A reverse mortgage is a type of loan where the homeowner withdraws a portion of their equity but don’t have to repay the loan until they leave the house. One of the most popular types is the Home Equity Conversion Mortgage (HECM), which is insured by the U.S. federal government. Although widely available, HECM products are only offered by FHA-approved lenders.
Reverse mortgages can be a solution for consumers ages 62 and older who own their homes outright — or at least have a considerable amount of equity to draw from.
You may be wondering why anyone would want to borrow against a home they worked hard to pay off. Why not remain in your home and live there debt-free?
According to Steve Irwin, executive vice president of the National Reverse Mortgage Lenders Association (NRMLA), nobody gets up in the morning and thinks about a reverse mortgage and whether they should get one.
“Instead, they think how they are going to pay for health care, fix the roof, pay the property taxes or have enough money to outlive their retirement,” he says. “A reverse mortgage provides solutions to these issues and many others, so that people can live more financially secure lives as they age.”
Who is eligible for a reverse mortgage?
The primary homeowner must be age 62 or older to apply. However, Irwin says that if one spouse is under 62, you may still be able to get a reverse mortgage if you meet other eligibility criteria. For example:
- You must own your home outright or have a single primary lien you hope to borrow against.
- Any existing mortgage you have must be paid off using the proceeds from your reverse mortgage.
- You must live in the home as your primary residence.
- You must remain current on property taxes, homeowner’s insurance and other mandatory obligations, such as homeowners association dues.
- You must participate in a consumer information session led by a HUD-approved counselor.
- You must maintain your property and keep it in good working condition.
- Your home must be a single-family home, a multi-unit property with up to four units, a manufactured home built after June 1976, a condominium, or a townhouse.
How does a reverse mortgage work?
Qualified homeowners may not be able to borrow the full value of their home — even if it’s paid off. The amount you can borrow (also called the principal limit) varies based on the age of the youngest borrower or eligible non-borrowing spouse, prevailing interest rates, the HECM FHA mortgage limit ($726,525 as of February 2020), and your home’s value.
Generally the older you are, the lower the interest rates and the more your property is worth, the more likely you’ll receive a higher principal limit. This amount can increase each month because borrowers with variable-rate HECMs may be able to receive additional funds.
If you choose a HECM with a fixed interest rate, you will receive a single disbursement lump sum payment. On the other hand, if you opt for a reverse mortgage with a variable rate, you can choose to accept:
- Equal monthly payments provided at least one borrower lives in the property as their primary residence
- Equal monthly payments for a fixed period of months agreed on ahead of time
- A line of credit that can be accessed until it is exhausted
- A combination of a line of credit and fixed monthly payments for as long as you live in the home
- A combination of a line of credit plus fixed monthly payments for a set length of time
The money you borrow via a reverse mortgage doesn’t need to be repaid until the borrower dies, moves out, or leaves the home for any reason.
Furthermore, the borrower will never owe more than the home is worth regardless of how much they borrow or what happens to their property value over time. The borrower or heirs keep the difference if the reverse mortgage’s balance is less than the home’s value at the time of repayment.
If you believe a reverse mortgage is the solution for you, applying for one is similar to that of a traditional home equity loan. Once you meet the eligibility criteria, shop around to find the best deal.
The lender will assess your financial situation including evaluating your credit history, any outstanding mortgage and ensuring your property qualifies (as in you don’t have any active property liens). You’ll also need to provide proof that you’re able to pay for ongoing housing costs, and order a property appraisal to determine its value and how much you can borrow.
Once you close on your loan, you have the right of rescission, or your right to cancel your mortgage without penalty. In order to do so, you need to notify your lender within three business days after closing in writing.
Make sure to keep all copies of any correspondence and send your letter via certified mail and ask for a return receipt so that you’ll know it got into the right hands. Afterwards, your lender will have 20 days to return any fees you’ve paid for the reverse mortgage.
What are the types of reverse mortgages?
Now that you know how a reverse mortgage works, you’ll want to consider which type will best suit your needs.
- Proprietary reverse mortgages. These are private loans not backed by any government entity. Typically you can receive a larger loan advance from this type of reverse mortgage, especially those who have higher-valued homes.
- Single-purpose mortgages. Not as common as the other two options, this type of reverse mortgage is usually offered by non-profit organizations and a few state and local government agencies. Borrowers can only use the loan for one specific purpose.
- Home Equity Conversion Mortgages. The most popular type of reverse mortgage and backed by the U. S. Department of Housing and Urban Development (HUD), these federally insured mortgages usually have higher upfront costs, but the funds can be used for any purpose. Before closing on a HECM, all borrowers will need to go through counseling from a HUD-approved counselor. The point is to help you understand how a reverse mortgage works from someone who won’t benefit from you taking out the loan.
Reverse mortgages — what are the pros and cons?
Borrowing against your home equity to free up cash for living expenses is an option if you need the money. However, there are advantages and disadvantages with this type of mortgage.
Here are the main details to keep in mind:
- Borrower does not need to make monthly payments toward their loan balance
- Proceeds can be used for living expenses, debt repayment, healthcare expenses, and more
- Funds can help borrowers enjoy their retirement
- Non-borrowing spouses not listed on the mortgage can remain in the home after the borrower dies
- Borrowers facing foreclosure can use a reverse mortgage to pay off the existing mortgage, potentially stopping the foreclosure
- Borrower must maintain the house and pay property taxes and homeowners insurance
- A reverse mortgage forces you to borrow against the equity in your home, which could be a key source of wealth
- Fees and other closing costs can be high and can lower the net amount available
How much does a reverse mortgage cost?
Speaking of higher costs, it’s important to understand that closing costs for reverse mortgages tend to be significant. Most HECM mortgages let you finance closing costs into the new loan, however, meaning you won’t have to fork over the money out-of-pocket.
Here’s a breakdown of HECM fees and charges, according to HUD:
Mortgage Insurance Premium (MIP). You’ll pay a 2 percent initial MIP at closing, as well as an annual MIP equal to 0.5 percent of the outstanding loan balance. MIP can be financed into the loan.
Origination fee. Lenders charge the greater of $2,500 or 2 percent of the first $200,000 of your home’s value to process your HECM loan, plus 1 percent of the amount over $200,000. The FHA caps HECM origination fees at $6,000.
Servicing fee. Lenders can charge a monthly fee to maintain and monitor your HECM for the life of the loan. Monthly servicing fees cannot exceed $30 for loans with a fixed rate or an annually adjusting rate, or $35 if the interest rate adjusts monthly.
Third-party charges. Third parties charge their own fees for closing costs, such as the appraisal, title search and insurance, inspections, recording fees and mortgage taxes.
Also keep in mind that the interest rate for reverse mortgages tends to be higher than that of a traditional home equity loan. Of course, rates can vary depending on your lender, your home value, your creditworthiness, market fluctuations and other factors.
Reverse mortgages vs. home equity loans
If you’re not yet 62 or older but still want to tap into your home equity, you may want to consider a home equity loan or home equity line of credit (HELOC) instead. Both loan products will let you borrow against the equity you have in your home, although you can typically only borrow up to 15 to 20 percent of your home’s equity.
However, it’s important to understand the differences you’ll find with a home equity product.
“The main difference between a reverse mortgage, a home equity loan, and a HELOC is that the homeowner doesn’t need to make monthly payments with a reverse mortgage,” said Irwin. Plus, any funds borrowed from the reverse mortgage don’t need to be repaid until the borrower passes away or permanently vacates the property.
With a home equity loan or HELOC, the borrower does have to make monthly payments until the loan is paid off. Home equity loans can also be more difficult — or impossible — unless retirees have sufficient income to repay the loan.
On the flip side, home equity loans and HELOCs don’t require you to be at least 62 years old to apply. Fees and interest rates for both can also be significantly lower than what you’ll qualify find with a reverse mortgage.
How to shop around for a reverse mortgage
It’s a good idea to speak with a HUD-approved counselor before shopping around for reverse mortgages. That way, you get to learn the ins and outs of what this type of loan entails and provide relevant information to ensure you make an educated decision.
When shopping around, decide which type of reverse mortgage you want based on your financial needs. Once you get a few quotes, compare offers based on loan terms and fees. Mortgage insurance premiums are typically the same between lenders but other costs can vary greatly — including interest rates, closing costs, origination fees and service fees.
How to avoid scams related to reverse mortgages
Unfortunately, there are individuals who target those looking for low cost home loans. Here are two common scams related to reverse mortgages
- Contractor “loans.” Some contractors will try to convince you to get a reverse mortgage when touting home improvement services.
- Veteran “loans.” The Department Veterans Affairs (VA) doesn’t have reverse mortgages. You may see ads promising special deals for veterans such as a fee-free reverse mortgage to attract borrowers.
The best way to avoid them is to be aware of potential scams. If you don’t understand what you’re getting into — especially the cost and terms of one — don’t sign on the dotted line. This is especially important if you’re feeling pressure to do so. Instead, do more research or find a company that you trust.
Alternatives to reverse mortgages
If you’re not convinced of any of the reverse mortgage solutions mentioned above, here are some alternatives:
- Downsize. If you’re able and willing to move, selling your home and moving to a smaller one will give you access to your existing home equity. You can use the proceeds however you wish.
- Sell the house to your children. Consider a sale-leaseback agreement which means the buyer (children) agree to let you rent the property from the proceeds of the sale.
- Decrease expenses. Cutting out unnecessary expenses can mean you’ll be able to stay in your home. Consider contacting local programs such as ones through the Administration for Community Living that might provide assistance with fuel payments, utilities and home repairs.
- Refinance your home. Refinancing your current loan could mean the ability to lower your monthly payments. Make sure to check the new terms to see how it will affect your retirement years.
The bottom line
Nobody wants to have to borrow money just to get by, but reverse mortgages do serve an important purpose. For the most part, they are intended to generate income to help consumers cover living expenses without having to move in old age. For those struggling to pay for healthcare, food or experiences as they enjoy their golden years, a reverse mortgage can be a game-changer.
Then again, they’re not for everyone. A reverse mortgage isn’t a good option if you can’t keep up with the costs associated with the home, even without a monthly mortgage payment.
If you die or the home is no longer the primary residence for more than 12 months, the loan comes due, which means either you or your estate has to repay the loan or put the home up for sale to settle it.
Another potential drawback: if the loan balance exceeds the home’s value, you or your heirs may need to sign a deed-in-lieu of foreclosure and give the house to the lender.
Homeowners interested in taking out a HECM-type reverse mortgage must also receive mandatory counseling with an independent agency approved by the U.S. Department of Housing and Urban Development (HUD). Typically, counseling is free or available at a reduced cost.
To locate a FHA-approved lender or HUD-approved counseling agency, you can visit HUD’s online locator or call the department’s Housing Counseling Line at (800) 569-4287.
With additional reporting by Sarah Li Cain.