What Is a Reverse Mortgage?

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DEFINITION

A reverse mortgage allows you to receive payments against your home’s equity when you’re 62 or older while you remain in the house. This loan supplements your retirement income while staying in your home. The loan is repaid when you move out, sell the house, pass away, or at the term’s end.

Definition and Examples of a Reverse Mortgage

A reverse mortgage is a loan providing predictable, tax-free cash payments for those ages 62 or older. The loan is based on the borrower’s substantial home equity. Repayment is delayed if the borrower lives in the home or otherwise meets the loan’s terms. The borrower’s death or moving out triggers repayment.

For many individuals and families approaching retirement, their most significant asset is equity in their homes. A reverse mortgage is for homeowners who built home equity but don’t have retirement funds; the reverse mortgage allows a retiree to live in the house and receive the equity. Cash could be received as a lump sum or on a dependable schedule, such as monthly payments for 10 years, or another structure.

  • Alternate name: home equity conversion mortgage (HECM) when government-insured through HUD

As an example, imagine your home is currently worth $400,000. At 63 years old, you finish paying off your mortgage, but your savings and retirement income don’t quite meet your needs. You could request a reverse mortgage of $120,000 where the lender gives you $1,000 a month for 10 years. If at age 70 you sell the home and move, the loan is repaid (along with fees and interest) from the home sale proceeds.

Other mortgages (including HELOCs) you have now likely need to be paid off at or before reverse mortgage closing. You could pay off those mortgages with a reverse mortgage’s proceeds.

How Does a Reverse Mortgage Work?

With a reverse mortgage, your loan balance goes up as you receive payments, while a regular mortgage balance goes down as you pay it off.

A home equity conversion mortgage (HECM) is the most common type of reverse mortgage and the least costly. To get an HECM, you first meet with an HECM counselor, who presents you with reverse mortgage options, repayment, and alternatives, given your complete financial picture.

Watch out for reverse mortgage scams targeting veterans or that come from housing contractors.

You’ll then apply for a reverse mortgage with an FHA-approved lender. The lender reviews your borrower and property qualifications for the loan. If married, at least one spouse must be 62 years old or older.

A FHA-certified appraiser compares your home to recent nearby sales. The loan is then processed for required paperwork and underwriting to verify your income, assets, credit history, and month-to-month living expenses, and ensure you’ve made all required tax and insurance payments.

The amount of equity you can withdraw from is based on:

  • Your age (older people qualify for more)
  • Interest rate (lower interest rates lead to higher amounts)
  • Lesser of: appraised value, sales price, or limit of $970,800

You’ll be able to choose between varying payment plans for your amount and interest rates—a fixed interest rate, or monthly or annually adjusting interest rate. Available terms might include a single payment in one lump sum, monthly payments for a specific time period, or as long as you live in the home. You might also receive a line of credit such as a HELOC.

After signing the closing paperwork, you receive the funds. If you still have a mortgage, you will need to pay it off with the proceeds. You will continue to receive payments for as long as the reverse mortgage agreement allows.

The loan is repaid at the term’s end, which may be defined as when you sell the home, pass away, or the loan term ends. It could also become due if you require long-term care and move to an assisted-living facility, a nursing home, or a convalescent home. Typically in these cases, the home is sold, and the sale proceeds pay back the loan.

Reverse mortgages can grow to a relatively large principal by the end of the loan, as interest, closing costs, and fees are usually rolled into the loan. A reverse mortgage’s “non-recourse” clause means that the estate cannot owe more than the home's value, if the house sells for at or above appraised value.

Other reverse mortgages may exist, but aren’t common. State and local programs may offer reverse mortgages for tax credits or tax deferral, or home repair and improvement. Proprietary reverse mortgages are private reverse mortgage loans, but are extremely rare, as the HECM program is more appealing to consumers and lenders alike.

Pros and Cons of a Reverse Mortgage

Pros
  • Cash flow

  • Stay in home

  • Non-taxable income

Cons
  • Could lose your home

  • Heirs may inherit less

  • Income can affect benefits

Pros Explained

  • Cash flow: Equity you’ve built up over the years can give you the money to help you stay independent and less cash-strapped during retirement.
  • Stay in home: You can pay off your current mortgage and stay in your home without worrying about monthly mortgage payments.
  • Non-taxable income: Income from a reverse mortgage usually isn’t taxable, although you should speak with a tax professional to confirm this.

Cons Explained

  • Could lose your home: You’re still responsible for home maintenance, property taxes, and insurance payments. Failing to pay property tax or keep the home in good shape can jeopardize your reverse mortgage and lead to foreclosure.
  • Heirs may inherit less: You’re turning back the clock on accrued equity. The home must be sold to pay off those amounts owed, although any remaining proceeds can become part of the estate.
  • Income can impact benefits: Money you receive could influence any needs-based benefits amount you qualify for (from Social Security, for example).

Key Takeaways

  • Reverse mortgages are a loan product for homeowners ages 62 or older who lack liquid assets but have substantial home equity and want to keep living in their homes long term.
  • Reverse mortgages come with substantial interest rates and closing costs, which should be considered as part of acquiring this loan.
  • When getting a reverse mortgage, a realistic potential outcome is having less to leave as an inheritance overall, including your heirs potentially having to sell the home upon your passing to pay off the lien against the house.

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Article Sources

  1. CFPB. "Reverse Mortgage Answers."

  2. Washington State Department of Financial Institutions. "How Reverse Mortgages Work."

  3. Consumer Financial Protection Bureau. "Can Anyone Take Out a Reverse Mortgage Loan?

  4. U.S. Department of Housing and Urban Development. "How the HECM Program Works."