If you own your home and are 62 or older, a reverse mortgage could allow you to access your home’s equity without selling or moving from your property. It’s important to understand how reverse mortgages work before signing up, as some types of reverse mortgages have downsides. This guide explains the fundamentals of reverse mortgages so you can decide whether a reverse mortgage is right for you.
How Does a Reverse Mortgage Work?
A reverse mortgage lets you borrow against your home’s equity so you receive cash without selling your home. You can choose to receive a lump-sum payout, regular payments over time, or set up a line of credit that allows you to take out money when you need it.
You do not need to pay back your reverse mortgage as long as you continue to live in your home, and you do not have to make any payments on the loan. However, you will need to keep up with other housing costs like property taxes, homeowners insurance, repairs and association dues.
When you die, the loan will be due. Your heirs can pay off the loan balance if they want to keep the property or they can let the lender keep the property to settle the debt
If you change your primary residence before passing away, you will need to repay the loan, which is usually done by selling the home. The lender considers that you changed your residence if you live outside your property for more than six months in a year for nonmedical reasons or 12 consecutive months for medical reasons.
Types of Reverse Mortgages
Home Equity Conversion Mortgages (HECM) – HECMs are the most common type of reverse mortgages. They offer federal backing, limits on certain fees, and once you receive your money, you can spend it any way you want.
These loans are insured by the U.S. government through the Federal Housing Administration (FHA). If the amount you owe from the reverse mortgage grows to exceed the value of your home, the FHA will assume most or all of the loss. You will pay a mortgage insurance premium to cover the potential for this type of loss, but it can be financed into the cost of your loan.
HECMs have restrictions on eligibility and borrowing. The maximum property value that a lender can use to determine how much to lend for an HECM reverse mortgage is the FHA maximum loan limit. This was $636,150 in 2017 and $679,650 in 2018. Even if your home is worth more than the FHA limit, the lender has to base its calculation on a maximum value of $679,650 in 2018.
Before applying for an HECM, you must meet with a HUD-approved counselor and pass verification of your income, assets, monthly living expenses, and timely payment of real estate taxes and insurance premiums. The counselor will review your financial situation to help you decide whether a reverse mortgage is the right option.
Although the loan has restrictions, it is a good choice for many seniors considering a reverse mortgage. The government limits the origination and servicing fees that can be charged for these loans. These loans are more standardized, so it’s easier to compare programs between different lenders.
Proprietary Reverse Mortgages – Proprietary reverse mortgages are similar to HECMs, but they do not offer a government guarantee. They have fewer restrictions and the lender could loosen the eligibility requirements, like not requiring a financial review with a HUD counselor, but fees may be higher with a proprietary reverse mortgage than an HECM.
A proprietary reverse mortgage can create loans secured by more than the $679,650 property value limit from HECMs, so they can be a good option if you have a high-value property. However, lender fees are not restricted to a specific amount, so fees may be higher. These loans can be harder to compare because they aren’t standardized. Finally, you can only receive a lump-sum payment from a proprietary reverse mortgage. Other payment options are not available.
HECM reverse mortgages make sense for most properties valued at less than $1 million, whereas people with homes worth more than $1 million should consider both options, says Peter H. Bell, president and CEO of the National Reverse Mortgage Lenders Association.
However, he cautions that the right option depends on your personal situation. “Proprietary loans are not available in every area,” Bell points out. “On the other hand, some properties do not qualify for an HECM reverse mortgage, like a condominium that doesn’t meet the FHA standards.”
HECM for Purchase – An HECM for purchase can be used to buy a new home for your primary residence. You enter into a contract to buy your new home, pay a down payment and then finance the balance of the purchase with the reverse mortgage rather than paying cash or using a first-lien mortgage. The new home can’t be a vacation home or investment property.
This strategy lets you complete everything in one transaction and you will not owe monthly mortgage payments for your new home. Many seniors use an HECM for purchase to downsize or move closer to family members.
Single-Purpose Reverse Mortgages – With a single-purpose reverse mortgage, the lender restricts how you can use the money from a reverse mortgage. For example, a single-purpose reverse mortgage may only be used to pay off property taxes or to make home repairs. These reverse mortgages are typically the least expensive option, but they are limited in availability. They are offered by some state and local governments and nonprofits, and are typically only available for low- and moderate-income borrowers who may not be able to qualify for other types of reverse mortgages.
Reverse Mortgage Benefits
Access to Cash Through Home Equity
With a reverse mortgage, you get access to home equity without selling your home. These funds can offer extra money during retirement to pay off debt, maintain your lifestyle and handle surprise expenses.
No Monthly Mortgage Payments
Like a reverse mortgage, a home equity loan borrows against your home’s equity. But with a home equity loan, you’ll make monthly mortgage payments, which cuts into how much you have left to spend. With a reverse mortgage, you don’t have to make monthly payments. The loan only needs to be repaid when you sell your house, move out or pass away, and is typically paid for with the money from the sale of your home. You don’t have to pay off the loan balance or interest before then.
Andrina Valdes, executive vice president at Cornerstone Home Lending, says her company’s loan officers recommend clients compare both a forward mortgage (home equity loan) and a reverse mortgage as the right option depends on the client’s personal situation.
Maintain Ownership of Your Home
You’re still the owner of your home after taking out a reverse mortgage. The lender doesn’t receive the title or the right to sell your house, so long as you keep up with the housing costs including property taxes and homeowner’s insurance. The house remains yours until you move out or pass away. Even if you move out, you still have the option to pay off the loan to keep the property.
Flexible Payment Options
There are a range of different ways to borrow through a reverse mortgage, including taking lifetime payments, a lump sum or a line of credit. You may be able to switch to a different payment option during your loan, like converting your line of credit into guaranteed lifetime payments. If you borrow money from a line of credit, you can pay the money back and reborrow again later.
“With a reverse mortgage, people take their home equity and turn it into a flexible source of money,” says Bell. “This gives them more options during retirement. For example, when they need money, they can borrow through their line of credit rather than being forced to sell a stock that’s paying a nice dividend.”
Social Security and Medicare Not Affected
When you receive money from a reverse mortgage, it counts as a loan, not income. As a result, your Social Security and Medicare will not be affected.
Reverse Mortgage Drawbacks
Lenders charge a number of fees to close on and maintain a reverse mortgage. While you don’t have to pay the majority of fees until you leave your home, you could receive less money overall than if you had sold the home outright.
Interest grows over time.
Since a reverse mortgage is a loan, the lender will charge interest on the amount you take out. While you don’t have to pay interest as long as you’re living in the property, this reduces the amount you or your heirs would receive for selling your home.
Interest isn’t tax-deductible.
The interest on a reverse mortgage is not tax-deductible on your annual tax return. Since you do not make payments on the interest while living in your home, it cannot be deducted every year but will instead accumulate to the mortgage balance.
Loan must be repaid if you move out.
If you live somewhere besides your home, you will eventually need to repay your reverse mortgage. Your loan is due if you live somewhere else for nonmedical reasons for a majority of the year. Additionally, if you move out for medical reasons, such as to live in an assisted living facility, and are out of your home for more than 12 consecutive months, your loan must be repaid. This can force you to pay off the reverse mortgage earlier than expected.
Additional Housing Costs
While you don’t have to make loan payments on a reverse mortgage, you still need to cover other housing costs including taxes, maintenance and housing association dues. If you fail to make these payments, the lender could foreclose on your home.
However, Bell notes that this concern is not unique to reverse mortgages. “If you don’t pay your property taxes, you could eventually lose your home in any situation.”
A reverse mortgage could reduce the inheritance for your heirs, as it reduces the equity in your home. If your heirs sell your home after your death, proceeds from the sale of the home will be used to pay off the loan, and then they will receive any remaining proceeds. If they want to keep your property, they will need to pay off the loan first.
Valdes says this can be a concern for clients. “It’s all about the borrower choosing the best option for their situation and long-term assets plan. We often have clients that decide not to proceed with a reverse loan because they’re worried they won’t leave as much of an inheritance. We also counsel clients to think about discussing with their potential heirs before moving forward.”
Eligibility requirements can vary depending on the type of loan you’re taking out and the lender. HECMs have the following requirements:
- Be at least 62 or older – You cannot qualify if you are younger than 62, even if you are already retired or are disabled.
- The property must be your primary residence – You must be living in the property. It can’t be a vacation or second home. After taking out your reverse mortgage, you cannot live elsewhere for more than six months for nonmedical reasons and more than 12 consecutive months for medical reasons or you will need to repay the loan.
- Your home must be paid off or have a low mortgage balance – The government requires that the reverse mortgage has first-lien position. This means your home must already be paid off before you take out the reverse mortgage or the reverse mortgage proceeds must be enough to pay off your remaining home loan.
- Be able to pay future housing costs – The lender will verify whether you can continue paying the housing costs including taxes, homeowners insurance and maintenance after you take out the reverse mortgage. If you can’t keep up with these payments, you could lose your home to foreclosure.
- No delinquent federal debts – If you are delinquent on other federal debts, like taxes or an FHA-insured mortgage, you cannot take out a reverse mortgage until the issue is resolved. You either need to pay off the debts or enter a valid payment plan so the debt is no longer delinquent.
- Satisfy property requirements – Not every property is eligible for a reverse mortgage. Single-family homes are eligible. If you own a multifamily property, it can be no more than four units of housing and you must live in at least one of the units.
- Manufactured homes and condominiums can be eligible if they meet HUD requirements.
- Meet with a HUD-approved counselor – You will be required to meet with a HUD-approved counselor, either by phone or in-person, to talk about the financial consequences of taking out an HCEM, analyze your situation and consider alternatives to a reverse mortgage.
“If your income is below 200 percent of the poverty line, the HUD counselor is required to see whether you qualify for any type of government help,” says Bell. “If your income is above this level, ask the counselor to check on your behalf because they won’t do it automatically. You might be eligible for benefits you don’t know about. For example, a veteran discovers they are eligible for a housing grant through the VA.”
If you are married, you and your spouse should both be listed as co-borrowers on the reverse mortgage so that if one spouse dies or has to move out for medical reasons, the other can continue living in the property and receiving money from the reverse mortgage.
However, this may not be possible if one spouse is younger than 62, the minimum age limit to take out an HECM reverse mortgage. In this case, only the spouse who is 62 or older can be listed as a borrower.
On Aug. 4, 2014, the government launched new protections for nonborrowing spouses. They can continue living in the home after the borrowing spouses dies provided that:
- They were married before the reverse mortgage was taken out.
- They were named a nonborrowing spouse in the reverse mortgage documents.
- They occupy the house as their primary residence.
- The borrowing spouse must certify at the loan closing and each year after that they are married to the non-borrowing spouse.
If the nonborrowing spouse is 62 or older after the borrowing spouse dies, they could also refinance with their own reverse mortgage loan to continue living in the property.
How Much You Can Borrow With a Reverse Mortgage
When you take out a reverse mortgage, the lender will let you borrow a percentage of your home equity. A reverse mortgage typically lets you borrow up to 60 percent of your home equity, but the actual amount you take out depends on a few factors, including:
Age – The older you are, the more you can potentially borrow. Since you can stay in your home for the rest of your life without paying back the reverse mortgage, the lender uses your life expectancy to estimate how long it will be until it’s repaid. As you get older, the lender lets you borrow a greater percentage because it predicts it will be paid back quicker.
Appraised value of your home – The more valuable your home is, the more you are able to borrow.
Current interest rates – A reverse mortgage is still a loan. The lender is charging interest on the amount of money you take out. The higher market interest rates are, the less money you will receive because a higher percentage will be going toward interest.
Type of reverse mortgage selected – Proprietary reverse mortgages could let you borrow a greater percentage than HECM reverse mortgages.
Your financial situation – Your credit score and income do not determine how much you can borrow. However, lenders will do a financial analysis to make sure you can still cover property taxes, homeowners insurance and other housing costs after taking the loan.
If the lender determines you do not have enough income to cover your future housing costs, it may require that part of the reverse mortgage proceeds go toward a Life Expectancy Set Aside (LESA). The lender will set aside part of your loan to cover future housing costs. You will receive a smaller payout because part of your money is going into the LESA.
Nicholas Maningas, a reverse mortgage loan originator from Gateway Mortgage Group LLC, says that lenders look at your credit report to see your historic willingness to pay debts. “If someone has income but hasn’t been making their debt and tax payments, they may be required to use a LESA,” Maningas says. “However, exceptions can be made for extenuating circumstances. Like someone can show they ran into financial difficulties because of a medical illness or because a spouse recently passed away.”
When you qualify for a reverse mortgage, you can choose to receive your money in the following ways:
- Single disbursement – This is a lump-sum payout. You get the entire value of your reverse mortgage all at once.
- Tenure – These are monthly payments that will keep coming in as long as you’re alive and still living in the home as your primary residence.
- Term – These are monthly payments over a fixed amount of time that you agree to, such as 10 years. This could be useful if you only want income for a certain period of time. For example, if you want to delay Social Security until you turn 70 and it maxes out.
- Line of credit – This is a line of credit that you can access when needed. Over time, the amount of your line of credit increases. “Your line of credit increases every year by roughly your interest rate when you don’t borrow off it,” says Bell. “If your original line of credit is $100,000 and your loan interest rate is 4 percent, in a year, the line of credit will be about $104,000.”
- Combination – This is a combination of a line of credit along with either tenure or term payments.
- For purchase – You receive a lump-sum payout specifically to buy a new property while selling your existing home.
Costs of a Reverse Mortgage
When you take out a reverse mortgage, lenders charge upfront fees to set up your loan, as well as ongoing expenses. Fees will vary depending on the type of reverse mortgage you obtain, but you can expect these fees with an HECM:
Appraisal fee – The lender will hire an appraiser to estimate the value of your home, as this determines how much money you can borrow. The appraiser will also inspect your home for any property damage. If there are significant problems, you will need to repair them before you can take out a reverse mortgage.
The average cost of an appraisal is $287 to $373, according to HomeAdvisor.com, though it can depend on your region and type of property. You typically pay the appraisal fee out of pocket, but other fees can usually be paid with the loan proceeds.
Closing costs – The lender will charge many of the same closing costs for a reverse mortgage as it does to set up a first-lien mortgage. Some of the closing costs include:
- Credit report fee: $20 to $50
- Title search, escrow and loan settlement fees: $150 to $800, depending on the location
- Document preparation fee: $75 to $150
- Recording fee: $50 to $500
- Title insurance: Average cost is roughly $830 for a $200,000 home in California, according to personal finance advice site ValuePenguin, though it depends on the value of the property and the state where the property is located. The more expensive the property, the more expensive the title insurance.
- Pest inspection: $100
Loan origination fees – The lender will charge an origination fee to process your loan. This fee is a percentage of the value of your home. The government limits how much lenders can charge for origination fees on HECM reverse mortgages.
For the first $200,000 of property value, the lender can charge 2 percent or $2,500, whichever is greater. If your home is worth more than $200,000, it can charge another 1 percent of the amount over $200,000. For example, if your home was appraised for $300,000, the lender can charge a maximum origination fee of $5,000 ($200,000 x 2 percent + $100,000 x 1 percent).
The maximum limit for loan origination fee on HECM reverse mortgages is $6,000. Fees can be higher for proprietary reverse mortgages.
Initial Mortgage Insurance Premium (MIP) – The FHA charges an upfront fee to pay for its guarantee of HECM reverse mortgages, known as mortgage insurance. This initial fee for the Mortgage Insurance Premium is 2 percent of the maximum claim amount, according to the Department of Housing and Urban Development, which is typically the appraised value of your home when you take out the loan.
Points – Mortgage points are an optional upfront fee that you can pay to get a discount on your loan interest rate. In exchange for paying points, the lender will charge a lower interest rate on your reverse mortgage.
Loan interest – Reverse mortgages are loans, so you will owe interest for borrowing money. You do not need to pay the interest while you are living in your home. Reverse mortgages can charge fixed or adjustable interest rates. A fixed rate stays the same over the entire reverse mortgage. An adjustable rate can change over time based on a market index. Your reverse mortgage will list how often the rate can change.
If you use a reverse mortgage to take out a line of credit, you only owe interest when you borrow money through the line of credit. The lender won’t charge interest on the unused portion of your line of credit.
Valdes recommends that you research all the possibilities for loans. “Adjustable-rate mortgages often scare people but the ARM features in an HECM can create more options and let the borrower use their equity more wisely,” she says. “A well-informed borrower makes better decisions.”
Mortgage insurance – You will continue paying mortgage insurance to the FHA for guaranteeing your loan, an annual MIP of 0.5 percent of the outstanding mortgage balance. This is added to your outstanding loan balance and you don’t have to pay for the mortgage insurance while you’re still living in your home.
Servicing fee – The lender can charge a monthly servicing fee for managing your loan. The maximum monthly servicing fee is $30 for fixed or annually adjusting interest rate loans, or $35 for adjustable-rate loans.
“The main cost difference between lenders will be the origination fee,” says Maningas. When you compare, he cautions against automatically picking the lowest-cost lender. “Cost is one thing but you have to consider the expertise and professionalism of the person you’re dealing with. Will the lender meet you face-to-face? Will they personally advise you and customize the loan to your situation? For such an important decision, it can be worth the investment to get the higher level of service.”
Bell says, “Often the difference between lenders is where they put the costs. Lenders that charge a lower interest rate are usually charging more upfront, while low-cost lenders may charge a higher interest rate. The right choice depends on when you want to pay: upfront or over the course of the loan.”
Consider how a lender rates in customer satisfaction. You can check with J.D. Power to see if it has rated a lender. You can also check with the Better Business Bureau to see whether a lender has any complaints or comments from other borrowers.
Bell recommends that you use lenders who are members of the National Reverse Mortgage Lenders Association. “Our lenders have to follow a code of ethics for how they treat their customers. If a customer ever has an issue with a lender on our list, they can reach out to us and we can help resolve the dispute.”
For more information in Birmingham to Huntsville , Alabama call Alabama’s local Reverse Mortgage Guy since 2007 at 205-908-2993.