A reverse mortgage is a type of loan that allows you to cash out the equity of your principal residence while you still live in the house.
Instead of making monthly mortgage payments to the lender, the lender pays you the way you would with a traditional mortgage. However, you generally don’t have to pay back the money until you move out, sell the house, fail to meet the loan obligations, or pass away. Reverse mortgages aren’t exclusively made for single-family homes, and you can apply if you live in a condominium, so long as it’s your primary residence.
- How Does a Reverse Mortgage Work?
- Is A Reverse Mortgage Right for You?
- How to Avoid Reverse Mortgage Scams
- Summary of Money’s Guide to Reverse Mortgages
How Does a Reverse Mortgage Work?
To understand how reverse mortgages work, first, you first need to understand what equity is. In real estate terms, equity is the actual market value of your property minus any mortgages still owed on it.
For example, if the value of your home is $300,000 and you still owe $100,000 on the mortgage, your home equity line is $200,000. That’s the amount you would be able to borrow through a reverse mortgage. If, on the other hand, you don’t have a mortgage on the house, then the total market value of the property is the equity you have available.
When you apply for a reverse mortgage, the bank will issue you a payment for the equity amount you want. This money is yours tax-free and may be paid upfront in a single lump sum, in monthly payments, as a line of credit, or in a combination of all three.
Types of Reverse Mortgages
There are four types of reverse mortgages: home equity conversion, home equity conversion for purchase, proprietary, and single-purpose reverse mortgage. Single-family homes are not exempt as long as they are the principal residence. Much like a regular mortgage, these loans offer a fixed rate or an adjustable interest rate. Check out our page on current mortgage rates.
Just like with a traditional mortgage, reverse mortgage borrowers must remain current on their property-related taxes, insurance and maintenance as part of ongoing loan obligations.
Home Equity Conversion Mortgage (HECM)
A Home Equity Conversion Mortgage allows homeowners to convert the equity they’ve accumulated in their homes into cash. HECMs are available only through lenders approved to disburse FHA loans, insured by the Federal Housing Administration (FHA), and regulated by the U.S. Department of Housing and Urban Development. The amount that can be borrowed is based on the appraised value of the property, and subject to FHA limits.
Some HECM lenders require two appraisals of the property. Of those two, the lender will use the lowest appraised value for the loan. For 2021, the principal limit for this loan is $822,375, and there are no limits on how reverse mortgage borrowers can use the money. You’ll be required to attend a HUD counseling session through a counsel agency and pay a mortgage insurance premium (MIP).
With an HECM, your home is insured by mandatory Mortgage Insurance Premiums. This means that even if the house has a loan balance larger than the property’s value, the owners cannot owe more on the property than the actual loan balance.
Home Equity Conversion Mortgage (HECM) for Purchase
An HECM for Purchase allows seniors to use the proceeds from a reverse mortgage to buy a new principal residence. Just as with a regular HECM, this is a Federal Housing Administration (FHA)-insured program. It also has a non-recourse feature, which means that the borrower will never owe more than the home is worth when the loan is repaid.
This loan type features flexible repayment. That means that the borrower can repay as much or as little as they like each month, or even make no monthly principal and interest payments. This makes it easier for a buyer to be able to afford the home they really want, while keeping more of their savings and retirement assets.
As an HECM for Purchase involves buying a new primary residence, there are regulations related to the down payment on the new home. If closing costs are financed, the minimum required downpayment is usually between 29% to 63% of the purchase price, depending on the buyer or eligible non-borrowing spouse’s age, when applicable. The remainder of the purchase funds come from the HECM loan.
If the HECM for purchase resulted in a substantial enough amount, the homebuyer may even have some of the proceeds left over to use for other retirement goals.
According to the NRMLA, this type of reverse mortgage is often preferred by people living on a fixed income who are looking to downsize, move closer to family, or whose current home no longer meets their needs.
Proprietary Reverse Mortgage
A proprietary reverse mortgage is a kind of loan offered by private reverse mortgage lenders. Also known as a jumbo reverse mortgage, this type of loan is for homes exceeding the value limits set by HUD.
Proprietary reverse mortgages don’t require the borrower to pay a monthly insurance premium or financial counseling since the federal government does not insure them. However, these loans tend to have a higher interest rate than a HECM loan. Borrowers can get the money as a lump sum or monthly annuity for any purpose. Check out our selection for the best mortgage lenders.
Single-Purpose Reverse Mortgage
Local and state government agencies and nonprofit entities offer single-purpose reverse mortgages for a specific purpose, such as paying off property taxes or making home improvements. Also known as “deferred payment loan” or “property tax deferral loan,” this kind of reverse mortgage has lower fees and interest rates.
Eligibility requirements also tend to be less strict, so this is one type of reverse mortgage low-income borrowers and homeowners can afford. Check out our selection for the best home improvement loans.
Types of Reverse Mortgage Payment Options
The amount you will be able to borrow with a reverse mortgage depends on the type of reverse mortgage loan you select, the age of the youngest borrower, current interest rates, and the value of the home. Much like when you take out a traditional mortgage, a reverse mortgage also has origination fees, servicing fees, and other closing costs.
You will also be required to pay mortgage insurance premiums. These expenses can be taken out of the loan amount, so you don’t have to pay them out of pocket, but they will reduce how much cash you receive after closing. In addition, reverse mortgages tend to have higher interest rates than traditional mortgages.
HECMs give you plenty of payment options:
- A single lump-sum payment
- Tenure: a monthly annuity for a specific number of months or for as long as the house is your primary residence
- A line of credit: has the benefit of growing every year as you don’t withdraw the total amount
These options can be combined to fit your needs.
Reverse Mortgage Pros and Cons
- Access a large amount of cash or a steady source of income in your retirement, even if you already have an existing mortgage
- Choose to receive the money as a lump sum, annuity, line of credit, or a combination of all three
- No payments until you move out, sell the house or die
- HECMs are non-recourse loans, so you will only owe what you borrowed even if your house loses value
- Reverse mortgage payments are non-taxable because they are loan proceeds, not income
- You have the right to change your mind for any reason and cancel the reverse mortgage within three business days of closing on the loan
- If your spouse is a co-borrower, they will be able to stay in the house after your death, with no repayment required until they die
- You must pay mortgage insurance premiums and homeowners insurance for the life of the loan
- Other expenses associated with reverse mortgages, like fees and closing costs, will reduce the amount of cash you get
- With an HECM, if you and your non-borrowing spouse die before paying back the loan, should your heirs wish to keep the home, they must pay off the full loan balance or 95% of the home's appraised value (whichever is less)
- Falling behind on property taxes or insurance payments could trigger default and foreclosure
- The loan proceeds could affect your Medicaid and Supplemental Security Income eligibility, if you take them as a lump sum and these are unspent after thirty days
- The loan becomes due immediately if you and your co-borrowing spouse need to move out of your house, such as into a long-term care facility. Keep the home well-maintained, or the lender could declare the loan in default.
- If your non-borrowing spouse outlives you, the loan comes due, which may mean they must move out if they can't afford to pay it back
Is a Reverse Mortgage Right For You?
Depending on the kind of reverse mortgage you choose, there may be limits placed on how you can use the money.
For single-purpose reverse mortgages, the purpose for the money needs to be reviewed and approved by the lending agency. The house has to comply with HUD’s minimum property standards to qualify for a HECM mortgage. In addition, you have to use some of the loan money to pay for improvements to make the structure eligible for the loan.
If you are searching for a reverse mortgage loan, keep in mind that to qualify,
- You must be at least 62 years old, own your home, and live in it as your primary residence
- Your home must have enough equity for the reverse mortgage amount you need
- You must be able to pay taxes and homeowners insurance premiums on the house
- Maintain the house in a good physical state
- In the case of a HECM, you have to attend financial counseling with a HUD-approved counsel agency
If you receive Medicaid or Supplemental Security Income (SSI) benefits from the Social Security Administration, consult a financial expert to determine if your benefits will be affected by this kind of home equity loan.
How Do You Pay Back A Reverse Mortgage?
When the borrower dies, the bank explains to the heirs their options regarding loan payments and their mortgage balance. They have 30 days to decide what to do with the loan and with the property. These are some of the options available for you or your heirs to pay a reverse mortgage:
- Sell the home and use the proceeds to pay off the balance on the reverse mortgage loan
- If the heir wishes to keep the property, they must find a means of repaying the loan balance or 95% of the home’s appraised value, whichever is less
- An heir takes a loan on the property after the borrower has passed away to cover the balance on the mortgage
- Refinance with a forward mortgage loan
If the heirs decide not to keep the house, the lender may proceed with foreclosure.
When Do You Pay Back a Reverse Mortgage?
As long as you live in your home, you don’t have to pay back the reverse mortgage loan. However, the loan will become due and payable if one of the following situations happen:
- Death – When you pass away, if your heirs are not interested in paying back the mortgage or making an arrangement with the financial institution, the lender will take possession of the mortgaged property.
- Selling the property – The loan is paid off with the money acquired by the sale
- Living outside the home for one straight year – If you live more than 12 months out of the house, you will need to sell it to pay off the loan. If your spouse is a co-borrower, they can stay in the home without paying back the loan
- Not paying property taxes or homeowners insurance – HECMs require that the borrower pays taxes and homeowners insurance. Failure to do so will result in foreclosure. If you are unable to pay, seek a reverse mortgage counselor right away
- Not maintaining the house -The home needs to be kept in liveable conditions to maintain its value
Once the loan is due, you need to speak with your lender to determine the time period to settle the loan balance. Depending on your situation, the amount of time varies. It could be as little as 30 days in some cases before the lender begins the foreclosure process.
How to Avoid Reverse Mortgage Scams
Unfortunately, reverse mortgages are a favorite of unscrupulous individuals to scam homeowners. Here are some practices you should stay away from regarding reverse mortgage loans:
|Warning Signs||Cut off Signs|
|Some lenders misconstrue how a reverse mortgage works and don’t explain the fine print to their clients||A contractor tries to convince a homeowner that the best way to pay for costly home repairs is to take out a reverse mortgage|
|Some companies market aggressively to older adults who may not have the financial know-how to understand the implications of taking out a new loan like this||Some homeowners are tricked into investing the loan proceeds in risky stocks or schemes (like house-flipping) or signing over the money to a third party.|
|Beware of someone who claims you can purchase a home without a down payment|
The best way to avoid being a victim of a reverse mortgage scam is:
- Understand how reverse mortgages work
- Read the fine print before signing any loan documents
- Don’t sign any documents you don’t understand
- Be aware that you have a right to cancel your reverse mortgage loan within three business days of closing for any reason whatsoever. You’ll need to send a request in writing to your lender, who will then have to return any loan expenses you have already paid
- Seek out a reverse mortgage counselor
- Don’t respond to unsolicited advertisements
If you or someone you know is a victim of a reverse mortgage scam, submit a tip to the FBI, file an online complaint with HUD-OIG, or call their hotline at 1-800-347-3735. You can also submit a complaint through the Consumer Financial Protection Bureau by calling 1(855) 411-2372.
Reverse Mortgage FAQ
What is a reverse mortgage?
A reverse mortgage is a loan that allows people 62 years old and older to cash the equity value of their home. The loan is paid off when the borrower dies, lives outside of the house for more than 12 months, sells the property, or stops paying taxes and homeowners insurance. You can obtain this type of loan through authorized FHA loan lenders and private lenders.
How does a reverse mortgage work?
Reverse mortgages are loans made for people 62 years old or older who are the owners of their principal residence. These loans are disbursed in one lump sum, as a line of credit, or as a monthly annuity. They require the borrower to maintain the house in good condition and to pay taxes and insurance. When the borrower passes away, moves out of the home for more than 12 months, or fails to comply with other loan requirements, the financial institution will put the house in foreclosure.
What is the downside to a reverse mortgage?
The main downside to reverse mortgages is that you’re using the equity of your principal property while you’re alive. If your heirs are unable to buy back the property from the bank, they will not be able to receive the home as part of their inheritance. If the borrower has time-sensitive health issues and has to spend more than 12 months outside the home or move to an assisted living facility, the loan is annulled and must be paid back to avoid foreclosure.
Reverse mortgages are also risky in terms of scams, and many adults fall victim to predatory practices that can cost them substantial amounts of money.
How much money do you get from a reverse mortgage?
The amount of money you will receive from a reverse mortgage depends on the market value of your house. If there are no debts on the property, you will receive the market value of your home as payment. However, if the property owns money from a previous mortgage, the bank will subtract the debt and give the borrower the equity value of the house.
How does a reverse mortgage work when you die?
When the borrower passes away, the financial institution explains to the heirs the different options and gives them around 30 days to decide what they want to do with the property. If the spouse of the principal borrower is a co-borrower on the reverse mortgage, they are allowed to stay in the house without paying back the loan.
Summary of Money’s Guide to Reverse Mortgages
- A reverse mortgage can be a powerful tool to access funds to perform necessary home improvements, pay back property taxes, or other essential living expenses
- Reverse mortgages can be accessed through FHA loan lenders and private lenders and are available for homeowners 62 years of age and older
- These loans are disbursed as a lump sum payment, as a line of credit, or as a monthly annuity
- Homeowners should be fully aware of the responsibilities, conditions, and possible scams when looking for and applying for a reverse mortgage
- It’s crucial to make a financial assessment before applying for a reverse mortgage to see if you will be able to afford living expenses, insurance, and taxes to continue living in your house after taking this type of loan