A reverse mortgage is a type of loan that provides you with cash by tapping into your home's equity. It's technically a mortgage because your home acts as collateral for the loan, but it's "reverse" because the lender pays you rather than the other way around.
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.
What Is a Reverse Mortgage?
Like a traditional mortgage, a reverse mortgage uses your home as collateral, but these loans are different in a couple of important ways. You don't have to make monthly payments to your lender to pay the loan off. And the amount of your loan grows over time, as opposed to shrinking with each monthly payment you'd make on a regular mortgage.
How Does a Reverse Mortgage Work?
The amount of money you'll receive from a reverse mortgage depends on three major factors: your equity in your home, the current interest rate, and the age of the youngest borrower.
The more equity you have in your home, the more money you can take out. Your equity is the difference between its fair market value and any loan or mortgage you already have against the property. It's usually best if you’ve been paying down your existing mortgage over many years, or—better yet—if you've paid off that mortgage entirely.
Older borrowers can receive more money, but you might want to avoid excluding your spouse or anyone else from the loan to get a higher payout because they're younger than you. A younger spouse or co-owner would have to move out at the death of the older borrower if the younger person isn't included on the loan.
The National Reverse Mortgage Lenders Association’s reverse mortgage calculator can help you get an estimate of how much equity you can take out of your home. The actual rate and fees charged by your lender will probably differ from the assumptions used, however.
Types of Reverse Mortgages
There are several sources for reverse mortgages, but the Home Equity Conversion Mortgage (HECM) available through the Federal Housing Administration is one of the better options. An HECM is generally less expensive for borrowers due to government backing, and the rules for these loans make them relatively consumer-friendly.
Reverse Mortgages vs. Home Equity Loans
Reverse mortgages and home equity loans work similarly in that they both tap into your home equity. One might do you just as well as the other, depending on your needs, but there are some substantial differences as well.
|Reverse Mortgages||Home Equity Loans|
|No monthly payments are required.||Loan must be paid back monthly.|
|Loan can be called due if the borrower moves out of the residence or fails to pay property taxes, insurance, or maintain the property.||Loan can only be called due if contract terms for repayment, taxes, and insurance aren't met.|
|Lender takes the property upon the death of the borrower so it can't pass to heirs unless they refinance to pay the reverse mortgage off.||Property might have to be sold or refinanced at the death of the borrower to pay off the loan.|
Pros and Cons of Reverse Mortgages
You must live in the home for the entire term of a reverse mortgage, although hospitalizations of 12 months or less are okay. You'd find yourself in a position where you must repay the loan at a time when doing so might be impossible if you require an extended stay in a long-term facility. A reverse mortgage lender can foreclose and take your property if you fail to repay the loan when you move out.
A reverse mortgage probably isn't an ideal option if there's any chance that you might want to or have to move out of your home.
Another downside is the ongoing expense of keeping your home. You'll be required to keep up with your home's associated expenses. Foreclosure is possible if you find yourself in a position where can't keep up with property taxes and insurance.
Your lender might "set aside" some of your loan proceeds to meet these expenses in the event that you can't, and you can also ask your lender to do this if you think you might ever have trouble paying for property taxes and insurance.
Your reverse mortgage debt is likely to increase exponentially as time goes by because interest piles on incrementally. Your lender might opt for foreclosure if and when your loan balance reaches the point where it exceeds your home's value.
On the positive 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 in retirement.
You'll probably have a lesser income when you retire, so 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 improve your lifestyle in your golden years.
Requirements for a Reverse Mortgage
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.
You must meet some basic criteria to qualify for a reverse mortgage. For example, you can't be delinquent on any debt owed to the federal government. 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 it.
You must attend counseling, a “consumer information session” with a HUD-approved counselor, before your HECM loan can be funded. This rule is intended to ensure that you understand the cost and consequences of taking out this type of loan. Counselors work for independent organizations. These courses are available at a low cost and sometimes they're even free.
The reverse mortgage must be the first lien on your property. For most borrowers, this means paying off your remaining mortgage debt with part of your reverse mortgage. This is easiest to achieve if you have at least 50% equity or so in your home.
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 will simply grow 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 lifetime, or "term payments" when you receive them for just a set period of time, such as 10 years.
It’s possible to take out more equity than you and your lender expected if you opt for tenure payments and live an exceptionally long life.
You can also take a line of credit rather than take the cash immediately. This allows you to draw funds only 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.
You can also use a combination of payment options. For example, you might take a small lump sum upfront and keep a line of credit for later.
Do I Need to Pay Off a Reverse Mortgage?
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. That cash that must then be used to pay off the loan.
The full loan amount comes due, even if the loan balance is higher than the home’s value, if your heirs decide they want to keep the home. They'll have to refinance or otherwise come up with the money to pay off the reverse mortgage.
Many reverse mortgages include a clause that doesn't allow the loan balance to exceed the value of the home's equity, although market fluctuations might still result in less equity than when you took out the loan.
It's possible that your estate might provide enough other assets to allow your heirs to pay off the reverse mortgage at your death by liquidating them, but they might otherwise not be able to qualify for a regular mortgage to pay off the debt and keep the family home.
Other Associated Costs
As with any home loan, you’ll pay interest and fees to get a reverse mortgage, but most won't come due until you sell, die, or vacate. You’ll pay many of the same closing costs required for a traditional home purchase or refinance, but these fees can be higher.
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 mortgage. 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 when they're rolled into your loan balance.
Fees are often financed, or built into your loan. You don’t write a check for them at closing so you might not feel these costs, but you’re still paying them regardless.
You must have your home appraised, adding to your costs. The lender will want to be sure that your home in tip-top shape before writing the 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.
- A reverse mortgage lets older homeowners tap into their home’s equity for a lump sum payment, periodic payments, or in the form of a line of credit.
- Reverse mortgages don’t have to be repaid until the homeowner dies or moves out of the residence. Stays in care facilities for less than a year are okay.
- Homeowners must be at least age 62 to qualify, and they can’t be delinquent on any debt that’s owed to the federal government.
- Interest accrues over the life of the loan, so the amount necessary to pay off the mortgage will almost certainly be significantly more than the original loan proceeds.