How a reverse mortgage works
A reverse mortgage loan allows you to take advantage of the financial value that you've built up in your home, often through years of making mortgage payments.
Whether you've paid off your house completely, or paid off a good chunk of your mortgage, it allows you to draw on that equity.
This can be a tremendous help if your savings, pensions and Social Security check aren't enough to allow you to live comfortably in your retirement years.
It can also provide help if there's an unexpected financial emergency.
But it isn't free money. Sooner or later, someone must pay. With a reverse mortgage, it can be your heirs, whose inheritance is disappearing as you're collecting reverse mortgage payments.
Kinds of reverse mortgages
Several kinds of reverse mortgages exist, but for retirees, a common option allows homeowners to continue taking money out of the house until they move out, sell it or die.
During this time, they're not only drawing down the equity in their home but also paying interest on the loan.
In effect, they're slowly building up a debt that is secured by the home.
If the homeowner finally sells because he or she must move into a nursing home, or for any other reason, the loan must be paid off.
When the balance comes due
"Basically, the reverse mortgage becomes due when the last surviving borrower vacates the property for 12 consecutive months," says Greg Womack, a certified financial planner in Edmond, Oklahoma.
The loan also becomes due after the last surviving borrower dies.
The heirs can repay the loan from another source if they wish. But if not, the house will be sold to pay off the balance of the loan.
"If there's any net equity left, it will go to the estate," Womack says.
If the reverse mortgage is a Federal Housing Administration-insured home equity conversion mortgage, or HECM, neither you nor your heirs are liable if the outstanding loan is more than the house is worth. The insurance covers any remaining balance.
If the house is worth less than owed, and the heirs decide they don't want the house, "the borrower's estate is not responsible for the difference," Womack says.
In addition, with an HECM loan, if your heirs want the house, they have the right to pay off the loan at the amount of the existing balance or 95% of the current market value, whichever is less.
For example, if the house is worth $100,000, but the balance on the mortgage is 125,000, the heirs can keep the home by paying $95,000.
They can't be saddled with an excessive debt or charged an excessive price to hold onto the home, but they also aren't getting the house for free. The lender, as is almost always the case, does get paid in the end.