More than three-quarters of people ages 50 and over say they want to stay in their homes as they grow older.But it’s not always affordable for older adults to continue living in their homes. Aging can come with financial challenges, such as unexpected health care costs, rising overall expenses, and a fixed income.
At the same time, many older adults have plenty of equity, which is what their homes are worth minus what they still owe on their mortgage. About 80% of adults ages 65 and over own their homes,and homeowners over age 62 collectively have $9.2 trillion in home equity.
A reverse mortgage is a way to bridge this gap. It lets older adults convert their equity into cash, and continue to afford living in their homes.
But there are drawbacks. Reverse mortgages reduce the homeowner’s equity and increase their debt. They are a complicated financial product, so it’s important that homeowners fully understand how reverse mortgages work before committing to one.
Here’s what you need to know about reverse mortgages:
- What Is a Reverse Mortgage?
- Types of Reverse Mortgages
- How Do You Qualify For a Reverse Mortgage?
- How Does a Reverse Mortgage Work?
- Avoiding Reverse Mortgage Scams
- Pros and Cons of a Reverse Mortgage
- Reverse Mortgage FAQ
- The Bottom Line on Reverse Mortgages
What Is a Reverse Mortgage?
A reverse mortgage is a loan where the lender pays the homeowner — essentially buying a portion of their home’s equity from them.
“A reverse mortgage means you don’t make any payments, and the loan balance increases each month,” says Steve Hill, a mortgage broker at SBC Lending in Redondo Beach, California. “So, the loan balance gets higher each month instead of lower — it goes in reverse.”
The money that a homeowner receives from a reverse mortgage usually is tax-free, and has no effect on their eligibility for Medicare or Social Security benefits.
Homeowners also don’t have to repay the money from a reverse mortgage as long as they live in the home and meet the conditions of the loan.
A reverse mortgage is repaid once the borrower moves out, sells the home, or dies. The owner or their family usually sells the home, and uses the proceeds to repay the reverse mortgage. The owner’s heirs will need to repay the reverse mortgage if they want to keep the home.
Reverse mortgages are meant to provide funds for older adults to continue living in their homes in their later years.
Older adults generally can use the money from a reverse mortgage for any reason they wish. Common uses include supplementing income, covering health care, or paying off their original mortgage.
However, certain types of reverse mortgages specify what the funds may be used for. For example, the lender could specify that the loan may only be used for home repairs.
Types of Reverse Mortgages
There are three main types of reverse mortgages: home equity conversion mortgages, proprietary reverse mortgages, and single-purpose reverse mortgages.
A home equity conversion mortgage is the most common type of reverse mortgage, and is backed by the Federal Housing Administration. The FHA sets conditions and limits on the loans that it backs.
HECMs are more expensive than traditional home loans, and can come with high upfront costs. In addition to paying closing costs, borrowers need to pay origination fees and a mortgage insurance premium, and cover a visit with a reverse mortgage counselor approved by the Department of Housing and Urban Development. The counselor will explain the terms, costs, and risks of a reverse mortgage, so that the homeowner knows what they’re getting into.
Funds from an HECM can be used for any purpose. The more equity that borrowers have in their home, the more money they’ll typically be able to borrow.
While HECMs don’t have specific income requirements, they do require the reverse mortgage lender to assess the borrower’s eligibility. As a general rule, HECMs provide larger loan advances and typically cost less than proprietary reverse mortgages.
Here are recent average interest rates for reverse mortgages:
Reverse Mortgage Interest Rates for HECMs
|Month||Fixed Rate||Adjustable Rate|
Proprietary reverse mortgages
Proprietary reverse mortgages are private loans, and aren’t backed by a government agency. If you have a small mortgage balance, and your home has a higher appraised value, you might be able to borrow more with a proprietary reverse mortgage.
Like an HECM, proprietary reverse mortgages are more expensive than traditional home loans. But when your home is worth more, a proprietary reverse mortgage could let you borrow more, if qualified.
Single-purpose reverse mortgages
Single-purpose reverse mortgages are offered by some state and local government agencies, as well as a few nonprofit organizations, and are usually the least expensive type of reverse mortgage. However, they aren’t offered everywhere, and can only be used for one purpose.
The lender will specify that the loan can only be used for property taxes, home improvements, maintenance, or some other purpose. This type of reverse mortgage is geared toward homeowners with low and moderate income.
How Do You Qualify For a Reverse Mortgage?
Not everyone is eligible for a reverse mortgage. Here’s a look at some of the requirements to get one.
The personal requirements for reverse mortgage loan eligibility include:
- You — and your spouse, if they’re on the loan — must be at least 62 years old.
- You must live in the home as your primary residence. Rental and vacation properties are ineligible.
- You must own your home outright, or have a low balance on your mortgage. Lenders typically require that you have at least 50% equity in your home. If you have a mortgage balance, then you’ll need to be able to pay it off with the money from the reverse mortgage.
- You must meet with a government-approved reverse mortgage counselor to review the costs, risks, and alternatives to reverse mortgages.
To qualify for a reverse mortgage, your home needs to be in good condition. If it isn’t, your lender may require you to make specific repairs before you can be approved.
Eligible properties include:
- Single-family homes, or two- to four-unit properties where one unit is occupied by the owner.
- HUD-approved condominium projects.
- Individual FHA-approved condominium units.
- FHA-approved manufactured homes.
The financial requirements for a reverse mortgage include:
- You must not be delinquent on any federal debts, including income taxes and student loans.
- You must have enough income to pay your property taxes, homeowners insurance, and home maintenance costs. If your income is insufficient to cover those costs, then you agree to set aside a portion of the funds you receive to pay them.
HECMs have no specific income requirement, but they do require lenders to verify your income, assets, credit history, and expenses. The results of the financial assessment could mean that you must set aside funds for property taxes and homeowners insurance to make sure those costs get paid. These “set-aside” amounts will be deducted from the total amount you get out of the reverse mortgage.
How Does a Reverse Mortgage Work?
If you’re a qualified older adult, a reverse mortgage loan allows you to borrow against the equity you’ve built in the home. Instead of making monthly mortgage payments, you receive an advance payment on your equity. You also keep the title as long as you live in the home. If you move out or sell the home, then you’ll have to repay the loan. If you die, then your heirs or estate will be responsible for repaying the loan, and may have to sell the home to do so.
Keep in mind that reverse mortgages also include fees and costs, and most have adjustable interest rates. This means your interest rate likely will change periodically. If rates go up, more interest will be added to the total amount you owe.
Also, be aware that the loan balance will grow over time as interest is added to it each month.
The interest on your reverse mortgage isn’t tax deductible. You’ll have to pay for maintenance, property taxes, homeowners insurance, utilities, and other costs. If you fail to pay for homeowners insurance and property taxes, then the lender may require you to repay the loan.
After you close on your reverse mortgage, you typically have three business days to cancel the deal without penalty. This is called your right of rescission, and must be done in writing.
How much money can you get from a reverse mortgage?
If you’re getting an HECM, the amount of money you’ll receive depends on your age, current interest rates, a financial assessment, and your ability to pay property taxes and homeowners insurance. The FHA limit on an HECM reverse mortgage is $970,800.
The more equity you have, the more money you’ll be able to access. However, there’s also a limit on how much you can take out in the first year — typically 60% of the loan amount.
If you have a proprietary reverse mortgage, how much money you can borrow depends largely on the value of your home.
How is the money paid to you?
How you receive the money from the loan depends on what type of reverse mortgage you have. Here are some of the options.
If you want or need the full total of the loan upfront, then you can get it as a lump sum. HECMs with fixed rates often require you take your loan as a lump sum when you close on it. This option tends to not offer as much money.
Line of credit
This option lets you withdraw cash at any time in whatever amounts you choose, up to the loan limit. You’ll pay interest on the line of credit, but borrowing cash only as needed could reduce the amount of interest you’re charged on the overall loan.
Term payments mean that you’ll receive fixed monthly cash payments for a specified period.
This option gets you equal monthly payments for a fixed period, as well as access to a line of credit. This means you’ll be able to draw on that line of credit as needed, until you reach the credit limit.
With this option, you get equal monthly payments as long as at least one of the borrowers listed on the reverse mortgage lives in the home.
This option is a hybrid, where you get scheduled monthly payments and a line of credit as long as you live in the home.
Reverse mortgages come with certain costs, including an origination fee to get the loan set up, servicing fees, and other costs. HECMs also charge mortgage insurance premiums.
You must repay a reverse mortgage when you’re no longer living in the home. This means if you sell it or move out, the loan will need to be repaid. If you die, your heirs or estate will have to repay the loan, which often is done by selling the home.
If you stop paying for homeowners insurance or property taxes, or fail to maintain the home, the lender may require that you pay back the loan.
Avoiding Reverse Mortgage Scams
Be mindful of the difference between a counselor from an independent, government-approved agency, and a salesperson from a lender. The counselor is there to make sure you understand the terms and risks of a reverse mortgage, while the salesperson is trying to convince you to buy something.
There are different types of reverse mortgage scams that target older adults. Some will try to sell you on particular ways to invest the money, while downplaying the costs associated with a reverse mortgage. Contractors might pressure you to get certain repairs done, or salespeople might pressure you to invest the money you take out in certain financial products. There also have been cases of scams targeting veterans, even though Veterans Affairs doesn’t offer reverse mortgage loans.
Reverse mortgages can be complicated, and some scammers obscure important details to rush people through the process without fully explaining what they’re signing up for. Never commit to a reverse mortgage if you don’t fully understand the details.
Pros and Cons of a Reverse Mortgage
Before you decide whether a reverse mortgage is right for you, it’s important to weigh the advantages and disadvantages.
“They’re a great option if you’re on low fixed income, have lots of equity, want to stay in your home, and maybe don’t have many heirs to pass along your income to,” Hill says. “A disadvantage would be the interest rate, which is generally higher than for a conventional loan, and the rate at which your equity is used up. It can be used up fairly quickly, leaving less money available to pass along to your heirs.”
Benefits and advantages of a reverse mortgage
Here are some ways a reverse mortgage can be helpful:
- You can convert some of the equity in your home into cash.
- The money usually is tax-free.
- You keep the title to your home.
- You don’t have to repay the loan as long as you’re living in your home.
- Income from a reverse mortgage won’t affect your Medicare or Social Security benefits.
Risks and disadvantages of a reverse mortgage
Beware of some of the following downsides to reverse mortgages:
- You’re using up equity.
- You’ll have to repay the loan if you move out or sell the home.
- Your heirs or estate are responsible for repaying the loan if you die, and may need to sell the home to do so.
- The amount you owe grows over time.
- The interest paid on a reverse mortgage is not tax deductible.
- You still have to pay for homeowners insurance, property taxes, and other home costs.
Reverse Mortgage FAQ
If you’re still unclear about certain aspects of reverse mortgages, here are some answers to frequently asked questions.
HECMs and proprietary reverse mortgages are more expensive than single-purpose reverse mortgages. If you’re looking to get a reverse mortgage for a specific reason — like paying for property taxes or home repairs — then you can save money with this type of reverse mortgage. It’s also a good idea to shop around, and compare the different options and fees.
If a married couple has a reverse mortgage, the loan won’t be due for repayment until both spouses die or no longer live in or own the home. If all listed borrowers die, their heirs or estate will be responsible for paying off the loan. In many cases, doing so involves selling the house.
Because a reverse mortgage reduces your home’s equity, you’ll have fewer assets to pass on to your heirs. Most reverse mortgages come with a nonrecourse clause, which means that neither you nor your estate can owe more than the home is worth when the loan comes due.
When it’s time to repay your reverse mortgage, keep in mind that interest and fees have been added to the balance every month, so the amount you owe the lender has been increasing. It’s common for borrowers to repay their reverse mortgage using the funds they receive from selling the house. It’s also possible to refinance a reverse mortgage into a traditional type of mortgage.
The Bottom Line on Reverse Mortgages
Reverse mortgages are one way for older adults to tap into the equity in their home and supplement their income. However, they also come with serious downsides, and should not be thought of as free money. With a reverse mortgage, you lose equity, and the amount you owe on the loan will increase. Before choosing a reverse mortgage, be sure to weigh all your financial options first.