Reverse Mortgages Explained

As you explore options for buying a house, you may have come across the term “reverse mortgage.”

However, you should know that you can’t use a reverse mortgage to buy a house. Instead, you would only ever seek a reverse mortgage if you’ve already owned your home for some time and have built up a significant amount of equity.

So how does a reverse mortgage work, exactly?

In a reverse mortgage situation, the lender makes a loan to you using your home as collateral. The lender will lend you money in monthly installments, which will be paid back with interest when your home is sold.

Whether you are currently in the market for a reverse mortgage or not, it’s still a smart idea to learn how a reverse mortgage works when planning your financial future. If you’ve ever wondered what a reverse mortgage is, keep reading to learn how they work and if they are right for your situation.

How does a reverse mortgage work?

The primary type of reverse mortgage used by the majority of borrowers is called a Home Equity Conversion Mortgage, or HECM for short. These loans are federally insured and available only from FHA-approved lenders.

A Home Equity Conversion Mortgage works like this: If a home is paid off, or almost paid off, the qualifying homeowner can apply for a HECM. If approved, the homeowner will continue to live in the home and receive a monthly payment from the lender. The monthly payments are added to the borrower’s line of credit, plus interest and fees every month. The homeowner is responsible for paying property taxes and keeping the home in good condition.

Each month, as the borrower’s loan balance rises, the value of their home equity falls by the same amount. The borrower does not need to repay the loan balance until he or she sells the house, or until the borrower dies. The longer that the homeowner receives reverse mortgage payments, the greater the balance will be at the end.

For example, imagine that a homeowner takes out a HECM on their $250,000 house that they own outright. Then, they begin receiving monthly installments of around $500 a month. A few years later, the homeowner passes away and they have accumulated a loan balance of $50,000, including fees and interest. The estate sells the house for $275,000. The estate then pays the lender the $50,000 and the remaining $225,000 would be distributed to the heirs.

Who qualifies for a reverse mortgage?  

Not everyone qualifies for a reverse mortgage. In fact, a homeowner must meet several different criteria in order to even be considered for a Home Equity Conversion Mortgage.

• You must be at least 62 years of age.
• The home must be used as a primary residence.
• The home must be paid off, or have a very low mortgage balance that will be paid off by the reverse mortgage.
• You must not be delinquent on any federal debts, meaning that you’ve neglected to make loan payments. This includes debt such as student loans or back taxes.
• Your home must be in good condition. You may need to make certain repairs in order to obtain a reverse mortgage loan.

Reverse mortgage pros and cons

A reverse mortgage isn’t for everyone. Generally, you will only consider reverse mortgage solutions if you’ve paid off your home but you do not have enough monthly income to maintain a certain standard of living.

Pro: Unlock your home equity

The good thing about reverse mortgages is that they allow you to essentially borrow back the money that you paid for the house. This may be necessary if you need additional funding for medical expenses, home improvement, or for traveling and vacation.

Con: Your home might not stay in the family

Not everyone is sentimental about real estate, but those that are they should know that a HECM makes it much more likely that your heirs won’t be able to keep your home. They will either have to sell your house to pay off your reverse mortgage or come up with another source of funds to pay the balance.

Pro: No monthly payments

Reverse mortgages allow you to borrow money without making any monthly payments. Other means of unlocking home equity, such as a home equity loan or a home equity line of credit, require that the borrower start making payments right away.

Con: You’ll have less to leave behind

A reverse mortgage might seem like a great idea at the moment but consider the interest rate. If you receive payments from your reverse mortgage for many years, you’ll rack up a big balance and plenty of interest. When all is said and done, those funds will need to be paid back by your heirs — and depending on how much you borrow, there might not be much left for them.

Types of reverse mortgages

There are three common types of reverse mortgages, with the HECM, in particular, being the most accessible to borrowers. When shopping for a reverse mortgage, always pay close attention to the terms of the loan and get quotes from several different lenders before committing.

1. Home Equity Conversion Mortgage. This is an FHA-insured reverse mortgage that is available to homeowners over the age of 62.
2. Proprietary Reverse Mortgage.  These reverse mortgages are not federally regulated or insured by the FHA. Instead, these loans are offered by private lenders and typically carry much higher interest rates than the HECM. Because they charge high interest rates, these companies typically offer higher loan amounts. When you put those two together you can rack up quite a bit of debt.
3. Single-purpose Reverse Mortgage. These mortgages are designed with the purpose of helping a homeowner stay in their home. That means the loan amount is restricted to a specific purpose such as paying property taxes or making necessary repairs. They are offered by state and local housing agencies to help at-risk homeowners.

Other factors to consider

Regulations affecting reverse mortgages

Remember that regulations require that you be at least 62 years old to take out a reverse mortgage. If you are opting to apply for a HECM, you should also know that the maximum loan amount is $726,525.

Reverse mortgage lenders

Not all reverse mortgage lenders are the same. Remember that FHA-backed HECMs are federally regulated, while proprietary reverse mortgages are private lenders who are able to charge exorbitant interest rates if they wish. Choose wisely!

Fees

Just like any real estate transaction, you can expect a lot of fees. Some things you can shop for and others you can’t. You can expect fees that include: an origination fee, mortgage insurance premium, an appraisal fee, and a number of closing costs.

Potential Scams

Be wary of scams that target seniors with unfavorable reverse mortgage loans. Known scams involve those pushed by shady contractors and those promoting non-existent VA-backed loans.

The bottom line

When it comes to reverse mortgages, you have to be careful. You should consider obtaining a reverse mortgage among various other options including taking out a home equity loan or HELOC, refinancing your existing mortgage, selling your home and moving to a more affordable location, or reducing your expenses via other means.

Frequently Asked Questions

How does a reverse mortgage work?

The lender will loan you money in monthly installments. The balance is paid when you sell the house or when you die and your estate sells the house.

What is the most common type of reverse mortgage?

The most common type of reverse mortgage is called a Home Equity Conversion Mortgage. They are federally backed and offer the lowest interest rates.

Will my spouse be able to stay in the house if I pass away?

You may designate your spouse as an Eligible Non-Borrowing Spouse, which means they are allowed to stay in your home even if you pass away with an outstanding reverse mortgage.  In that case, the balance won’t be due until they sell the home or they pass away.

Will I still own the home if I get a reverse mortgage?

Your name will remain on the title when you get a reverse mortgage.