Reader-friendly reverse mortgage guide
If you're an older home owner, you've likely heard about reverse mortgages. There's also a good chance you've got a lot of questions about them. A loan you don't have to repay? Just how does that work?
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What is a reverse mortgage? It's a type of home equity loan for borrowers age 62 and over. It's like a regular mortgage that runs backward – instead of paying money toward your mortgage every month, the mortgage pays money to you – even every month, if you like.
Because you don't have to repay it as long as you remain in your home, a reverse mortgage can be a useful financial tool for retirees on a limited or fixed income. But you need to understand the ins and outs before proceeding.
Reverse mortgage information can be a challenge to sort through, so we've broken everything down by section to make it easy to find answers to your main questions. At certain points you'll also find links to other articles that may be useful.
How do reverse mortgages work?
A reverse mortgage is really just another type of home equity loan. The big difference is that you don't have to make any loan payments as long as you remain in the home.
You receive your money, the same as with other loans. But instead of making regular loan payments, a reverse mortgage is designed to be paid off once you no longer live in the home. Usually, that's done by selling the property at that time.
Interest rates and fees are charged in the meantime. These are added to the loan principle and are paid off with the rest of the loan once the home is vacated.
In most cases, you can use the funds from a reverse mortgage for any purpose you wish – you don't have to justify your plans for the money. You can receive your money in a variety of ways – as a lump sum, a line of credit, a series of regular payouts or a combination of these.
Most reverse mortgages have what is called a "non-recourse clause." That means your debt obligation can never exceed the value of your home. So even if the home falls in value, or if you stay there long enough that the accumulated loan principle, interest and fees exceed what the home is worth, you or your heirs can never be required to repay more than what the home can sell for when you vacate it.
However, if your home sells for more than the balance on the loan, you or your estate receives the difference. The loan can also be repaid from other sources if you or your heirs wish to retain the property.
Reverse mortgage pros and cons
Before going any further, here's a quick summary of the pros and cons of reverse mortgages.
- No need to make any loan payments as long as you live in the home
- You can usually use the funds for whatever purpose you wish
- Can be used to pay off remaining balance on the existing mortgage (see below)
- You can't lose your home for nonpayment
- Allows you to tap the value locked up in your home while still enjoying the use of the property
- Multiple options for receiving the money you borrow, including a lump sum, line of credit or regular monthly payments
- Your debt obligation can never exceed the value of the home
- Any funds left from the sale of the home after satisfying the debt go to you or your estate
- Reverse mortgages tend to be more costly than other types of home loans
- You can still lose your home if you fail to pay your property taxes or homeowners insurance
- The loan becomes due if you need to leave the home and move into an assisted living or other long-term care facility
- Interest charges and ongoing fees accumulate over the life of the loan, so the longer you remain in the home the more equity you'll use up
- Using a reverse mortgage reduces the assets you'll have available if you eventually need nursing home care
- A reverse mortgage may make it difficult to keep the home in the family and pass it along to your heirs
More information: Four misunderstandings about reverse mortgages
Reverse mortgage borrowing options
You have several choices for receiving your money when you take out a reverse mortgage. Depending on what you need the money for, you may choose just one or a combination of options.
Lump sum: You receive a single payment of cash, similar to a regular home equity loan. This option is the only one available as a fixed-rate loan. The maximum amount available to you is usually less with this option than with the others.
Line of credit: Rather than receiving money right away, your reverse mortgage lender sets up a line of credit you can draw on as you wish. You only borrow money as you need it, with no further approvals required, and only pay interest on the sum you have borrowed to date.
Tenure: This provides you with a regular monthly payment for as long as you stay in the home. It's a good choice if your goal is to supplement your other income and assets on an ongoing basis. It's like an annuity in that it's open-ended – it can never run out, even if the amount you receive and accumulated interest eventually exceed the value of your home.
Term: This is similar to the tenure option, except that you only receive payments for a limited time.
Combination: You can also choose certain combinations of the above, such as a lump sum upfront, followed by tenure payments or a line of credit to draw upon as you choose.
Only the lump sum option is available as a fixed-rate loan. All the rest have adjustable-rates, meaning the interest rate charged will vary according to market conditions. The interest charges and any other ongoing fees, such as for mortgage insurance, are added onto the principle and repaid at the end of the loan.
Types of reverse mortgages
Reverse mortgages fall into three categories, depending on what sort of institution is backing the loan. They are:
Home equity conversion mortgages, or HECMs. These are reverse mortgages offered through the FHA and the U.S. Department of Housing and Urban Development (HUD). These are the most popular type of reverse mortgage and offer the most options for receiving your money.
Proprietary reverse mortgages. These are reverse mortgages that are backed by private lenders. These may allow owners of high-value homes to borrow more than they could with an FHA-backed HECM. Other rules may be different as well.
Single-purpose reverse mortgages. These are a special type of reverse mortgage where the funds can only be used for a specific purpose, such as home repairs or medical expenses. They're offered through some state and local governments, and certain non-profit agencies as well. These are the least expensive type of reverse mortgage, but are not available in all areas.
How much can you borrow with a reverse mortgage?
The maximum you can borrow on a reverse mortgage depends on a variety of factors – there's no hard and fast answer. Generally speaking, how much you can borrow will depend on:
– Your age. Older borrowers are allowed to tap more of their equity.
– Your equity. The more you have, the more you can borrow.
– How much your home is worth.
– The type of reverse mortgage you choose.
–Your finances, particularly your ability to continue to pay your property taxes and homeowner's insurance.
– Current interest rates.
You're also limited to borrowing no more than 60 percent of your available equity during the first year of the reverse mortgage, either as a lump sum or spread out into multiple payments.
If your finances are limited, a reverse mortgage lender may require that the loan be structured to pay your homeowner's insurance and property taxes as part of the loan on an ongoing basis. Of course, this will reduce the amount of equity that is available for you to borrow against for other needs.
Do I qualify for a reverse mortgage?
Reverse mortgages are unusual in that your credit score and income don't play a big role in qualifying. The main factors are your age and the amount of home equity that you have.
The home must be your primary residence – you can't get a reverse mortgage for a vacation home or investment property.
The reverse mortgage definition requires that you be age 62 or older to be eligible. You also need to have a minimum of 40-50 percent equity in your home to qualify..
If you are married, only one partner needs to be age 62 or above. The younger spouse is still protected from having to repay the loan as long as he or she lives in the home, even if the older one dies or moves into an extended care facility, but only if you are already married at the time you take out the reverse mortgage.
If you take out a reverse mortgage and get married afterwards, your loan comes due when you die or move out of the home, regardless of your spouse's age.
While your income and credit don't matter as far as qualifying for the reverse mortgage itself, you will need to undergo a financial assessment. This is to ensure that you can handle the ongoing costs of property taxes, homeowner's insurance and maintaining the property.
With an FHA-backed HECM, you'll also need to meet with a housing counselor before a reverse mortgage can be approved.
More information: "Am I eligible for a reverse mortgage?" and other questions answered
Where do I get a reverse mortgage?
You obtain a reverse mortgage through a regular bank or any other financial institution that is a reverse mortgage lender. Not all of them do so – reverse mortgages are a financial product that a lender may or may not choose to offer.
While a reverse mortgage may be backed by the FHA or another public agency, they do not actually issue the loans. They provide certain guarantees for loans that meet their guidelines, which provides security for reverse mortgage lenders to make these loans.
What charges are there on a reverse mortgage?
As with any loan, a reverse mortgage charges interest and fees. There are closing costs when you first take out the loan and you may be charged other fees during the life of the loan as well. For example, all FHA-backed reverse mortgages include regular charges for mortgage insurance as part of the loan.
Depending on your financial situation, a reverse mortgage lender may also require that your property taxes and homeowners insurance payments be paid out of the loan as well, to ensure they are kept up.
You generally don't have to pay these fees out of pocket. They, and any interest charges, are typically added into the loan and repaid when the home is eventually vacated.
That means they accumulate over time, and the longer you stay in the home, the more they pile up, even if you don't take out any more money yourself. So if you're a relatively young senior, in your 60s, you could be looking at some 30+ years of interest and fees over the course of the loan.
Of course, you don't have to pay these out of your pocket. That's the key attraction of a reverse mortgage. But they do whittle down the amount of home equity that will be left for you or your heirs when you eventually die or move out.
Do reverse mortgages cost more than other loans?
Reverse mortgages do tend to be more expensive over the long haul than other types of loans, such as a conventional home equity loan or line of credit. That's the trade-off you make for not having to repay them as long as you live in your home.
If you can afford to do so, many financial advisers will encourage you to consider other options first, such as a regular home equity loan. If you can afford the payments, those will be cheaper over the long haul.
A reverse mortgage's primary advantage is that it frees you from the need to make regular loan payments while protecting your right to live in your home. As noted before, it also caps your debt obligation at the value of your home – you and your heirs can never be required to repay more than what the home will sell for when you die or move out.
Those are pretty big advantages, but they do come with a cost. The interest rates and fees tend to be higher than with traditional home equity loans, and because a reverse mortgage is open-ended, those fees and interest charges can add up over a long time, leaving you or your heirs with little or no equity left when you finally vacate the home.
More information: Are reverse mortgages too expensive?
Paying off your current home loan with a reverse mortgage
With most reverse mortgages, you can use the funds for any purpose you wish. But one of the more unusual reverse mortgage solutions to a financial problem is using it to pay off the existing mortgage on the home.
At first glance, that may seem impossible. It sounds like the old joke about lengthening a blanket by cutting a piece off one end and sewing it onto the other. And that's sort of what happens – except it works.
Here's why. What you're doing is simply converting your remaining mortgage debt into a reverse mortgage. So instead of paying it off month by month, the remaining balance doesn't come due until you eventually vacate the home, along with any fees and interest charges.
For example, suppose your home is worth $350,000 and you still owe $50,000 on your mortgage. You could take out a reverse mortgage for $50,000 and use it to pay off your current home loan. You'd now have zero regular mortgage debt and a $50,000 reverse mortgage, plus your closing costs and fees.
You could also take out a larger reverse mortgage and use part of it to pay off your current home loan and take the rest as a lump sum, line of credit or tenure payments, as suits your needs.
This is actually one of the most popular uses for a reverse mortgage, as it allows seniors with limited incomes to escape the burden of monthly mortgage payments while still enjoying the use of their home.
In fact, you can even use a reverse mortgage to buy a new home! This can be a useful option for seniors who are looking to downsize to a new home in retirement.
Know your options
While these loans can be a useful financial tool for seniors on a limited income, you have to carefully assess your financial situation and consider reverse mortgage pros and cons before making a decision. The financial counseling required with an FHA-backed HECM is a big help here, but you should have good understanding of things before you start the process. As with any major financial decision, you need to do your homework before committing to a reverse mortgage.