If you are nearing retirement and are a bit worried about your liquid assets, reverse mortgages may help supplement your income.
The U.S. Department of Housing and Urban Development (HUD) launched the Home Equity Conversion Mortgage (HECM) program in 1990 and has since extended over 1 million federally-insured reverse mortgages to Americans 62 years of age and older.
But what is a reverse mortgage in simple terms and is it right for you? Here’s everything you need to know.
What is a reverse mortgage?
A reverse mortgage is a loan for qualified borrowers who want to convert part of the equity in their home into cash. This money is usually tax-free and can then be used for any purpose.
The borrower keeps the title of the house and is still responsible for paying property taxes, utilities, home insurance, maintenance, and other related costs.
Different options are available for loan disbursements, such as receiving a lump sum, a line of credit, or monthly payments. And, interest is added to the loan each month, so the amount grows over time.
The borrower doesn’t have to make any payments on the loan while he or she is living in the house.
Andrina Valdes, Division President at Cornerstone Home Lending, Inc., says, “One of the most convenient aspects of a reverse mortgage is that, as long as the borrower continues to meet requirements (living in the home, paying property taxes, etc.), no monthly payment is required on the loan.”
She adds, “The borrower certainly has the option to make monthly payments, which they may do if they plan to leave the house to family members in their will, but the borrower is not obligated to make those payments.”
How exactly does a reverse mortgage work?
You apply with a lender to borrow against the equity you have in your home. Upon approval, a lien will be placed against your home, and you will begin to receive the payments (or will gain access to a lump sum or credit line). You will not initially make any payments on the money you borrow.
How do you pay back a reverse mortgage?
When the last surviving borrower on the reverse mortgage meets one of the qualifying events for repayment, the loan will become due. Qualifying events include death, selling the home, or not living in the home anymore. If the qualifying event was death, the lender will sell the home to repay the reverse mortgage. If it was something else, the borrower will pay the balance back. Borrowers can do so by selling the home and using the proceeds to repay the mortgage, using other sources of cash to repay it, or refinancing the amount.
Why do people get reverse mortgages?
Reverse mortgages can be helpful as a part of a retirement strategy. Many people use them to supplement their income, pay off their mortgage, pay for healthcare, or cover other expenses.
Types of reverse mortgages
Next, let’s look at the three types of reverse mortgages on offer.
Single-purpose reverse mortgages (property tax deferral programs)
Single-purpose reverse mortgages are like regular reverse mortgages but they have the added requirement that the borrower must use the loan to pay for a specific approved item, such as a home repair or property taxes.
This type of loan is not widely available. Only select non-profit organizations and state and local governments offer it. In fact, they make up only a small portion of reverse mortgages.
Each state can set requirements for the loan and may not disburse cash to the borrower directly. Instead, they sometimes pay for the item directly.
These mortgages are not federally-insured and are often only available for older homeowners with low-to moderate incomes. Lastly, interest and fees on this type of reverse mortgage are typically lower than other types.
Proprietary reverse mortgages (jumbo reverse mortgages)
Proprietary reverse mortgages are ideal for senior borrowers with home values that exceed the maximum limit set by HECM for their state.
Being that the loan amounts are higher and come with more risk, the loans also usually have higher interest rates. These are typically insured by private lenders and banks.
Home Equity Conversion Mortgages (HECMs)
Most reverse mortgages (about 90%) are HECMs, which are insured by the Federal Housing Administration (FHA). These are available to borrowers who live in homes with values below the maximum limit, which, according to HUD, is $765,600 for the 2020 calendar year.
These are the HECM requirements for reverse mortgage borrowers:
To qualify for a HECM, you must:
- Be at least 62 years old.
- Own home outright or have a low remaining balance that can be paid off at closing using the reverse mortgage loan.
- Have resources to pay for the ongoing costs of maintaining the home (insurance, taxes, etc.).
- Live in the home as their primary residence.
- Complete financial counseling by a HUD-certified professional.
- Meet financial eligibility obligations set by the HUD.
HECM home requirements:
A borrower’s home can be a single-family home, a two-to-four unit home where the borrower lives in one unit, or a HUD-approved manufactured home or condo that meets FHA requirements.
HECM loan amounts:
The amount you can borrow will depend on the interest rate and the age of the youngest eligible non-borrowing spouse or borrower. The appraised value of the home can’t exceed the maximum limit of $679,650. The older you are, the more you can borrow.
You can get this type of reverse mortgage through any FHA-approved lender.
When it comes to getting the money, there are various options which include:
- Lump-sum option: Receive a single lump-sum disbursement when the mortgage closes (available on fixed-rate loans).
- Equity line option: Gain access to the loan as a credit line (available with adjustable interest rates).
- Tenure option: Receive equal monthly payments as long as one borrower is living in the house as their principal residence (available with adjustable interest rates).
- Term option: Receive equal monthly payments for a fixed period (available with adjustable interest rates).
- Combination option: There are also options to combine a line of credit and monthly payments as long as you stay in the home or for a fixed period (available with adjustable interest rates).
Casey Fleming, mortgage advisor and author of The Loan Guide: How to Get the Best Possible Mortgage, created this chart to help borrowers decide which payment option is best for them:
While HECMs are the most common of the reverse mortgage types, there are other options in case you can’t get approved or have a home with a value that exceeds the maximum loan limit.
Next, let’s look at the costs.
Reverse mortgage costs
There are often origination fees, closing costs, servicing fees, and interest involved with reverse mortgages. With a HECM, you will be required to get FHA mortgage insurance which has an upfront and annual cost.
The initial mortgage insurance premium is 2%, which can be financed as part of your loan. The annual mortgage insurance premium will end up equaling 0.5% of the outstanding mortgage balance.
HECM closing costs can include the costs for inspections, surveys, mortgage taxes, appraisals, title searches, recording fees, and more. HECM origination fees compensate the lender for processing your loan.
Lenders can charge $2,500 or 2% of the first $200,000 of your home’s value (whichever is greater) plus 1% of the amount over $200,000, up to $6,000. Lenders may also charge servicing fees over the life of the loan up to $35 per month.
Lastly, interest will accrue each month and will be added to the amount you owe. Fixed and adjustable rates are available.
As for writing off the interest on your taxes, it won’t become tax-deductible until after you pay it, which is usually when the loan is paid off in full.
When shopping around for a lender, ask for a complete list of costs and fees and compare at least three options.
Who can get a reverse mortgage?
Reverse mortgage age limits can vary by the type of reverse mortgage you get. For HECMs, the minimum age is 62. There will be other requirements as well, which can vary by lender and mortgage type.
Before applying, be sure to read through all of the eligibility requirements.
How much do you get from a reverse mortgage?
The amount of money you can get from a reverse mortgage will depend on several factors.
These include your age, the number of borrowers on the application, the value of the property, the type of loan you are getting, current interest rates, and an assessment of your ability to pay homeowner’s insurance and property taxes.
As a general rule, the older you are and the more equity you have, the more money you can get.
Reverse mortgage pros and cons
While there are many pros, there are also important reverse mortgage disadvantages to consider. Here’s a look at both.
Compare the pros and cons to make a better decision.
- No need for repayments initially.
- No income requirements to qualify.
- You can increase your income stream in retirement.
- Maintain ownership of the home.
- You can often roll the costs into the loan so you don’t pay them upfront.
- You are using up the equity in your home which means you will have fewer assets to pass on to your heirs.
- Costs are high, especially for Proprietary and HECM loans.
- The loan will become due if you move somewhere else for 12 months (like a full-time care facility).
- WIthout a “non-recourse” loan, you can owe more than the property is worth.
- You can’t get a reverse mortgage if you have a conventional mortgage (unless you use it to pay off the conventional loan balance).
Be sure to talk with an unbiased financial advisor if you have any questions or concerns.
If you decide that getting a reverse mortgage is the right financial move for you, here’s how to find the best lender.
How to compare reverse mortgage lenders
First, you will want to determine which loan type works best for you. Does a single-purpose reverse mortgage suit your needs? If so, great! That will be the cheapest of the three options.
If not, do you have an expensive home with a high value? In this case, a proprietary reverse mortgage is a good place to start. For everyone else, HECM is the way to go.
The next step is to find lenders who offer the reverse mortgage type you want. Read reviews and company information to find reputable prospects.
To start your search, check out our extensive list of reverse mortgage lenders and even filter them by their fee amount. Other ideas include:
- Talking to a Home Equity Conversions Counselor at the Department of Housing and Urban Development (800) 569-4287.
- Searching for FHA approved reverse mortgage lenders if you’re looking for a HECM.
- Verifying lenders through the National Mortgage Licensing System (NMLS) Consumer Access.
- Vetting reverse mortgage lenders by checking their rating with the Consumer Advocate Group.
Once you have a list, create a spreadsheet and compare lenders side-by-side based on their terms, fees, interest rate, total costs, and repayment options. Run all the numbers to find the one that offers the most value for your situation.
Comparing alternatives to reverse mortgages
Reverse mortgages aren’t the only option. If you need more cash, you could also consider:
- Home equity loans: Cash out your home equity in a loan with monthly repayments over a set term.
- Home equity lines of credit: Gain access to your home equity in the form of a credit line which you can make withdrawals from as needed over a set period.
- Refinancing your home: Get a new loan to replace your existing home loan and potentially lower your costs.
- Personal loans: Get a loan based on your credit.
- Downsizing: Sell your home and move into a smaller home to reduce house debt.
- Lower your expenses and get debt help.
It’s wise to review all of your options so you can make an informed decision on which will be most beneficial.
FAQs on reverse mortgages
Here’s a look at answers to some of the most frequently asked questions about reverse mortgages.
What is a reverse mortgage?
A reverse mortgage is a loan that enables older homeowners, age 62 and older, to convert a portion of their home equity into tax-free cash in the form of loan proceeds* while continuing to hold title to your home and without being required to make monthly mortgage payments.
What is the downside of a reverse mortgage?
With a traditional mortgage, you borrow money upfront and pay the loan down over time. A Reverse Mortgage is the opposite – you accumulate the loan over time and pay it all back when you and your spouse (if applicable) are no longer living in the home. Any equity remaining at that time belongs to you or your heirs.
How much equity do you have to have to qualify for a reverse mortgage?
Generally, you need at least 50% equity in your home to qualify for a reverse mortgage. But that number can depend on your individual situation. With a reverse mortgage, the lender pays you.
What happens to a reverse mortgage when you die or sell your home?
you pass away and are the last surviving borrower or eligible non-borrowing spouse on a reverse mortgage, the loan balance and interest would become due. Your beneficiary would be responsible for paying it in full.
To do so, they will have to put your home on the market, sell it, and use the proceeds to pay it off, or pay off the loan in another way and keep the home. Beneficiaries have 30 days to make a decision and six months to complete the transaction.
Similarly, if you sell your home, the loan balance and accumulated interest will become due, and you will need to pay it.
Are reverse mortgages transferable?
Reverse mortgages are not typically transferable. Instead, when a qualifying event occurs, they must be repaid. If the borrower passes away, the lender can sell the home to repay the debt.
Are heirs responsible for reverse mortgage debt?
No, reverse mortgage heirs do not have to take on the remainder of the loan balance and are not held responsible for paying back the loan. If the loan balance is more than the appraised value of the home, heirs will not have to pay the difference.
So, when is a reverse mortgage a good idea?
A reverse mortgage makes sense if a qualified borrower:
- Is planning to stay in their home for the foreseeable future.
- Isn’t concerned about passing the home to heirs.
- Needs extra money for living expenses.
Beyond that, you’ll want to make sure it provides the most value when compared to every other option.
“Reverse mortgages are often misunderstood by Americans, resulting in a strong negative bias toward this loan type. But the reality is that a reverse mortgage could be an excellent source of tax-free income for older homeowners who may be limited on funds,” says Valdes.