A reverse mortgage is powerful financial tool that can help seniors unlock home equity and supplement their retirement income. These loans let qualified homeowners ages 62 and older take cash from their home’s equity while still living in the house. The lender pays the homeowner in a monthly payment, in a lump sum, as a line of credit, or a combination of the three.
Borrowers are required to meet all loan obligations, including living in the property as the principal residence and paying property charges, including property taxes, fees, and hazard insurance. And the borrower must maintain the home. If the homeowner does not meet these loan obligations, then the loan will need to be repaid.
Many people continue to have misconceptions about these loans. Reverse mortgages have evolved over the past decade. Now, certain safeguards are in place to protect consumers. Members of the National Reverse Mortgage Lenders Association (NRMLA) are required to adhere to a strict code of ethics and pledge to serve borrowers with integrity.
Also, the U.S. Department of Housing and Urban Development (HUD) requires borrowers who are interested in a home equity conversion mortgage, or HECM (pronounced “heckum”), to go through an approved counseling agency to ensure they fully understand the process, the loan terms, and what all their options are before they apply.
How Do Reverse Mortgages Work?
A reverse mortgage is a tool that lets the borrower convert part of their home’s equity into cash without selling the house or making monthly mortgage payments. Typically, when you’re older, you may not owe that much on your home, and you may have built up a lot of equity, in which case you may be able to pull more money out of it.
Unlike a conventional mortgage, where you make monthly payments to the lender, in this case, the reverse mortgage lender pays loan proceeds to you. You will be required to pay for things like property taxes, homeowner’s insurance, the upkeep of the property, and other obligations outlined in the terms of your loan agreement.
Types of Reverse Mortgages
According to the Federal Trade Commission’s Consumer Information website, there are three types of reverse mortgages. Each type of reverse mortgage is unique and has it’s own advantages. Here are the main types:
- Home Equity Conversion Mortgages. HECMs are insured by the Federal Housing Administration (FHA), which is part of the U.S. Department of Housing and Urban Development (HUD).
- Single-purpose reverse mortgages. These are the least expensive option and great for homeowners with low to moderate income. They’re offered by some state and local government agencies, as well as nonprofit organizations. But there are some limitations. They’re not available everywhere and can only be used for a single purpose designated by the lender, such as paying for home repairs, making improvements, or paying property taxes.
- Proprietary reverse mortgages. These are private loans that are only backed by the companies that develop them. The advantage here is for owners of higher-valued homes. They can possibly get a bigger loan advance from a proprietary reverse mortgage. If your home has a small mortgage but appraises at a high value, you may qualify for more funding.
Who Qualifies for a Reverse Mortgage?
Reverse mortgages are specifically designed for older borrowers. This option is generally only available to people 62 and older who meet the following basic criteria:
- You must be listed on your home’s title as the owner.
- Your income and credit clear a financial evaluation.
- Your home is your primary residence for the life of the reverse mortgage.
- You cannot be delinquent on any federal debt.
Reverse mortgages require borrowers to meet a specific set of requirements. To be eligible, you must:
- Meet with a reverse mortgage counselor who’s approved through HUD before you apply to discuss what a reverse mortgage is, how it works and the fees associated with it.
- Be able to show you can pay your property taxes, condo association fees, and home insurance, as well as keep up with maintenance and repairs.
- Make timely payments on property taxes and flood and hazard insurance.
Be aware that if you don’t pay your property taxes or homeowner’s insurance, the property deteriorates and necessary repairs are not made, or if you no longer occupy the home as your principal residence, you will default on the loan, and the balance you owe will be due immediately.
Reverse Mortgage Misconceptions Debunked
There’s a lot of bad information out there about reverse mortgages. Here are the most common myths:
- You won’t own your home anymore. False. You are still the owner, and the title stays in your name. A reverse mortgage is simply a loan that gives you access to your home’s unused equity.
- The lender will get your home instead of your heirs. False. A reverse mortgage is like a traditional mortgage, in that the title of the home stays in your name. As the owner, you can leave your home to whomever you want. If your heirs want to keep the home, they’ll need to pay off the loan balance or refinance it. If they don’t want to take possession of your home, either your heirs or the lender can sell it to pay back the loan. If there is any remaining balance over and above what is owed, it goes to your heirs.
- HECMs have prepayment penalties. False. There is no prepayment penalty on a HECM. A reverse mortgage is a way to tap home equity and you can choose to pay down or off the loan ahead of schedule without any penalties.
- A reverse mortgage prevents you from selling your home. False. If at any time you need to sell your house, you can. The proceeds from the sale would go to pay off the remaining balance of your loan. Whatever’s left over is yours to keep.
Cost of a Reverse Mortgage
The cost of your reverse mortgage will depend on the type of loan you choose and the lender. There are, of course, some upfront costs.
Here are some of the costs you can expect with a HECM:
- Reverse mortgage counseling. The average cost for HUD-approved counseling is around $125, which can usually be rolled into your loan costs.
- Origination fees. This fee is paid to the lender and can’t exceed $6,000.
- Real estate closing costs. These costs often include an appraisal, a title search, surveys, inspections, recording fees, mortgage taxes, credit checks, and other fees paid to third parties.
- An initial mortgage insurance premium. For HECMs, an initial two percent mortgage insurance premium (MIP) is charged by your lender and paid to FHA.
Once the HECM is established, there are ongoing fees you should plan for, including:
- Servicing fees paid to your lender that covers such things as sending out your account statements, loan proceeds distribution, and ensuring that you’re maintaining your loan requirements
- An annual MIP that equals 0.5% of the outstanding mortgage balance
- Association dues if you own a condo, home owner’s insurance, and property taxes
To really get an idea of your potential expenses, ask your counselor or lender to explain the Total Annual Loan Cost (TALC) rates which project the annual average cost of a reverse mortgage, including all the itemized costs.
How to Apply for a Reverse Mortgage
Applying for a reverse mortgage is a straightforward process. The steps are similar to applying for a regular mortgage.
- Choose a lender. The National Reverse Mortgage Lenders Association is a good resource to find a reputable lender. Be sure to compare the rates that are being offered.
- Ask questions. Once you find a lender, ask as many questions as you can. You want to know your options, how long the loan will take to close, whether a fixed rate or variable rate is better for you, etc.
- Choose your disbursement type. If you choose a fixed-rate mortgage, you’ll receive your money in a single lump-sum payment. If you go with a variable-rate mortgage, you can get the money you’re borrowing as a lump sum, line of credit, in monthly payments, or a combination.
- Get counseling. Before you can apply, you’ll need to attend a counseling session from a HUD-approved counseling agency. HUD has a list of approved counselors available in your state.
- Fill out the application. Once you’ve gone through your consultation, you can apply with your chosen lender. As with any traditional mortgage, you fill out an application and provide various documentation requested by your lender.
- Wait for appraisal. Once you apply, your application will be evaluated and your home appraised.
- Receive funds. If all goes well, you’ll close on your loan and receive your funds.
Pros and Cons of Reverse Mortgages
Reverse mortgages are powerful financial planning and retirement funding tools. However, they aren’t for everyone, so you should understand the benefits and drawbacks of these loans.
Pros of a reverse mortgage:
- You are still the owner of the house and retain the title. You can continue to live in your home as long as you meet all of the loan obligations, including living in the property as the principal residence, maintaining the home, and paying property charges, including property taxes, fees, and hazard insurance. The loan will need to be repaid if you do not meet these loan obligations.
- A fixed-rate reverse mortgage keeps the same rate for the entire loan term, so you are protected if market rates rise.
- With a HECM, with very few exceptions, you can use the money as you see fit.
- You do not make any monthly mortgage. The only mortgage payment you make is due in full when you sell your home, pass away or otherwise fail to meet all loan obligations. However, you must continue to pay taxes and insurance on the property and maintain the property.
- A reverse mortgage is what’s known as a non-recourse loan. Upon sale of the property, neither your nor your heirs are personally liable for any amount of the mortgage above the value of your home. If you sell your home at the appraised fair market value, and that amount is less than what you owe, your mortgage insurance will pay the remaining balance of your loan.
Cons of a reverse mortgage:
- While the interest rates are similar to other types of mortgage loans, the fees tend to be higher, though the majority of these can be rolled into the loan.
- Interest and fees are added to the loan balance, which increases over time.
- A variable-rate reverse mortgage means your rate could go up if the market fluctuates.
- Vacation homes and rental properties aren’t eligible.
Reverse Mortgage Calculator
A reverse mortgage calculator can help you get a rough idea about how large of a loan you may qualify for. Many lenders offer free loan calculators. Typically, these tools factor in the day’s current interest rate and can let you know if a reverse mortgage even makes sense for you.
Usually, all you have to do is supply your age, home value, current mortgage balance, if you’re still carrying one, and the state where you live. Instantly, the reverse mortgage calculator displays an estimate of how much money is available to borrow and your remaining equity.
The decision to take out—or not take out—a reverse mortgage is a big one. Before you apply, it’s always a good idea to speak with a financial advisor to discuss your goals and options.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.