What is a reverse mortgage?
For many seniors, their home represents not just a place to live but also a valuable asset that can help fund their retirement. One financial tool that allows them to unlock their home’s equity is a reverse mortgage.
In this article, we’ll explore how a reverse mortgage works, the different types of reverse mortgages, the benefits and potential drawbacks, alternative ways for seniors to tap their home equity, and answers to some frequently asked questions.
How does a reverse mortgage work?
A reverse mortgage is a loan that lets homeowners convert a portion of their home’s equity into cash. Unlike a traditional mortgage, where homeowners make monthly mortgage payments to a lender, a reverse mortgage allows homeowners to receive payments from a lender. These payments can be received in various forms, including a lump sum payment, regular monthly payments, a line of credit, or a combination of these options.
Here’s a breakdown of how a reverse mortgage works:
Eligibility: Generally, to qualify for a reverse mortgage homeowners must be age 62 or older (although some select lenders offer reverse mortgages to individuals as young as 55). This applies to both reverse mortgages offered by private lenders and reverse mortgages through the Federal Housing Administration’s Home Equity Conversion Mortgage (HECM) program.
Beyond the age requirement, the home must be your primary residence, the property must be in good shape, you cannot be delinquent on any federal debt, and you must either own the home outright or have a low mortgage balance. And if you’re getting a HECM loan, you’ll be required to receive counseling from a HUD-approved reverse mortgage counseling agency; the counseling session can help you understand the benefits and drawbacks of the loan.
Disbursement Options: You can choose how you want to receive your reverse mortgage funds, whether as a lump sum, monthly payments, a line of credit, or a combination of these methods.
Repayment: The loan becomes due when you sell the home, move out permanently, or pass away. Typically, the balance is paid from the sale of the property. If the proceeds from the sale exceed the loan balance, the excess funds go to you or to your heirs.
Types of reverse mortgages
Generally, there are three types of reverse mortgages:
- HECMs, which are insured by the FHA
- Reverse mortgages funded by private lenders
- Single-purpose reverse mortgage loans offered by state and local governments
Most reverse mortgages are HECMs. Reverse mortgages from private lenders, which are not insured by the federal government, are typically designed for borrowers with higher home values. Single-purpose reverse mortgages can be used only for the purpose specified by the lender, such as for home repairs or property taxes.
What are the rules of reverse mortgages?
There are limits on how much you can borrow through a reverse mortgage. The maximum loan amount is determined by a variety of factors, including your home’s appraised value, your age, and current interest rates.
Another critical component: You’ll still be responsible for paying property taxes and home insurance when you take out a reverse mortgage.
Are reverse mortgages a scam?
Reverse mortgages aren’t a scam but many bad actors try to take advantage of homeowners seeking a reverse mortgage.
Watch out for contractors who approach you about getting a reverse mortgage to pay for repairs to your home, says the Consumer Financial Protection Bureau (CFPB). These contractors, who are often unlicensed, will try to strong-arm you into getting a reverse mortgage to pay for home repairs that you don’t need — or they provide a cost estimate that’s much higher than the actual cost of the repair.
Some scams target veterans. The Department of Veterans Affairs (VA) does not offer reverse mortgages, yet some mortgage advertisements “falsely promise veterans special deals, imply VA approval, or offer a ‘no-payment’ reverse mortgage loan to attract older Americans desperate to stay in their homes,” according to the CFPB.
Be on the lookout for foreclosure scams, too. These scams target older homeowners who are at risk of losing their homes to foreclosure. In this instance, the con artist promises relief by providing a reverse mortgage, but the reverse mortgage they offer comes with exceptionally high fees.
Some scammers may also pose as financial planners. These individuals advise you to get a reverse mortgage and to let them manage the funds, but they use the money for their own financial gain.
Pros & cons of reverse mortgages
|Supplemental income: A reverse mortgage provides a source of tax-free income for seniors, helping them cover living expenses, healthcare or in-home care costs, or other financial needs in retirement.
|Accruing interest: The loan balance increases over time due to interest, potentially eating into the homeowner’s equity.
|No risk of losing the property: Homeowners who get a reverse mortgage retain ownership and continue to live in their home, so long as they maintain the property and keep up with their property taxes and insurance.
|Costs: Reverse mortgages often come with upfront fees and closing costs, such as loan origination fees, appraisals, title searches, and, in the case of HECMs, an annual mortgage insurance premium of 0.5% of the outstanding mortgage balance. Some lenders also charge servicing fees to cover costs such as distributing the funds.
|Flexibility: Borrowers can choose how they receive the funds and, in most cases, choose how to spend the money.
|Negative impact on heirs: When the borrower dies, the loan must be repaid, which could significantly reduce the inheritance left to their heirs.
What alternatives are there to reverse mortgages?
Reverse mortgages aren’t the only way to tap into your home equity. Other options for accessing home equity include:
- Cash-out refinances: Replace your existing mortgage with a loan that’s larger than what you currently owe and pocket the difference in cash
- Home equity loans: Get a second mortgage secured by your house as collateral, providing you a lump sum of cash with a fixed interest rate
- Home equity lines of credit (HELOCs): Borrow funds against your home equity through a revolving line of credit as needed and pay interest only on the money that you borrow
Most home equity loans and HELOCs allow you to tap as much as 80% to 85% of your home equity.
Reverse mortgage for seniors FAQ
What is a reverse mortgage for seniors?
A reverse mortgage is a type of loan that lets seniors convert a portion of their home’s equity into cash. Generally, to qualify for a reverse mortgage you must be 62 or older, the home must be your primary residence, the property must be in good condition, you cannot be delinquent on any federal debt, and you must either own the home outright or have a low mortgage balance.
How much money can you get from a reverse mortgage?
Reverse mortgage lenders use your age, home value, and loan balance to determine how much you can borrow. Typically, the older you get, the more you can borrow.
In addition, HECMs have loan limits, which are subject to change annually. Currently, the maximum HECM is $1,089,300, according to HUD.
How do I find a reverse mortgage lender?
The simplest way to search for a FHA-approved reverse mortgage lender in your area is through the U.S. Department of Housing and Urban Development’s (HUD) database of reverse mortgage lenders. (Select your state, uncheck Title I Property Improvement, and check off HECM.)
When do you have to pay back a reverse mortgage?
The loan becomes due when you sell the home, move out, or pass away.
Can you lose your house with a reverse mortgage?
Generally, no. However, if you fall behind on your property taxes and home insurance, the lender could potentially foreclose on your home.
What is the downside to a reverse mortgage?
The most notable drawbacks of a reverse mortgage are that you accrue interest and pay upfront fees and closing costs to obtain the loan.
What are the 3 types of reverse mortgages?
There are three types of reverse mortgages: Home Equity Conversion Mortgages (HECMs), which are funded by the FHA, reverse mortgages funded by private lenders, and single-purpose reverse mortgage loans offered by state and local governments.
What is the best age to take a reverse mortgage?
The best age to take out a reverse mortgage depends on how much equity you’ve accrued, how much money you’re looking to borrow (since loan limits for reverse mortgages increase as you get older), and how you plan to spend the money.
Is a reverse mortgage a good idea for seniors?
For some seniors, a reverse mortgage can be a good way to unlock their home equity, especially if they’re looking for a way to supplement their income in retirement.
The bottom line: Are reverse mortgages worth it?
A reverse mortgage can be a valuable financial tool for eligible seniors looking to access their home’s equity without selling their home. For example, it may be a good option for seniors looking to supplement social security income. Still, it’s essential to consider the associated costs, risks, and potential impact on heirs before pursuing a reverse mortgage.
It can also be beneficial to meet with a financial advisor or reverse mortgage counselor to fully understand the implications and determine if a reverse mortgage aligns with your retirement goals.