In case you’re not familiar with a reverse mortgage, it’s a type of loan that allows homeowners ages 62 and older to leverage the equity in their house. If a homeowner owns their property outright—or has considerable equity to draw from—they can withdraw a portion of the equity as tax-free income without having to repay it until they leave the home.
While a homeowner makes payments to the lender with a regular mortgage, the lender pays the homeowner with a reverse mortgage. Here’s more on how reverse mortgages work, and what you should know if you’re considering one.
What exactly is a reverse mortgage?
Those who choose this kind of mortgage won’t have a monthly payment and won’t have to sell their home, meaning they still will be able to live there. But the loan must be repaid when the borrower dies, permanently moves out or sells the home.
Reverse mortgage proceeds typically are used to supplement retirement income, to cover the cost of needed home repairs or to pay out-of-pocket medical expenses, which keeps seniors from having to turn to high-interest lines of credit or other costly loans. Among the most popular types of reverse mortgages: The Home Equity Conversion Mortgage (HECM), which is backed by the federal government.
Who is eligible for a reverse mortgage?
The primary homeowner must be age 62 or older. However, if a spouse is under 62, you still might be able to obtain a reverse mortgage if other eligibility criteria are met. For example:
• You must own your home outright or have a single primary lien you hope to borrow against;
• Any existing mortgage you have must be paid off using the proceeds from your reverse mortgage;
• You must live in the home as your primary residence;
• You must remain current on property taxes, homeowner’s insurance and other mandatory legal obligations, such as homeowner’s association dues;
• You must participate in a consumer information session led by a HUD-approved counselor;
• You must maintain your property and keep it in good condition; and
• Your home must be a single-family home, a multiunit property with up to four units, a manufactured home built after June 1976, a condominium or a townhouse.
What are the types of reverse mortgages?
There is a variety of reverse mortgages, with each one serving a different financial need.
Home Equity Conversion Mortgage (HECM) – These popular federally insured mortgages usually have higher upfront costs, but the funds can be used for any purpose. Although widely available, HECMs are only offered by the Federal Housing Administration (FHA)-approved lenders, and before closing, all borrowers must receive HUD-approved counseling.
Proprietary reverse mortgage – This private loan is not backed by the government. You usually can receive a larger loan advance with 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 mostly is offered by nonprofit organizations and state and local government agencies. Borrowers only can use the loan (typically for a much smaller amount) to cover a single purpose, such as a handicap accessible remodel.
How do reverse mortgages work?
Qualified homeowners may not be able to borrow the entire value of the home even if the mortgage is paid off in full. The amount a homeowner can borrow (the principal limit) varies based on the age of the youngest borrower or eligible non-borrowing spouse, current interest rates, HECM mortgage limit ($765,600, as of July 2020) and home value.
Homeowners likely will 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, your 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 is depleted;
• A combination of a line of credit and fixed monthly payments for as long as you live in the home; and
• A combination of a line of credit plus fixed monthly payments for a set length of time.
If you opt for a HECM with a fixed interest rate, you’ll receive a single-disbursement, lump-sum payment. The interest on a reverse mortgage accrues every month, and you’ll need to have adequate income to continue to pay for property taxes, homeowner’s insurance, and upkeep of the home.
How much money can you get from a reverse mortgage?
This depends on several different factors, including 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 also will be affected if the home has any other mortgages or liens. For example, if there’s a balance from a home equity loan or home equity line of (HELOC), or tax liens or judgments, those must be paid with the reverse mortgage proceeds first.
How much does a reverse mortgage cost?
The closing costs aren’t inexpensive, but the majority of HECM mortgages allow homeowners to roll the costs into the loan to avoid having to shell out the money upfront. Doing this, however, reduces the amount of funds available 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.
Note: 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.
Reverse mortgage pros and cons
Although borrowing against your home equity can free up cash for living expenses, the mortgage insurance premium and origination and servicing fees can add up quickly. Here are the advantages and disadvantages of a reverse mortgage.
Pros
• 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; and
• Borrowers facing foreclosure can use a reverse mortgage to pay off the existing mortgage, potentially stopping the foreclosure.
Cons
• Borrower must maintain the house and pay property taxes and homeowners insurance;
• A reverse mortgage forces you to borrow against the equity in your home, which could be a key source of retirement funds; and
• Fees and other closing costs can be high and will lower the amount of cash that is available.
Alternatives to a reverse mortgage
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 likely will be a better option. Both 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. Just be sure to weigh the closing costs and the new loan terms to determine how it will affect your finances in your retirement years.
