How does a reverse mortgage work?
A reverse mortgage is a loan based on your home equity. But unlike a traditional loan, you don’t have to make payments to the lender but can if you so choose to. In some cases, like opting for the term or tenure programs, the lender makes payments to you. Most often, payments come in monthly installments, though some loan programs offer lump sums or even lines of credit.
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Loan repayment
If you decide not to make payments, the loan balance increases, which also means that your home equity decreases. Providing the borrowers adhere to their minimal standard responsibilities throughout the loan term, it is only paid back if you sell your home or when all borrowers pass away. Your inheritors obtain the property, just as they would with any other loan or scenario, and then can repay the mortgage by selling the home or refinancing the balance owed.
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Protection of inheritors
Once again, this is just like any other conventional mortgage lien that may exist on the property at the time of the borrower(s) passing. Even if your loan amount exceeds the sale price of the home, you’ll never have to pay more than the home’s value. Actually, the inheritors always have a 5% buffer in equity obtained, based on the current value when inherited.
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Mitigating risks and industry changes
Industry changes within the last decade have made it very much less likely the balance due will supersede the value of the property and in the cases that it does, this is a non-recourse loan, meaning that only the borrowers are ultimately responsible for the repayment of the loan. Heirs have the option to have the lender handle the sale for repayment. Once again, this scenario has been mitigated substantially with Principal Limit Factor or PLF calculations within the last decade.
Who would benefit from a reverse mortgage?
Is a reverse mortgage right for you? The answer depends on your exact needs and financial situation. First, you must meet the criteria outlined above to even qualify for a reverse mortgage. But assuming you qualify, you’ll find that a reverse mortgage can be a particular advantage if you:
- Pass a financial assessment (a monthly residual income calculation to determine that the borrowers can sustain paying property taxes, homeowners insurance, HOAs (if applicable), and standard living expenses while living in place)
- Have significant home equity (Based on age to determine PLF)
- Planning to live in place as this is only available in your primary residence
- Would like to access tax-free funds from the equity of your home to use as you wish
Ideally, your home should be paid in full to get the maximum benefit from a reverse mortgage credit line or the monthly payment option, but you’ll still reap the rewards if you have substantial equity in your home which may enable you to pay off your current mortgage and no longer have monthly payments. On the flip side, a reverse mortgage may not be the best choice if you have low home equity or if you plan to leave your home in the near future.
3 Types of reverse mortgages
Reverse mortgages work differently depending on the type of loan program you choose. Make sure to examine each type of reverse mortgage to see which option may be right for you.
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Home equity conversion mortgage (HECM)
A home equity conversion mortgage is not only the most common type of reverse mortgage but also the only one insured by the federal government.
Backed by the Federal Housing Administration (FHA), this loan allows you to borrow up to $1,149,825 (as of 2024). You can choose equal monthly installments for a lifetime or for a specified loan term, obtain a credit line that grows monthly at a percentage, or you can receive the funds in a single lump sum.
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Single-purpose reverse mortgage
In a single-purpose reverse mortgage, your lender can stipulate what the funds can be used for. For example, you might use this loan to cover home repairs, property taxes, insurance premiums, or other defined expenses.
These loan programs are not as common as others and are typically offered by nonprofits or local government agencies as a way to help seniors struggling with household expenses.
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Proprietary reverse mortgage
Proprietary reverse mortgages are mortgage programs that are not insured by the federal government. These loan programs are offered by private lenders and may come with higher interest rates.
The advantage of a proprietary reverse mortgage is that you can typically receive a loan amount higher than the standard set by the U.S. government. You’ll likely receive your loan in the form of a single lump sum rather than installments.
What is the benefit of a reverse mortgage?
For some seniors, a reverse mortgage can truly be a valuable financial vehicle. A reverse mortgage will provide benefits that include:
- Supplemental retirement income to augment savings and Social Security benefits
- The ability to stay in your home while using the equity you’ve accrued
- Elimination of your existing mortgage, meaning no more monthly payments
- For some loans, the loan is insured against housing market declines
- For HECM loans, you have total flexibility in how you use the funds
Given today’s rates of inflation, seniors can tap into their home equity through a reverse mortgage to fund their retirement years while living in place.
What is the downside to a reverse mortgage?
Despite these advantages, a reverse mortgage is not for everyone. Reverse mortgages have the following drawbacks:
- A decrease in the equity of your home if you choose not to make payments
- There are closing costs but typically can be financed within the loan
- Possibility of loan balance increasing over time
- Smaller estate for your inheritors
Additionally, all HECM or proprietary reverse mortgage programs have certain requirements some conventional loan programs do not. For example, the Department of Housing and Urban Development requires a counseling session for all borrowers to qualify for a reverse mortgage. This is usually done over the phone with a qualified HUD counseling agency that you may choose.
Things to look out for
Reverse mortgages are a highly regulated industry, and you always want to speak to a licensed loan officer within a highly reputable mortgage company. There are unscrupulous actors who claim to be able to use reverse mortgages to help seniors with pending foreclosures. As stated above, this is a highly regulated industry for borrower protections and there are guidelines that prevent some people from qualifying for the product.
Examples include, currently being within bankruptcy proceedings, previous defaults on other federal debts and being listed on CAIVRS (Credit Alert Verification Reporting System), or not passing the financial assessment for qualification. If someone is claiming to be able to save you from foreclosure, it is always wise to do your extensive due diligence and have someone you trust consult with you.
Reverse mortgage requirements
To qualify for a reverse mortgage, you must meet the following criteria:
- You must be at least 62 years of age *Some proprietary products in certain states have a minimum age of 55 years old
- The home must be your primary residence
- You must not owe federal debt (student loans, income tax)
- The property must meet the required real estate standards
For a home equity conversion mortgage (HECM), the U.S. Department of Housing and Urban Development (HUD) requires that borrowers attend a reverse mortgage counseling session and submit to a financial assessment to ensure that they are financially eligible for a reverse mortgage.
Keep in mind that you’ll still pay your property taxes and homeowners insurance on your home, just as you always would. There is something within the program called a Lifetime Expectancy Set Aside (LESA) which allows an escrow account to be set up for property taxes and homeowners insurance payments to be paid by the lender, but you must have enough equity for this to be established. You may also need to pay for any origination fees or closing costs when you set up your reverse mortgage.
Does your home have to be paid in full to qualify?
No. A reverse mortgage can pay off your existing mortgage, then the balance can be yours. But that’s why you need at least 50% equity in your home, with higher levels of equity achieving the greatest benefits. The PLF is calculated with the home value and the age of the youngest borrower. The older the youngest borrower is, the more money equity that may be accessed within the loan.
Loan alternatives
If you’re not sure if a reverse mortgage is your best choice, you might consider other alternatives that allow you to convert your home equity into cash.
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Home Equity Line of Credit (HELOC)
A home equity line of credit (HELOC) allows you to turn the equity in your home into a line of credit, not unlike a consumer credit card. During the draw period, you can borrow money up to a certain credit limit and then repay the balance to create a revolving line of credit.
The flexibility of this option makes it one of the best reverse mortgage alternatives. To pay back the loan, you’ll simply repay the amount you borrow, plus interest. Just be aware that it’s possible to overspend, which can impact your credit and even jeopardize your home.
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Refinancing
Seniors might also consider one of many home refinancing loan options. Refinancing replaces your existing mortgage with a brand-new one. You might opt for a cash-out refinance, which allows you to borrow more than your home’s value and then use the excess for any purpose you want.
Refinancing is a reliable option with low interest rates and predictable fees. But make sure you’re capable of handling the additional fees and closing costs along with repaying the loan.
Aging in place with the right lender
A reverse mortgage can be an ideal choice for seniors looking to supplement their retirement income while staying in their home. But the trick is to find the right lender who offers favorable rates and terms.
By partnering with a trusted, reliable lender, you can access the funds you need without navigating the complexity of government-backed loan programs or falling victim to possible misrepresentations. Choose the right lender and discover a whole new way to enjoy your golden years.
