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10 Min. Read

How Does a Reverse Mortgage Work?

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A couple studying how a reverse mortgage works

Just the name “reverse mortgage” suggests that this type of mortgage works a little differently than more common mortgage types. Here’s what you need to know about how reverse mortgages work. 

What Is a Reverse Mortgage? 

A reverse mortgage is a loan that helps qualified homeowners 62 and older tap equity they’ve built up in their homes without selling the home. Borrowers choose how to receive proceeds from their loan as a lump sum, monthly payments, a line of credit, or a combination of the three.  

HECMs and Reverse Mortgages. Is There a Difference?

Government backed reverse mortgages are called home equity conversion mortgages (HECM). Not all reverse mortgages are HECMs, but all HECMs are reverse mortgages. Individual lenders also offer proprietary reverse mortgages. The terms of these mortgages can vary depending on the lender. Proprietary reverse mortgages are not insured by the government.

Traditional vs. Reverse Mortgage Comparison 

With a traditional mortgage, borrowers take a specific amount of money to purchase a home. They then make a monthly payment with interest toward the loan balance for a predetermined term—usually 10, 15, or 30 years. Though they owe the lender a certain percentage of the home’s value, they fully own the home. The loan will be paid off at the end of the term, assuming the borrower has made all the agreed-upon payments.  

Although a reverse mortgage can be used to purchase a home, it is more commonly used to access equity without selling the home. Like with a traditional mortgage, the borrower always retains full ownership of the house. Instead of the borrower paying down the mortgage principal and paying interest over the life of the loan, nothing is due until the loan comes to term. When the last borrower on the loan leaves or passes away, the loan comes due. 

How is a Cash-Out Refi Different from a Reverse Mortgage? 

Both cash-out refis and reverse mortgages allow borrowers to borrow against the equity they’ve built up in their homes. There are a few notable differences: 

  • Reverse mortgages are only available to borrowers 62 and older 
  • Cash-out refis offer a one-time cash-out payment, while reverse mortgages offer multiple payout options. 
  • Like a traditional mortgage, you immediately begin paying back a cash-out refi. Reverse mortgages only come due when the loan ends. 

Qualifying for a Reverse Mortgage 

To apply for a reverse mortgage, borrowers must certify that they have undergone reverse mortgage counseling through a Housing and Urban Development (HUD) approved agency. This counseling ensures that the borrower fully understands the terms of their mortgage and what they are agreeing to. 

In addition to the mandatory counseling, the basic requirements to qualify for a reverse mortgage are as follows: 

  • Borrowers must be 62 years or older for HECMs. Ages for proprietary reverse mortgages can vary. In some states, borrowers can take proprietary reverse mortgages at 55. 
  • Borrowers must be able to meet financial obligations. Although borrowers aren’t required to make monthly payments for their reverse mortgage, they are responsible for property taxes, home association dues, and insurance. Borrowers must also have the means to maintain the condition of the property at an acceptable standard. A financial assessment the lender conducts as a part of the application process will help determine if a borrower is able to meet these obligations. 
  • Borrowers must live in the home. A home must be a borrower’s primary or principal residence. That means they typically reside in the house for the majority of their time. Borrowers must certify annually that they still live in the home. 
  • Borrowers must have substantial equity in the home. While there is not a set percentage of equity a borrower must have to qualify for a reverse mortgage, generally, 50% or more is required. 

  It’s not enough for a borrower to meet the qualifications of a reverse mortgage; the property must also be eligible. 

What Homes Are Eligible for a Reverse Mortgage?  

Broadly, single-family homes are eligible for a reverse mortgage. The definition of a single-family home can cover a variety of structure types. According to the Federal Housing Administration (FHA), a single-family home is a stand-alone unit or one attached to a building. This definition includes: 

  • Manufactured homes and townhomes affixed to a foundation. 
  • Duplexes, triplexes, and fourplexes if the borrower lives in one of the units. 
  • FHA-approved condominiums. Borrowers can determine if a condo is approved by checking the Housing and Urban Development (HUD) website.  

If a building contains more than five units, it is considered a commercial property and is not eligible for a reverse mortgage. 

Can You Rent a Home With a Reverse Mortgage?

Reverse mortgage borrowers must live in their mortgaged home. That means rental properties are not eligible for reverse mortgages. It is perfectly fine, however, for reverse mortgage borrowers to rent out rooms in their homes, or units on the same property (provided they are under four). Borrowers will still need to comply with their HOA rules regarding rentals.

What Are the Loan Terms of a Reverse Mortgage?  

Because reverse mortgage borrowers aren’t required to make payments to their mortgage until the loan comes due, staying on good terms with a reverse mortgage is relatively simple.  

Borrowers can keep their loan in good standing by complying with the following terms:  

  • Staying up to date and current on property taxes, homeowner’s insurance, and other home-related fees, such as HOA dues.  
  • Living in the home for the majority of the year. 
  • Maintaining the home and keeping up with necessary repairs .

As part of complying with the terms of the mortgage, reverse mortgage borrowers must sign an affidavit annually to verify they still reside in the home. Every year, the loan servicer will send borrowers a home occupancy certificate to their primary residence. Borrowers must sign and send the certificate back within 30 days of receiving it.  

Borrowers who fail to comply with the terms of the reverse mortgage risk default, at which point the loan may come due and payable. Borrowers who are struggling to meet the terms of their mortgage should communicate with their servicer early on. 

What Do Borrowers Pay With a Reverse Mortgage? 

During the life of the loan, a reverse mortgage requires very little cash out of pocket from the borrower. While reverse borrowers do not make required monthly mortgage payments, they do need to keep up with home repairs, home insurance, and property taxes. Because any payments received through the reverse mortgage are considered loan proceeds and not income, income taxes aren’t levied on reverse mortgage loan proceeds.  

Though monthly mortgage payments are not required, borrowers can choose to pay down the balance as they see fit. 

When taking out the loan, borrowers must pay a counseling fee, as well as regular closing costs and fees, many of which can be wrapped into the loan. Interest and mortgage insurance premiums are added to the balance on the loan monthly, but the borrower does not need to make payments on them until the loan comes due, at which point the full amount of the loan plus accrued interest and mortgage insurance premiums must be paid. 

Natural Disasters and Other Unexpected Events 

Homeownership involves a number of risks that even the most conscientious homeowner can’t completely eliminate. If your home is located in a specific disaster-prone area, adequate insurance coverage is essential. As a reverse mortgage borrower, should your home be damaged or destroyed by fire, flood, or some other unforeseen event, your insurance coverage will be instrumental in rebuilding. It is also essential that you notify the loan servicer immediately. If you intend to rebuild or bring the house back to its previous state, you will stay in good terms with the reverse mortgage. 

How Much Money Can You Get from a Reverse Mortgage? 

Several factors determine how much money you can borrow through a reverse mortgage. Those factors include your age, the interest rate offered, the home’s value, and how much equity you have in the home. A reverse mortgage calculator will estimate how much money is available to borrow and your remaining equity. The borrower must supply their age, home value, and any current mortgage balance, if applicable.    

Borrowers can receive money as a lump sum, monthly payments, a line of credit, or a combination of all these options. The best course of action will depend on the individual financial situation and strategy. 

It is worth mentioning that all HECMs are subject to the 60% utilization rule. This limits the amount any reverse mortgage borrower can take in the first year to the higher of 60% of the principal limit or mandatory obligations like an existing mortgage plus 10% of the loan amount. The remainder of the available principal will be available to the borrower in the 13th month of the loan and come from an established line of credit.  

Reverse Mortgage Interest Rates 

Reverse mortgages can have fixed or variable rates. Unlike traditional mortgages, for which a fixed rate is often preferred, most reverse mortgages have a variable rate. Though fixed-rate reverse mortgages are available, they commonly do not allow the borrower to access as much equity as they can with a variable rate. Reverse mortgage borrowers who choose the fixed rate only have the option of taking a one-time cash payout. Because of the 60% utilization rule mentioned above, that payout will only be a fraction of what would be available with a variable rate that does not have a single payment restriction.  

The majority of reverse mortgage borrowers opt for the flexibility that the variable rate mortgage offers. Because the term of the loan is open-ended, borrowers do not know in advance how much interest will accrue on the loan over time (they do receive an amortization table that estimates accrued interest over the life of the loan). However, the flexibility in payment options, including a line of credit that offers increased borrowing power over time, as well as the availability of more equity, usually makes this type of interest structure more attractive. 

How Changing Life Circumstances Impact a Reverse Mortgage  

It is not possible to remove or add a person to a reverse mortgage, so in the cases of death, remarriage, or divorce, in order to add or remove a party, the loan will need to be refinanced.  

Non-borrowing Spousal Protections

In a married couple in which one person is not included on the reverse mortgage, the spouse not on the mortgage is called a non-borrowing spouse. There are legal protections that help prevent eligible non-borrowing spouses from being removed from their homes in the event the borrower passes away or has to move into an assisted living facility. Though an eligible non-borrowing spouse will be allowed to remain in the home, they will no longer have access to remaining funds, including those set aside to pay taxes and insurance. 

Whether divorcing non-borrowing spouses remain in the home or leave is between the borrower and their attorney. The specifics of the divorce settlement may allow for the home to be refinanced in the non-borrowing spouse’s name or any number of other arrangements. 

Selling or Refinancing With a Reverse Mortgage  

Selling a home with a reverse mortgage works very much like selling a home with a traditional mortgage. The proceeds from the home sale are applied to the reverse mortgage balance when the home is sold. The remaining money goes to the borrower or their heirs.  

It is also possible to refinance a reverse mortgage. Generally, people choose to refinance a reverse mortgage if they want to add a new person to the mortgage, say in the case of marriage, or if the house has increased substantially in value and they would like to tap additional equity. 

What Happens at the End of a Reverse Mortgage? 

There are three ways for a reverse mortgage to come due: 

 When the last borrower dies, heirs are faced with deciding what to do. Heirs are not responsible for reverse mortgage debt. However, when the mortgage comes due, they do need to decide how they would like to resolve the debt. Options include the following:  

  • Sell the home. If the heirs want to repay the loan, they can use the proceeds from the sale of the house and apply this to the outstanding balance.   
  • Keep the home. The heirs can keep the house if they pay the mortgage balance or 95% of the property’s appraised value, whichever is less. Heirs can refinance the loan if they choose. If the heirs are over 62, a new reverse mortgage may be a possibility.   
  • Sign over the title and complete a deed in lieu of foreclosure. The heirs can give the property to the lender by signing the home’s heading to the lender accompanied by an act. By doing so, the debt is satisfied, and it will prevent foreclosure of the house.   
  • Do nothing. If the heir chooses to do nothing with the loan, the lender will foreclose on the home. While possible, this is not preferable or advantageous for the heir. Working with the servicer to complete the transfer in an official capacity should not be difficult.

Depending on your retirement strategy and goals, a reverse mortgage can help alleviate the stress in your golden years. A reverse mortgage isn’t complicated to understand once you learn the process and what is at stake during the life of the loan.