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With the average monthly Social Security check a scant $1,701.62 in 2023, many seniors struggle to find ways to survive in the face of rising inflation. In an effort to increase their incomes and remain in their homes, some turn to tapping the equity they’ve accrued in those homes, via a special form of financing: the reverse mortgage.
Geared specifically towards seniors, reverse mortgages can be a great tool — but that tool can also turn against them if it’s not fully understood. Here’s how reverse mortgages work, and what homeowners considering them need to know.
What is a reverse mortgage?
A reverse mortgage is a type of loan that allows homeowners ages 62 and older, typically ones who’ve paid off their mortgage, to borrow against part of their home’s equity. Unlike a regular mortgage in which the homeowner makes payments to the lender, with a reverse mortgage, the lender makes regular payments to the homeowner — hence the name. The money is tax-free.
Homeowners who opt for this kind of mortgage can continue to live in their homes. But the loan must be repaid when the borrower dies, permanently moves out or sells the home.
One of the most popular types of reverse mortgages is the Home Equity Conversion Mortgage (HECM), which is backed by the federal government.
How does a reverse mortgage work?
Reverse mortgage candidates typically own their homes free and clear. However, they may not be able to borrow the entire value of their home even if their primary mortgage is paid off.
The amount a homeowner can borrow, known as the principal limit, varies based on the age of the youngest borrower or eligible non-borrowing spouse, current interest rates, the HECM mortgage limit ($1,089,300 in 2023) and the home’s value.
Homeowners are likely to receive a higher principal limit the older they are, the more the property is worth and the lower the interest rate. The amount might increase if the borrower has a variable-rate HECM. With a variable rate, options include:
- 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 runs out
- 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
If you choose a HECM with a fixed interest rate, on the other hand, you’ll receive a single-disbursement, lump-sum payment.
The interest on a reverse mortgage accrues every month, and you’ll still need to have adequate income to continue to pay for property taxes, homeowners insurance and the upkeep of the home.
Typically, homeowners use reverse mortgages to supplement their retirement income, pay for home repairs, or cover medical expenses. “In each situation where regular income or available savings are insufficient to cover expenses, a reverse mortgage can keep seniors from turning to high-interest lines of credit or other more costly loans,” says Bruce McClary, spokesperson for the National Foundation for Credit Counseling.
|Reverse mortgage||Conventional mortgage|
|Minimum age||62 (younger with some non-HECM loans)||18 (or younger with a co-signer)|
|Loan amount||Determined primarily by value of home equity and borrower’s age||Determined by home sales price minus borrower down payment|
|Payment structure||Payments disbursed to borrower by the lender in a lump sum or monthly||Monthly installment payments that include principal and interest paid to the lender each month|
|Property taxes, homeowners insurance and maintenance||Borrower’s responsibility||Borrower’s responsibility|
|Mortgage balance||Increases over time since interest accrues monthly on the amount you borrow||Decreases as you make monthly mortgage payments since this amount includes interest|
|Tax-deductible interest||Not applicable until the loan is paid in full||Allowed for each year you pay interest on the mortgage balance (capped at a specific amount)|
Reverse mortgage requirements
To be eligible for a reverse mortgage, the primary homeowner must be age 62 or older (a small number of lenders may offer options for people as young as 55). The additional eligibility requirements include:
- You must own the property outright or have at least paid down a substantial amount of your mortgage (at least half).
- The property must be occupied as your primary residence.
- You cannot be delinquent on any federal debt.
- You must have the financial capability to continue to make payments on property taxes, homeowners insurance and homeowners association dues.
- You must participate in an information session provided by a U.S. Department of Housing and Urban Development (HUD)-approved reverse mortgage counselor.
“Seniors should be careful to make the most of the loan by budgeting carefully in order to avoid running out of funds too soon and to be sure that taxes and insurance are paid as agreed,” cautions McClary.
Types of reverse mortgages
There are different types of reverse mortgages, and each one fits a different financial need.
- Home Equity Conversion Mortgage (HECM) – The most popular type of reverse mortgage, these federally-insured mortgages usually have higher upfront costs, but the funds can be used for any purpose. In addition, you can choose how the money is withdrawn, such as fixed monthly payments or a line of credit (or both options simultaneously). Although widely available, HECMs are only offered by Federal Housing Administration (FHA)-approved lenders, and before closing, all borrowers must receive HUD-approved counseling.
- Proprietary reverse mortgage – This is a private loan not backed by the government. You can typically receive a larger loan advance from this type of reverse mortgage, especially if you have a higher-valued home. This
- Single-purpose reverse mortgage – This mortgage is not as common as the other two, and is usually offered by nonprofit organizations and state and local government agencies. A single-purpose mortgage is generally the least expensive of the three options; however, borrowers can only use the loan (which is typically for a much smaller amount) to cover one specific purpose, such as a handicap accessible remodel, explains Jackie Boies, a senior director of partner relations for Money Management International, a nonprofit debt counselor based in Sugar Land, Texas.
How much does a reverse mortgage cost?
The closing costs for a reverse mortgage aren’t cheap, but the majority of HECM mortgages allow homeowners to roll the costs into the loan so you don’t have to shell out the money upfront. Doing this, however, reduces the amount of funds available to you.
Here’s a breakdown of HECM fees and charges, according to HUD:
- Mortgage insurance premiums (MIP) – There is a 2 percent initial MIP at closing, as well as an annual MIP equal to 0.5 percent of the outstanding loan balance. The MIP can be financed into the loan.
- Origination fee – To process your HECM loan, lenders charge the greater of $2,500 or 2 percent of the first $200,000 of your home’s value, plus 1 percent of the amount over $200,000. The fee is capped at $6,000.
- Servicing fees – 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 rate adjusts monthly.
- Third-party fees – Third parties may charge their own fees, as well, such as for the appraisal and home inspection, a credit check, title search and title insurance, or a recording fee.
Keep in mind that the interest rate for reverse mortgages tends to be higher than that of their conventional counterparts, which can also add to your costs. Rates can vary depending on the lender, your credit score and other factors.
Is a reverse mortgage right for you?
A reverse mortgage can be a help to homeowners looking for additional income during their retirement years, and many use the funds to supplement Social Security or other income, meet medical expenses, pay for in-home care and make home improvements or modifications, Boies says. In a sense, it’s free money: No taxes are due on it, monthly payments aren’t required and the interest charges can be rolled into the loan balance.
For many homeowners, a reverse mortgage makes it possible to stay in their homes as they age.
Still, these loan products aren’t without drawbacks. Just because you’re not required to make monthly payments doesn’t mean interest isn’t accruing on the debt. As a result, the balance due, when it comes due, can seem startlingly high — especially if the borrowers haven’t made regular monthly payments or made interest-only payments.
If the loan balance exceeds the home’s value at the time of your death or permanent departure from the home, your heirs may need to hand ownership of the home back to the lender. There are also potential complications involving others who live in the home with the borrower, if they are not co-borrowers or an eligible non-borrowing spouse (someone who married the borrower and moved in after the loan was taken out).
Furthermore, while not all reverse mortgage lenders use high-pressure sales tactics, some do use them to attract borrowers.
Ultimately, deciding if a reverse mortgage is right for you can be complicated. Start by analyzing the pros and cons to decide if it’s ideal for your financial situation.
“It is always best to receive guidance from a nonprofit agency that offers reverse mortgage counseling before signing a loan agreement,” McClary recommends. “Taking advice from a celebrity spokesperson or a sales agent without getting the facts from a trusted, independent resource can leave you with a major financial commitment that may not be best for your circumstances.”
How to get a reverse mortgage
Here’s how to move forward if you decide a reverse mortgage is best for your financial situation:
- Step 1: Determine your eligibility for a reverse mortgage.
- Step 2: Research several lenders and choose the best fit.
- Step 3: Submit a formal application.
- Step 4: Complete the mandatory counseling session.
- Step 5: Get approved and select your disbursement method.
- Step 6: Receive your funds.
Alternatives to a reverse mortgage
If you’re not sold on taking out a reverse mortgage, you have options. In fact, a home equity loan or HELOC is likely a better option.
Both of these tools allow you to borrow against the equity in your home, although lenders limit the amount to 80-85 percent of your home’s value, and with a home equity loan, you’ll have to make monthly payments. With a HELOC, payments are required once the draw period on the line of credit expires.
The closing costs and interest rates for home equity loans and HELOCs also tend to be significantly lower than those of a reverse mortgage. Do bear in mind that your age may count as a risk factor (and translate to a higher interest rate).
Aside from a home equity loan or HELOC, you could also consider:
- Refinancing – If you haven’t paid off your mortgage yet, you could look into refinancing the loan to lower your monthly payments and free up the difference. Make sure to weigh the closing costs and the new loan terms, however, to see how these will affect your finances in your retirement years.
- Shared equity agreement – It’s an arrangement between you the homeowner and a professional investor. You can get ready money today in exchange for a stake in the home: a percentage of its value and often the future appreciation. Like reverse mortgages, you aren’t obligated to make monthly payments. But the money (technically an investment, not a loan) must be repaid once the term ends. Shared equity agreements cater to homeowners with credit challenges who generally won’t qualify for traditional home equity loans.
|Reverse mortgage||Home equity loan||HELOC||Cash-out refinance||Shared equity agreement|
|How it works||Borrow from the equity in your home without having to make payments||Borrow against your home equity without refinancing your current mortgage||Tap into your home equity as needed||Roll an extra amount, based on your home equity, into a new mortgage||Receive a set amount in exchange for a share of your home and its future appreciation|
|Disbursement||Lump-sum, monthly payments, line of credit or a combination||Lump-sum||Lump-sum or line of credit||Withdraw funds as-needed||Lump-sum|
|Minimum age||18 (or younger with a co-signer)||18||18||18||18|
|Equity requirement||Must own the home outright or owe no more than 50 percent on the mortgage||At least 15 to 20 percent||At least 15 to 20 percent||20 percent or more||Varies by investor|
Reverse mortgage FAQs
The amount of money you can get from a reverse mortgage depends upon a number of factors, such as the current market value of your home, your age, current interest rates, the type of reverse mortgage, its associated costs and your financial assessment. The amount you receive will also be impacted if the home has any other mortgages or liens. If there’s a balance from a home equity loan or home equity line of credit (HELOC), for example, or tax liens or judgments, those will have to be paid with the reverse mortgage proceeds first. “Regardless of the type of reverse mortgage, you shouldn’t expect to receive the full value of your home,” Boies says. “Instead, you’ll get a percentage of that value.”
Finding the right reverse mortgage lender can be difficult. When you’re shopping around, the two key things to look at are price and customer service. You should consider the interest rates and other fees related to the loan and make sure the lender is easy to work with.
Unfortunately, the reverse mortgage industry is rife with unscrupulous types. Many see seniors as an easier target and homes as a valuable asset worth going after. To avoid reverse mortgage scams, restrict yourself to federally-insured home equity conversion mortgages (HECM), consult with a HUD-certified counselor and only do business with reputable lenders.
Generally, you have to pay back a reverse mortgage only once you (the borrower) die. However, there are other scenarios where you could be forced to repay it — mainly if you no longer occupy it, either because you sell it or you permanently move out.
As with any mortgage, there are conditions for keeping your reverse mortgage in good standing, and if you fail to meet them, you could lose your home. For example, you could lose your home if:
- The home is no longer your primary residence.
- You decided to move or sell your home.
- You don’t pay your property taxes or homeowners insurance.
- The borrower dies or permanently vacates the home, and you are not a co-borrower or an eligible non-borrowing spouse.
Bottom line on reverse mortgages
A reverse mortgage presents a way for older homeowners to supplement their income in retirement by tapping the equity they’ve built up in their residences.
It’s best to speak with a HUD-approved counselor before committing to a reverse mortgage (and if you’re looking to get a HECM, you’ll be required to). A counselor can help outline the pros and cons and how this kind of loan might impact your heirs after you pass away. To locate an FHA-approved lender or HUD-approved counseling agency, you can visit HUD’s online locator or call HUD’s Housing Counseling Line at 800-569-4287.
Additional reporting by Allison Martin