Introduction to Reverse Mortgage Understanding the Basics

Reverse mortgages have gained popularity over the years as a financial tool that allows homeowners to tap into their home’s equity without selling it and to secure their retirement.

This concept can be quite appealing, especially for seniors who may be looking to supplement their retirement income, pay off existing debts, or cover healthcare costs.

However, there are still many misconceptions and questions surrounding reverse mortgages. How do they work, and are they a good idea for you?

The fundamental concept of a reverse mortgage

The first thing to understand is that a reverse mortgage is designed for homeowners aged 62 and above.

Unlike a traditional mortgage, where you make monthly payments to the lender, a reverse mortgage allows you to eliminate your mortgage payment and live in the home for the rest of your life. In some instances, you can even receive payments from the lender, receive a lump sum payment, or get a line of credit for future expenses.

The loan is repaid when the homeowner either sells, moves out, or passes away. The home can be sold to pay off the loan, or the heirs can refinance or pay off the home in cash. If there’s inadequate equity to sell or refinance, the heirs can simply sign the home over to the lender and they are not responsible for any shortfall.

How does a reverse mortgage work?

A reverse mortgage pays off your existing “forward” mortgage and eliminates the payment forever.

It can also turn your home equity into much-needed cash for home improvements, medical expenses, and any other purpose.

The amount you may borrow with a reverse mortgage depends on several factors—your age, the value of your home, and the interest rate on the loan.

Generally, the older you are, the more equity you have in your home, and the lower the interest rate, the more you’ll be able to borrow.

However, limits are set to how much you can borrow with a reverse mortgage, and you may not be able to access all the equity in your home.

There are three main kinds of reverse mortgages: federally-insured Home Equity Conversion Mortgages (HECMs), single-purpose, and proprietary reverse mortgages.

Federally-insured HECMs

Federally-insured HECMs are backed by the U.S. Department of Housing and Urban Development (HUD) and are the most common type of reverse mortgage.

These represent most reverse mortgages in the market today. They are so popular because they come with sturdy borrower protections. For instance, you’ll never be made to leave your home during your lifetime. Additionally, heirs are not responsible for any shortfall if the reverse mortgage balance exceeds the home value.

These are technically FHA loans, which come with a strong government guarantee that protects older homeowners.

Single-purpose reverse mortgages

Single-purpose reverse mortgages are generally offered by state and local government agencies and nonprofit organizations. They can only be used for a specific purpose, like home repairs or property taxes.

Proprietary reverse mortgages

These mortgages are private loans offered by financial institutions, which may have different eligibility requirements and loan terms than HECMs. They do not come with the same borrower protections as federally-insured reverse mortgages.

What happens with the reverse mortgage when the homeowner dies?

This is perhaps the most commonly asked question about reverse mortgages.

When the homeowner passes away, a reverse mortgage is just like any other loan on the home. Heirs can pay off the loan with cash or a refinance and keep the home. They can also sell the home and retain leftover equity.

But the reverse mortgage value appears when the reverse mortgage balance is larger than the home’s value at time of the homeowner’s death.

With an uninsured loan, the heirs may be liable to pay the shortfall. For instance, if a $400,000 home has a $450,000 loan, the heirs may need to sell the home and pay the $50,000 shortfall plus selling fees.

Not so with reverse mortgages. The federal government covers the shortfall so that the heirs are not responsible. They simply give the home back to the lender.

While the heirs don’t get any sale proceeds in this scenario, they are also not liable for a large closing bill after the sale.

In short, reverse mortgages protect the homeowner and their heirs.

Eligibility criteria for a reverse mortgage

Qualifying for a reverse mortgage means you must meet specific eligibility criteria. These requirements vary depending on the type of reverse mortgage you are applying for, but some general guidelines apply to all reverse mortgages.

• The homeowner must be at least 62 years old
• The home has to be the borrower’s primary residence
• Available on single-family residences and some condos
• The homeowner must live in the home over six months per year
• The homeowner must have sufficient equity in the home, typically over 50%
• The homeowner must have the financial ability to continue paying property taxes, homeowner’s insurance, and maintenance costs
• The homeowner must participate in a HUD-approved reverse mortgage counseling session

Can any home be eligible for a reverse mortgage?

It’s important to understand that not all homes are eligible for a reverse mortgage.

For example, multi-family homes, manufactured homes, and properties with certain deed restrictions may not qualify.

Additionally, the homeowner must be able to demonstrate their ability to continue paying property taxes and other ongoing expenses, which may include a review of their credit history and financial resources.

Pros and cons of reverse mortgages

Like any financial product, reverse mortgages come with both advantages and drawbacks. It’s essential to weigh these factors carefully in determining if a reverse mortgage fits your financial situation.

Pros:

• Allows you to access your home’s equity without selling or making monthly payments
• The loan proceeds are generally not considered taxable income and do not affect Social Security or Medicare benefits
• The loan is non-recourse, meaning the homeowner or their estate is not responsible for any remaining loan balance that exceeds the home’s value when it’s sold
• Reverse mortgage payments can be used for any purpose, such as supplementing retirement income, paying off debts, or covering healthcare costs

Cons:

• The fees and closing costs associated with reverse mortgages can be high
• Your loan balance grows over time as interest and fees are added to the principal
• A reverse mortgage can negatively impact your home’s equity, leaving less for your heirs
• If you fail to meet the ongoing requirements, such as paying property taxes, you could face foreclosure

Alternatives to reverse mortgages

If a reverse mortgage isn’t the right fit for you, there are other options to consider for accessing your home’s equity.

Home equity loans: If you need quick cash without high fees, a home equity loan can give you a lump sum payment at closing for any purpose.

Home equity line of credit (HELOC): A HELOC is a revolving line of credit. You can tap into it as needed for ongoing expenses. It will come with a monthly payment that fluctuates based on market rates.

Selling the home: If you are considering assisted living, it’s wise not to get a reverse mortgage. That’s because you must remain living in the home, or the loan comes due. In this case, it’s best to sell the home ahead of moving, instead of incurring reverse mortgage fees.

Government assistance programs: State or federal assistance programs could help you pay for certain costs in retirement.

Reverse mortgage costs

Perhaps the biggest deterrent for some homeowners is reverse mortgage fees.

According to the Consumer Financial Protection Bureau (CFPB), you’ll pay:

• up to $6,000 for the lender’s origination fee
• Up to a few thousand dollars for an appraisal, title, flood zone search, credit report, and other third-party fees
• An upfront mortgage insurance premium of 2% of the loan amount, plus 0.50% of the outstanding loan amount yearly

These costs can eat up a lot of the home’s equity. It’s important to make sure you need a reverse mortgage and that you’ll live in the home for many years to come.

If your plan is to stay in the home for the long run, reverse mortgage fees can be well worth it. No other program eliminates your mortgage payment and gives you fewer worries in retirement.

Make an informed decision about reverse mortgages

Reverse mortgages aren’t right for everyone, but they are the perfect loan for many seniors today.