Reverse mortgages are a popular way for older Americans to tap into the equity in their homes to fund their retirement. But there are strict rules governing who qualifies for a reverse mortgage, how much income they provide, and how much they cost.
What’s more, the federal government made important changes to those rules in 2017. If you are considering a reverse mortgage for your home, it’s more important than ever that you understand the basic rules and regulations.
Reverse mortgages: An overview
The most common type of reverse mortgage is a Home Equity Conversion Mortgage (HECM) offered by the Federal Housing Administration. These reverse mortgages allow homeowners to 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. Once the borrower dies or stops living in their home for 12 months, the loan, along with any interest, must be paid off.
Many retirees use reverse mortgages to cover unexpected expenses, such as health care costs or home improvements. However, 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. Anyone who is considering moving forward with a reverse mortgage should seek sound advice from a financial advisor.
Any homeowner who is age 62 or older is potentially qualified for an HECM reverse mortgage provided they are not delinquent on any debts owed to the federal government. There are no requirements related to income of health status of the borrower, but there are four main restrictions that apply to the borrower’s home:
- You must own your home outright or have a low balance owed on your mortgage.
- You must live in your home as your principal residence.
- You must be able to continue paying property taxes and other costs associated with the home (maintenance, insurance, HOA fees, etc).
- Your home must be a single-family home or a two- to four-unit home with one unit occupied by the owner. (Certain condominiums and manufactured homes that meet FHA requirements are also eligible).
To qualify you must also participate in an information session offered by a U.S. Department of Housing and Urban Development (HUD) counselor. Counseling isn’t always free.
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There are no restrictions on how a borrower uses the money they receive from a reverse mortgage. The size of the payments a borrower receives depends on a few factors:
- The borrower’s age.
- The lessor of these two amounts: the appraised value of the home or the FHA’s mortgage limit of $679,650.
- The current interest rate.
How the borrower gets paid depends on the type of mortgage. Homeowners with fixed-rate mortgages receive lump sum payments while homeowners with adjustable-rate mortgages can choose between receiving a lump sum, fixed monthly payments, a line of credit or some combination of these options.
The main cost of a reverse mortgage is the home equity that the borrower gives up in exchange for income. However, there are also substantial closings costs involved. One of the most significant of these costs is mortgage insurance. Premiums are based on the appraised value of the home, and include an initial insurance premium equal to 2 percent of the appraised value of the home, along with ongoing annual premiums equivalent to 0.5 percent of the value. The overall amount of the closing costs, which also include appraisal fees and origination fees, is largely determined by the home’s value.