What Is a Reverse Mortgage?
Reverse mortgages make a lot of sense for some homeowners
A reverse mortgage is a type of loan that provides you with cash by tapping into your home's equity. These mortgages can lack some of the flexibility and lower rates of other types of loans, but they can be a good option in the right situation—such as if you're never planning to move and you aren't concerned with leaving your home to your heirs.
Like a standard mortgage, a reverse mortgage uses your home as collateral. These loans are different in a few ways, however, leading to the “reverse” part of the name. First, you receive money instead of paying money to your lender. Second, the amount of your loan grows over time, as opposed to shrinking with each monthly payment you'd make on a regular mortgage.
The concept works similar to a second mortgage or home equity loan, but reverse mortgages are only available to homeowners age 62 and older. You generally don’t have to repay these loans until you move out of your house or die. You must typically certify to the lender each year that you do indeed still live in the residence. Otherwise, the loan will come due.
Several sources for reverse mortgages exist, but one of the better options is the Home Equity Conversion Mortgage (HECM) that's 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'll receive from a reverse mortgage depends on two major factors.
- The more equity you have in your home, the more money 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. The FHA limits HECM mortgages to $726,525 as of 2019 or the appraised value of your home, whichever is less.
- The age of the youngest borrower on the loan also affects how much you get. Older borrowers can take more. Be very careful, however, if you’re tempted to exclude somebody younger to get a higher payout. A younger spouse would have to move out at the death of the older borrower if the younger person isn't included on the loan.
Try the National Reverse Mortgage Lenders Association’s calculator to get an estimate of how much you can take out. Keep in mind, however, that the actual rate and fees charged by your lender will probably differ from the assumptions used.
How to Receive Loan Payments
You have a few options, but the simplest is to take all the money at once in a lump sum. Your loan has a fixed interest rate with this option, and your loan balance simply grows over time as interest accrues.
You can also choose to receive regular, periodic payments, such as once a month. These payments are referred to as "tenure payments" when they last for your entire life, or "term payments" when you receive them for a set period of time, such as 10 years. It’s possible to take out more than you and your lender expected with lifetime payments if you live an exceptionally long life.
You can also opt for a line of credit rather than take the cash immediately. This allows you to draw funds if and when you need them. The advantage of a line of credit approach is that you only pay interest on the money you’ve actually borrowed, so your credit line could potentially grow over time.
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.
Reverse Mortgage Interest and Fees
As with any other home loan, you’ll pay interest and fees to get a reverse mortgage. Pay attention to the costs and compare offers from several lenders.
Interest is compounded—it's periodically added to your loan balance, and interest is based on this increased loan balance the next time it's calculated.
You might experience sticker shock when you see the amount of servicing fees that eat into your monthly income from a reverse mortgage—as much as $30 a month for fixed-rate loans, or $35 for adjustable rate loans on HECM loans as of the end of 2018. It’s definitely worth shopping around for the lowest-fee lender.
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 decide to sell the home and pay off the loan. It might be wise to pay interest and fees out of pocket if you have the funds available, instead of paying interest on those fees for years and years.
Common Reverse Mortgage Costs
You’ll pay many of the same closing costs required for a home purchase or refinance, but these can be higher as well. Most HECM costs can be included in your loan, however. Some of these costs are beyond your control, but others can be managed and compared.
- You’ll need an appraisal. The average cost is about $450 in 2019, and it can be as much as $125 more if the appraiser must come out a second time after any necessary repairs have been made.
- Origination fees vary from lender to lender, but your county recording office charges the same no matter who you use. You can plan on paying 2 percent of the first $200,000 of your home's value plus 1 percent of the value over that, or a $2,500 flat fee, whichever is greater, up to a $6,000 cap on HECM loans.
- HECMs are backed by the FHA. This reduces the risk for your lender in the event that your home isn't worth the loan balance at the time you move out or die, so you'll have to pay an insurance premium to the FHA. The initial mortgage insurance premium (MIP) is typically between 0.5 percent and 2.5 percent as of early 2019. It's 2 percent for HECM loans. You'll also pay an annual premium fee of 0.5 percent of your loan balance for HECM loans, although this cost can be financed into your loan.
This doesn't take into account other typical closing costs associated with any mortgage, such as document preparation, inspections, certifications, recording fees, and the cost of credit reports as the lender will want to check your credit.
Repaying the Loan
The loan balance comes due when the borrower permanently moves out of the home, typically at death or when the home sells. However, reverse mortgages can also come due if you fail to meet the terms of your agreement, such as if you don’t pay your property taxes. The homeowner invariably has to keep up with the extra costs of taxes, property insurance, and maintenance.
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. Most reverse mortgages are repaid through the sale of the home. For example, the home will go on the market after your death, and your estate will receive cash when it sells—cash that must then be used to pay off the loan. If you decide to move and find that you owe less on the reverse mortgage than you sell the house for, you get to keep the difference.
You don’t have to pay the difference with an HECM loan if you owe more than you sell the house for, and that's a good thing. Most reverse mortgages include a clause that doesn't allow the loan balance to exceed the value of the home's equity, although market fluctuations can still result in less equity than when you took out the loan.
If your heirs decide they want to keep the home, the full loan amount is due in this case, even if the loan balance is higher than the home’s value. Your heirs will have to come up with the money if they want to keep the house in the family. It's possible that your estate might provide enough other assets to allow them to do this, but otherwise, they might not be able to qualify for a regular mortgage to pay off the debt and keep the home.
Pros and Cons
Remember, you must live in the home for the entire term. Hospitalization of 12 months or less is OK if you require an extended stay in a long-term care facility, but you'd find yourself in a position where you must repay the loan at a time when doing so might be impossible if you must stay longer than that. A reverse mortgage lender can foreclose and take your property if you fail to do so.
Obviously, if there's any chance that you might want to or have to move out of your home, a reverse mortgage is not an ideal option for you.
Be very sure that you can afford to keep up with your home's associated expenses. Again, foreclosure is possible if you can't keep up with these property taxes and insurance. Your lender might "set aside" some of your loan proceeds to meet these expenses if you can't. This is an arrangement you might voluntarily elect if you think you'll ever have trouble in this regard.
Another thing to keep in mind is that your reverse mortgage debt is likely to increase exponentially as time goes by and interest piles on. If and when your loan balance reaches the point where it exceeds your home's value, your lender might opt for foreclosure in this case as well.
On the flip side, 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, you can use the funds to supplement your other sources of income or any savings you’ve accumulated.
You'd be lessening your debt load in your retirement years if you take the money and pay off your existing mortgage. A reverse mortgage can certainly ease the stress of paying your bills in retirement...or even improving your lifestyle in your golden years.
How to Get a Reverse Mortgage
First, you must meet some basic criteria:
- You can't be delinquent on any debt owed to the federal government.
- You’re taking money out of your house, so you'll 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.
- You’ll have to prove to the lender that you’re capable of keeping up with the ongoing expenses of maintaining your home. This ensures that the property retains its value and that you keep ownership of the property.
- You must attend counseling, a “consumer information session” with a HUD-approved counselor, before your HECM loan can be funded. This ensures that borrowers understand each cost and the consequences of taking out this type of loan. Counselors work for independent organizations, so they should provide unbiased information about the product. These courses are available at low cost and sometimes they're even free.
- You can still get a reverse mortgage if you owe money on your home—you have a first mortgage against it. Some people take a reverse mortgage in order to eliminate the existing monthly payments by netting the loan income against their existing mortgage payment. But the reverse mortgage must be the first lien on the property. For most borrowers, this means paying off your remaining mortgage debt with part of your reverse mortgage. This is easiest if you have at least roughly 50 percent equity in your home or more.