Reverse mortgage: What it is and how it works
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With the average monthly Social Security check a scant $1,542.22 in 2022, many seniors struggle to find ways to survive in the face of rising inflation. In an effort to increase their income and remain in their homes, some turn to a reverse mortgage to access some much-needed cash.
Here’s how reverse mortgages work, and what homeowners considering one need to know.
What is a reverse mortgage?
A reverse mortgage is a type of loan that allows homeowners ages 62 and older, typically who’ve paid off their mortgage, to borrow part of their home’s equity as tax-free income. Unlike a regular mortgage in which the homeowner makes payments to the lender, with a reverse mortgage, the lender pays the homeowner.
Homeowners who opt for this kind of mortgage don’t have a monthly payment and don’t have to sell their home (in other words, they can continue to live in it), 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?
Despite the reverse mortgage concept in practice, qualified homeowners may not be able to borrow the entire value of their home even if the 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 ($970,800 in 2022) 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 upkeep of the home.
What can a reverse mortgage be used for?
Supplementing retirement income, covering the cost of needed home repairs or paying out-of-pocket medical expenses are common and acceptable uses of reverse mortgage proceeds, according to Bruce McClary, spokesperson for the National Foundation for Credit Counseling.
“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,” McClary says.
Reverse mortgage requirements
To be eligible for a reverse mortgage, the primary homeowner must be age 62 or older. The additional eligibility requirements include:
- You must own the property outright or have at least paid a substantial amount of your mortgage.
- 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.
- 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 housing and bankruptcy services for Money Management International, a nonprofit debt counselor based in Sugar Land, Texas.
Reverse mortgage pros and cons
While borrowing against your home equity can free up cash for living expenses, the mortgage insurance premium and origination and servicing fees can add up. Here are the advantages and disadvantages of a reverse mortgage.
- Borrower doesn’t need to make monthly payments toward their loan balance
- Proceeds can be used for living and healthcare expenses, debt repayment and other bills
- 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
- Forces you to borrow against the equity in your home, which could be a key source of retirement funds
- Fees and other closing costs can be high and will lower the amount of cash that is available
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 through the loan.
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, 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, Boies says.
There are also flexible ways to receive the money from the reverse mortgage: a lump sum, a monthly payment, a line of credit or a combination.
Plus, if the value of the home appreciates and becomes worth more than the reverse mortgage loan balance, you or your heirs may receive the difference, Boies explains.
The opposite, however, can pose a problem: If the balance exceeds the home’s value, 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, and what might happen to them if the borrower dies. Family members who inherit the property will want to pay close attention to the details of what is necessary to manage the loan balance when the borrower dies.
“There are provisions that allow family to take possession of the home in those situations, but they must pay off the loan with their own money or qualify for a mortgage that will cover what is owed,” McClary says.
Additionally, while not all reverse mortgage lenders use high-pressure sales tactics, some do use them to attract borrowers.
“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.”
Alternatives to a reverse mortgage
If you’re not sold on taking out a reverse mortgage, you have options. In fact, if you’re not yet 62 (and ideally not turning 62 soon), a home equity loan or HELOC is likely a better option.
Both of these loans allow you to borrow against the equity in your home, although lenders limit the amount to 80 percent to 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 what you’ll find with a reverse mortgage.
Aside from a home equity loan, you could also consider:
- Cutting expenses – Trimming discretionary expenses can help you stay in your home long-term. If you need help with a necessary bill, consider contacting a local assistance organization (the Administration for Community Living can help you find one), which may be able to assist with fuel payments, utility bills and needed home repairs.
- Downsizing – If you’re able and willing to move, selling your home and moving to a smaller, less expensive one can give you access to your existing home’s equity. You can use the proceeds of the sale to pay for another house in cash or pay off other debt.
- 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.
Reverse mortgage lenders
If a reverse mortgage sounds like a good idea for you, take time to research you options. Here are the top 10 reverse mortgage lenders as of 2022, according to Home Mortgage Disclosure Act data:
- American Advisors Group (AAG)
- Finance of America Reverse
- Reverse Mortgage Funding
- PHH Mortgage
- Mutual of Omaha
- Longbridge Financial
- Cornerstone First Mortgage
- Open Mortgage
- Nationwide Equities Corp.
How to avoid reverse mortgage scams
As you shop for a reverse mortgage and consider your options, be on the lookout for two of the most common reverse mortgage scams:
- Contractor “loans” – Some contractors will try to convince you to get a reverse mortgage when touting home improvement services.
- Veteran “loans” – The U.S. Department of Veterans Affairs (VA) doesn’t provide reverse mortgages, but you may see ads promising special deals for veterans, such as a fee-free reverse mortgage to attract borrowers.
The best way to avoid a reverse mortgage scam is to be aware and vigilant. If an individual or company is pressuring you to sign a contract, for example, it’s likely a red flag.
Reverse mortgage FAQs
The amount of money you can get from a reverse mortgage depends upon a number of factors, according to Boies, 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.”
Just like any other type of mortgage, you own the home in a reverse mortgage situation.
When the borrower dies or moves, however, the mortgage is payable in full. If you can’t, or won’t, pay off the debt, the lender can sell the home to recoup the money it’s owed, explains Michael Sullivan, personal financial consultant with nonprofit credit counseling and debt management agency Take Charge America.
“Typically, the homeowner or beneficiaries are not responsible for any costs if the house is sold for less than the amount owed,” adds Sullivan.
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. The ways you could violate the terms of a reverse mortgage include:
- The home is no longer your primary residence. As part of the reverse mortgage agreement, the home must be your primary residence. “This means that you cannot leave the home for more than 12 consecutive months,” explains Michael Micheletti, spokesperson for Unlock Technologies, a company that helps homeowners access their equity. This rule doesn’t bar you from leaving your home to travel or to come and go as you please, but if you vacate the property for 12 consecutive months, the reverse mortgage loan becomes eligible to be called due and payable.
- You decided to move or sell your home. If you have to move and put your home up for sale as part of the move, you’re still bound by the requirement to live in the house for 12 consecutive months. If selling your home becomes a challenge and you don’t find a buyer within that 12-month window, the reverse mortgage can be called due, Micheletti says.
- You don’t pay your property taxes or homeowners insurance. Even with a reverse mortgage, you’re still responsible for paying property taxes, and failure to do so could violate the terms of your loan. In addition, you must maintain current homeowners insurance.
Bottom line, “if a borrower fails to comply with the terms of the reverse mortgage contract, they could lose their home,” says Darryl Hicks, a spokesperson for the National Reverse Mortgage Lenders Association. “There are consumer protections established by HUD and by some states that require the company servicing the reverse mortgage to do everything possible to ensure that doesn’t happen.”
If you fail to pay property taxes, for example, or keep the home properly insured, the loan servicer could advance available loan proceeds from the reverse mortgage to cover these expenses, Hicks says. If there are not adequate proceeds available to cover these types of payments, the servicer could elect to advance its own funds to make the outstanding payments.
“Once this happens, the loan will be considered to be in technical default and the loan servicer will try to establish a repayment plan with the borrower to pay back any funds advanced to pay the property taxes or insurance premiums,” Hicks says. “If the terms of the repayment plan cannot be met, the loan servicer will have no choice but to call the loan due and payable, and could move to foreclose on the property.”
A reverse mortgage presents a way for older homeowners to supplement their income in retirement or pay for home renovations or other expenses such as healthcare costs. There are many alternatives that should be considered, including a HELOC or a refinance depending on the equity you have in your home.
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.