How Reverse Mortgages Work (original) (raw)

Generally, a reverse mortgage enables a homeowner age 62 or older to access equity in their home without making mortgage payments. The loan doesn’t have to be paid off until they move out of the home or die.

Proceeds from a reverse mortgage can help supplement your income, cover major medical bills, pay for a home improvement project, or consolidate debts. While there are lenders that offer reverse mortgages, most borrowers take out a federally-backed home equity conversion mortgage (HECM).

Key Takeaways

• Reverse mortgages are geared toward homeowners who are 62 or older.
• A reverse mortgage requires no monthly loan payments.
• Proceeds from a reverse mortgage can be put toward uses such as debt consolidation or medical bills.

How a Reverse Mortgage Works

The most popular type of reverse mortgage is known as a home equity conversion mortgage (HECM). The U.S. Department of Housing and Urban Development (HUD) regulates reverse mortgages and the Federal Housing Administration (FHA) insures them.

Borrowers use money from reverse mortgages for purposes such as:

• Consolidating debts
• Covering everyday expenses
• Paying tuition
• Undertaking a home improvement project
• Covering health care costs
• Paying for long-term care
• Delaying withdrawals from retirement accounts

One major advantage of a reverse mortgage is that the money you gain is normally not taxed and won’t impact your Social Security or Medicare benefits.

When Does a Reverse Mortgage Need to Be Paid Off?

As opposed to a regular mortgage, a borrower doesn’t make monthly payments on a reverse mortgage. Instead, a reverse mortgage must be paid off once the borrower sells the home or dies. A homeowner (or their heirs) usually pays back the loan by selling the home.

Generally, the balance of a HECM also must be paid in full if:

• You fail to pay property taxes, property insurance premiums, or similar home-related expenses.
• You don’t live in the home for at least 12 consecutive months.
• You neglect home repairs.

Who Is a Reverse Mortgage Right For?

A reverse mortgage may be right for a homeowner who wants to convert their home equity into cash to supplement their income, get rid of monthly mortgage payments, or pay major expenses such as medical bills. Of course, other situations might make a reverse mortgage appealing.

How Much Money Can You Get From a Reverse Mortgage?

How much money you can get from a reverse mortgage depends on several factors. These include current interest rates and the age of the youngest borrower or eligible non-borrowing spouse. If there’s more than one borrower and no eligible non-borrowing spouse, the age of the youngest borrower is used to calculate the loan amount.

Older borrowers typically are able to access more money than younger borrowers can.

The amount available to borrow is also dictated by the lowest dollar amount among these three:

• Appraised value of home
• FHA’s HECM mortgage limit, which is $1,149,825 for 2024
• Home sale price (if HECM is being used for a home purchase)

Other factors that affect how much you can borrow through a reverse mortgage are:

• Loan-to-value (LTV) ratio: The LTV ratio compares the amount of your mortgage with the appraised value of your home, giving you an estimate of how much home equity you have. As a rule of thumb, you must have equity of at least 50% to qualify for a reverse mortgage. At most, you can access 66% of your home equity through a reverse mortgage.
• Lending charges: Additional expenses may include loan origination fees and mortgage insurance premiums, for example. Keep in mind that a reverse mortgage might come with higher lending fees and closing costs than a traditional mortgage.

All of these factors might affect the payout from your reverse mortgage. For example, a higher appraised value for your home might give you access to more cash.

Note

No minimum credit score is required for a HECM. However, the application process will include a review of your credit history.

Who Is Eligible for a Reverse Mortgage?

A key factor in determining your eligibility for a reverse mortgage is your age. You must be at least 62 to take out a reverse mortgage.

Other eligibility requirements include:

• The home must be your primary residence.
• Your property must be a single-family, single-unit home or a two- to four-unit, owner-occupied dwelling. Some condos, manufactured homes, and planned unit developments are also eligible.
• Your home must be in good condition, or required repairs must be made before the loan can be taken out.
• Your home must be owned outright, or a considerable amount of the existing mortgage must be paid off.
• You cannot be delinquent on payment of federal debts, such as income taxes or student loans.
• You must have sufficient financial resources to cover property taxes, homeowners insurance, HOA dues, and other ongoing homeownership expenses.
• You must complete a mortgage counseling session.

How Is a Reverse Mortgage Paid Out?

Generally, the three options for a reverse mortgage payout are:

• Lump sum:This option enables you to withdraw all of the money you are approved for at once. However, because the amount of available money won’t grow, you may not be able to tap into as much cash as you might with the monthly payment and line-of-credit alternatives. Another drawback: You’ll pay fees and fixed-rate interest when the loan closes.
• Monthly payments: You can opt for monthly fixed-amount payments, which can supplement your regular income. These payments can be combined with a line of credit. With this arrangement, you’ll pay fees and adjustable-rate interest only on the amount of money that you borrow.
• Line of credit: This alternative lets you borrow money over time, rather than all at once. This method can be combined with monthly payouts. As with monthly payments, you’ll be charged fees and adjustable-rate interest only on the money you borrow.

Other Types of Reverse Mortgages

Aside from HECMs, the other types of reverse mortgages are:

• Proprietary reverse mortgages: These are loans from private lenders. Proprietary reverse mortgages are not federally insured and are not covered by FHA lending rules.
• Single-purpose reverse mortgages: These mortgages, which are the least common kind of reverse mortgage, are provided by government agencies and nonprofits in certain states. The mortgages serve a single purpose approved by the lender, such as paying for home repairs or covering property tax bills.

Alternatives to Reverse Mortgages

If you aren’t interested in taking out a reverse mortgage, but you still need access to a sizable sum of cash, your options include:

• Home equity loan
• Home equity line of credit (HELOC)
• Cash-out refinance loan
• Borrowing against a life insurance policy
• Borrowing against a 401(k)
• Selling or renting out your home

Frequently Asked Questions (FAQs)

What Is the Downside of Getting a Reverse Mortgage?

One of the biggest downsides to getting a reverse mortgage is that it reduces the amount of equity you’ve got in your home. You will also have to pay fees and the mortgage may complicate your estate for your heirs.

How Much Money Do You Get From a Reverse Mortgage?

Many factors affect how much money you get from a reverse mortgage. Generally, though, you can borrow 40% to 60% of your home’s appraised value with a HECM.

How Does a Reverse Mortgage Work?

A reverse mortgage lets you borrow against the equity in your home. You receive the loan payout in one lump sum, as monthly income, or as a line of credit. No monthly loan payments are required.

Why Would Someone Use a Reverse Mortgage?

Someone might use a reverse mortgage if they have adequate equity in their home and need money for major expenses like medical bills or college tuition, or if they need supplemental income.

The Bottom Line

A reverse mortgage can be an attractive way for a homeowner who’s at least 62 to access home equity to cover everyday expenses, pay for a home improvement project, or cover medical expenses, among other purposes. But before you agree to a reverse mortgage, you might look into other lending options, such as a home equity loan or home equity line of credit (HELOC). You should also weigh the costs of a reverse mortgage against the benefits. Consider consulting with a professional financial advisor for more guidance on your specific situation.