A reverse mortgage allows eligible borrowers of a certain age to tap the equity built up in their home while forgoing required monthly mortgage payments. Unlike a traditional mortgage that gets paid over a specific term, the balance and interest charged on a reverse mortgage are not due until the last borrower passes away or leaves the home.
Over the years, increased government regulation and oversight have made reverse mortgages safe and effective strategic financial vehicles. Though 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) must adhere to a strict code of ethics and pledge to serve borrowers with integrity.
Types of Reverse Mortgages
The most common type of reverse mortgage is a home equity conversion mortgage, also known as a HECM. These mortgages are insured by the government and subject to stringent regulations and protections. Often, when people talk about reverse mortgages, they are referring to a HECM — however, not all reverse mortgages are HECMs.
The two types of reverse mortgages are:
- Home Equity Conversion Mortgages (HECM). These reverse mortgages are the most common and popular because they give borrowers flexibility and freedom with how they will use their proceeds, in addition to government protection. Insured by the FHA, HECMs are non-recourse, which means the borrower or their heirs will never owe more than the home’s market value at the time it is sold.
- Proprietary Reverse Mortgages. Most states have specific lending qualifications that allow a mortgage to be classified as a reverse mortgage. A proprietary reverse mortgage is a mortgage product created by a lender that uses a reverse mortgage structure. These are private loans funded by the companies that create them. They are not government-backed. Because these loans are not guided by government regulations, the minimum age and available loan amounts are also set by the lender and may deviate from HECM requirements and limits.
How Does a Reverse Mortgage Work?
A reverse mortgage is a home equity loan that, as its name implies, works in reverse. In a traditional loan, the borrower takes the proceeds up front and then pays them back with interest over a specified time period.
With a reverse mortgage, interest is added to the balance each month, but neither the accrued interest nor the loan balance is due until the loan ends. The borrower is not required to make monthly mortgage payments (they do have financial obligations like property taxes, which will be covered later in this article). Also, differing from a traditional loan, the length of the reverse mortgage is not a specific time period. Instead, the loan comes due when the last borrower passes away, moves out, or sells the home.
With a reverse mortgage, the borrower has several options for how they will receive the loan funds:
- A lump sum
- Monthly payments
- Line of Credit
- Combination of the three
Reverse mortgage borrower eligibility requirements
To be eligible for a reverse mortgage, borrowers must meet the following requirements.
Eligibility requirement 1: Age
To apply for a home equity conversion mortgage (HECM), borrowers must be at least 62 years of age. Proprietary reverse mortgages may have different age requirements.
Eligibility requirement 2: Debt
To get a reverse mortgage, borrowers must be current on any federal debt. Reverse mortgage proceeds may be used to pay off existing mortgages, including FHA loans.
Eligibility requirement 3: Equity
Reverse mortgages are only available to people with a certain amount of equity in their homes. The financial assessment will help determine if the applicant has sufficient equity to qualify. In most cases, reverse mortgage borrowers own their homes outright or have a substantial amount of equity built up.
Eligibility requirement 4: Primary Residence
Reverse mortgages are for people who intend to live in the their homes. Borrowers must demonstrate annually that their mortgaged home is their primary residence and that they live there for the majority of the year.
Eligibility requirement 5: Financial obligations.
Though reverse mortgages remove mandatory mortgage payments, borrowers are still responsible for other fees and costs associated with home ownership. Borrowers must demonstrate that they can pay property taxes, homeowners’ insurance, homeowners association fees, home maintenance, and other costs required to maintain the property.
What Is a HELOC? How Is a Reverse Mortgage Different?
A HELOC or Home Equity Line of Credit is a different way of tapping equity. Though the acronyms HECM and HELOC are similar, the two kinds of loans are different in most other ways.
A HELOC is similar to a credit card that borrows against the equity in your home. It is like a traditional mortgage in the sense that once you use any of your available credit, you’ll need to start making monthly payments. Interest will accrue on the balance over the time that you continue to have a balance.
Although HECMs are different from HELOCs, they do have an option for opening a line of credit. This line of credit functions differently than a HELOC and is only available to borrowers through a reverse mortgage.
Regulations and Reversing a Bad Reputation
The first reverse mortgages were written in the 1960s. Because reverse mortgages were completely new, in the early days, reverse mortgages didn’t require credit checks or have caps on equity distributions. Although they were originally invented to help people, an unfortunate lack of oversight led to some people getting scammed and the industry earning a bad reputation.
Reverse mortgages have come a long way since 1960.
More stringent federal safeguards have been put in place to alleviate some of the concerns and issues faced by the reverse mortgage industry. To make certain borrowers understand the requirements and potential risks of a reverse mortgage, the government, through Housing and Urban Development (HUD), requires every reverse mortgage borrower to undergo mandatory counseling conducted by a third party before entering the loan.
To ensure loans comply with HUD regulations, lenders now conduct full financial assessments on borrowers before they qualify for a reverse mortgage. They evaluate incomes, credit history, and delinquencies to determine if the homeowner can maintain the home, pay property taxes, and afford home association fees and insurance.
Reverse Mortgage Misconceptions
The Federal Housing Administration (FHA) now ensures approximately 99% of reverse mortgages. Borrowers are guaranteed their payments even if the lender goes out of business. Additionally, FHA-insured reverse mortgages are non-recourse, meaning that should the home decrease in value, the borrower or their heirs will not be held responsible for the difference between the loan value and the sale price of the home.
Though reverse mortgages are safer than ever, myths and misconceptions persist. Mentioning reverse mortgages is likely to elicit a range of misguided and false beliefs.
Despite facts to contrary, here are some of the common myths that stick to reverse mortgages:
Why People Take Out Reverse Mortgages
Another way that a reverse mortgage is different from a traditional mortgage is the flexibility it offers borrowers to use it in a way that suits their needs. Borrowers are able to use their funds in whatever way they choose. Some of the most common ways people use reverse mortgages are to:
- Increase Cash Flow. In addition to allowing people to tap equity through monthly payments, the removal of monthly mortgage payments with a reverse mortgage offers increased cash flow.
- Pay Down Other Debt. Borrowers saddled with high medical bills, credit card debt, or another substantial financial obligation may find a reverse mortgage offers them the ability to get out from under it.
- Help heirs now. Reverse mortgage borrowers can use the proceeds to help a grandchild get through college or make another gift to their heirs \during their lifetime.
- Do something for yourself. In retirement, cash flow may be tight in certain seasons, but with a reverse mortgage, borrowers can have the freedom to splurge on a vacation, home renovation, or something else without withdrawing from savings or cashing in other assets.
Whatever you’re considering using a reverse mortgage for, it’s important to understand it is a loan, and taking one should be part of a larger financial plan. While reverse mortgages are safe and can be useful planning vehicles, they aren’t for everyone. Though reverse mortgages are often associated with people in dire financial situations, these financial vehicles are most useful for people who have substantial equity in their homes and relatively stable finances. If you are considering using home equity as part of your retirement plan, check with your financial advisor to see if a reverse mortgage might make sense for you.
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.