicated, and they reduce assets for your heirs.
While several sources for reverse mortgages exist, one of the better options is the Home Equity Conversion Mortgage (HECM) available through the Federal Housing Administration. An 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's 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 more of your loan equity goes to you as income rather than to cover interest payments.
Age: The age of the youngest borrower on the loan also affects how much you get, and older borrowers can take more. If you’re tempted to exclude somebody younger to get a higher payout, be very careful because 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.
How to Receive Loan Payments
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, such as 10 years. 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. Historically, fees have been notoriously high, but with more competition fees have been improving somewhat. Still, you need to pay attention to the costs and compare offers from several lenders.
Fees are often 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, plus interest.
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 the fees 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 the amount of fees that eat into your monthly income from a reverse mortgage. There are maximum limits on HECM fees, but it’s still worth shopping around for the lowest-fee lender.
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: You will pay interest on any money you’ve taken through a reverse mortgage.
Repaying the Loan
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, and 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 your estate receives cash that can be used to pay off the loan. If you decide to move and find you owe less on the reverse mortgage 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 an HECM; in other words, you “win.” Most reverse mortgages have a clause that doesn't allow the loan balance to exceed the value of the home's equity, although market fluctuations could still result in less equity than when you took the loan.
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 the difference if they want to keep the house in the family.
Requirements to Get a Loan
To get a reverse mortgage, you’ll need to meet some basic criteria.
- 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 to the lender 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 still need to keep up on maintenance, property taxes, and homeowners 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 to make sure borrowers understand each cost and the consequences of taking this type of loan. Counselors work for an independent organization, so they should 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 take a reverse mortgage in order to eliminate the existing monthly payments, by netting the loan income against their existing mortgage payment due.
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 percent equity in your home or more.