Reverse mortgages are a way for older Americans to access the equity in their homes and use it to fund retirement. However, there are strict rules and guidelines surrounding who qualifies for these mortgages, as well as how much income a reverse mortgage can provide and how much they cost.
If you’re considering a reverse mortgage, it’s important to understand the basic rules and regulations.
Reverse mortgages: An overview
A reverse mortgage is a loan that’s generally made to homeowners who are 62 and older. These loans allow borrowers to convert part of the equity in their homes into tax-free cash with no monthly payments required, says Darryl Hicks, vice president of communications for the National Reverse Mortgage Lenders Association.
“The loan is called a reverse mortgage because instead of making monthly payments to a lender, as with a traditional mortgage, the lender makes payments to the borrower,” says Hicks.
The most common type of reverse mortgage is a Home Equity Conversion Mortgage (HECM) offered by the U.S Department of Housing and Urban Development (HUD).
“A HECM is not a government loan. It’s a loan issued by a mortgage lender, but insured by the Federal Housing Administration, which is part of HUD,” explains Hicks.
Reverse mortgages allow the homeowner to borrow money using their home as collateral. Homeowners receive home equity loan payments from a bank — either as a lump sum or as ongoing payments — based on a percentage of the amount of equity they’ve accumulated in their home.
Eligibility requirements for a reverse mortgage
There are a variety of requirements and eligibility guidelines to meet in order to qualify for a HECM reverse mortgage.
First and foremost, the homeowner must be 62 or older. Additional requirements include:
- The home you’re seeking a reverse mortgage on must be your primary residence. That means it must be the address where you spend the majority of the calendar year.
- You must either own the home outright or have a very low balance on the home when applying for a HECM reverse mortgage. Those who still have a mortgage balance must be in a position to pay off that balance when closing on the reverse mortgage.
- You cannot be delinquent on any federal debt. This would include income taxes or federal student loans. However, it’s important to note that you may use funds from a reverse mortgage to pay off such debts.
- You must be willing to set aside some of the reverse mortgage funds at closing (or have enough of your own money) to pay for things such as property taxes and insurance, as well as home maintenance and repair costs.
To get approved for a reverse mortgage, your house must also be in good shape, and you must participate in counseling that’s provided by a HUD-approved reverse mortgage counseling agency. During the counseling session, an agent will review your eligibility for a reverse mortgage and also discuss the financial ramifications.
For instance, those who take out a reverse mortgage loan when they’re too young risk running out of money later in life, during a time when it’s likely income will be lower and healthcare bills may be steeper.
Cost of a reverse mortgage
A reverse mortgage is not free money — interest and fees will be added to your mortgage balance each month. That means the amount you owe on your mortgage will go up when signing on for this type of loan.
In addition, the borrower is still required to pay property taxes and homeowners insurance.
“The major benefit of a reverse mortgage is the cash flow benefit of eliminating the monthly mortgage payment, as well as accessing equity in the form of a line of credit or lump sum payment,” says David Reyes, financial advisor with Reyes Financial Architecture. Many financial experts suggest treating reverse mortgages as a last resort, since it often doesn’t make financial sense to sacrifice home equity for income.
“Overall, a reverse mortgage should be considered as part of a retirement plan for seniors,” says Reyes. “In some cases, the senior may only eliminate their monthly mortgage payments. In other cases, depending on their equity, they may eliminate their monthly mortgage payment and get access (to a) considerable amount of cash. In other situations, with a home that’s free and clear, the homeowner or senior can have access to a large line of credit that can be tapped into when the need arises.”
How the money is paid out
The loan amount available through a reverse mortgage depends on the age of the borrower (or the age of the youngest spouse when there’s a couple), as well as the home’s appraised value, current interest rates, and in the case of the HECM program, the FHA lending limit of $765,600, says Hicks. There’s a variety of choices when it comes to how borrowers receive payments from a HECM reverse mortgage. Options include:
Line of credit
A line of credit can be accessed when money is needed. Accessing the money will typically require submitting a written request to the loan servicer.
With this option, borrowers receive fixed monthly payments for a specified length of time, such as five years. During this time, the amount of cash the borrower receives each month won’t change. This is true even if the home loses value during the payment timeline.
Borrowers will receive fixed monthly payments for as long as they live in the home as their primary residence. The payments will continue even if the loan surpasses the value of the home. The payments end when the borrower dies or leaves the home.
Some of the additional options include Modified Term/Line of Credit, a type of hybrid payout in which the borrower gets both a line of credit and fixed monthly payments for a specific timeline. Similarly, a Modified Tenure/Line of Credit provides the borrower with a line of credit and fixed monthly payments as long as the home is their primary residence.
Through a reverse mortgage, it’s also possible to request a single disbursement or lump sum. This option means all of the loan proceeds are provided to the borrower at closing.
Repayment of a reverse mortgage
The borrower is not required to pay back a reverse mortgage loan until the home is sold, vacated or the last surviving borrower dies.
However, if the home at some point is no longer your primary residence, you will be required to pay back the loan.
In addition, you may also be required to pay back the loan sooner if:
- You fail to pay the property taxes or homeowners insurance
- You don’t keep the home in good condition
Proprietary reverse mortgages
While HECM reverse mortgages account for more than 90 percent of all reverse mortgages made in the U.S., there’s a growing market for what’s known as a proprietary reverse mortgage, which is privately insured by the mortgage companies that offer them, says Hicks.
“Proprietary reverse mortgages generally have higher loan limits (typically up to $4 million) and greater flexibility with property types,” Hicks explains.
Proprietary reverse mortgages also come with many of the same consumer protections associated with the HECM program, such as mandatory counseling.
Shopping for a reverse mortgage
It’s always a good idea to do your research and shop around when considering a loan of any type, including a reverse mortgage.
When shopping, compare fees and interest rates from multiple lenders to ensure you are getting the best deal possible for your financial situation.