A reverse mortgage lets you borrow from your home’s value, while you continue to live in the home. If you’re struggling for cash but have high equity, this might sound like a great solution to your trouble. But is it really?
Reverse mortgages can be a helpful financial strategy or turn into a disaster. The key is knowing your responsibilities as a borrower and determining whether you’re a good candidate for this kind of loan.
What Is a Reverse Mortgage?
A reverse mortgage is a loan for borrowers 62 years old or older. The lender gives you an advance on a portion of your home equity. You don’t make monthly payments, but interest and fees add onto the loan balance each month. Whenever you stop living in the home, whether that’s because you sell it or pass away, the loan balance is due.
There are three types of reverse mortgage available. They have their own requirements and pros and cons, so look into options carefully.
Home equity conversion mortgage
A home equity conversion mortgage (HECM) is federally insured through the U.S. Department of Housing and Urban Development (HUD). The amount you can borrow depends on your age (and possibly your spouse’s), current interest rate, and the appraised value, FHA mortgage limit, or sales price of the home.
Most reverse mortgages are HECMs. You can use the loan for anything, but the loan may be more expensive than a traditional home loan. To get started, you’ll need to complete a session with a HUD-approved financial counselor, which usually costs around $125.
Proprietary reverse mortgage
A proprietary reverse mortgage is backed by a private company. If your home is worth more than $765,600 and you have a high amount of equity, you may qualify for more money (e.g., a higher advance) out of a proprietary reverse mortgage than an HECM.
Single-purpose reverse mortgage
Single-purpose reverse mortgages are available through some non-profit organizations, as well as some state and local government agencies. Their main benefit is that they are less expensive, making them an option for more low-income borrowers. The main drawback is that you can’t use the funds for whatever you want, unlike HECMs and proprietary reverse mortgages. The lender specifies what you can use the funds for (e.g., home repairs and improvements).
Pros and Cons of a Reverse Mortgage
There are times when having cash in hand is more urgent than building higher equity in your home. Anytime you consider home financing, you should talk through pros and cons with a qualified financial advisor so you don’t end up in more serious financial difficulty later.
Reverse mortgage pros
Here are the benefits of applying for a reverse mortgage:
- Get cash without selling your home: You’re taking a loan against the equity, but the title remains in your name and you can stay in the home.
- No taxes: Reverse mortgage funds are loan proceeds, not taxable income, so the full amount is yours to keep.
- Freedom over spending: In most cases, you can spend reverse mortgage funds on whatever you choose.
- Payment cap: You never need to pay more than market value of the home, even if interest grows until your debt exceeds your home’s value.
Reverse mortgage cons
Consider these important downsides before proceeding with a reverse mortgage:
- You could lose your home: Even if you don’t have monthly payments, you may incur monthly fees. Fail to pay, and you could face foreclosure.
- Your family could end up homeless: If you die, the loan is due. If family members living in the house can’t pay, they could be left without a place to live.
- Interest and fees: Reverse mortgages increase your debt over time with interest and fees.
- Beware scams: Unscrupulous dealers run scams targeting seniors. Only consider reverse mortgage agreements insured by the Federal Housing Authority.
- Medical trouble could equal financial trouble: If you have to move out for medical reasons, you need to pay the loan balance in full.
A reverse mortgage can be a way to come up with much-needed cash, or it can turn into a nightmare. You should think seriously about your health, your heir’s ability to pay the debt if you pass away, and how to keep up with monthly bills for interest and fees. Without strong financial planning in place, a reverse mortgage could cause far more problems than it solves.
Is a Reverse Mortgage Ever a Good Idea?
It would hardly make sense for the federal government to offer any reverse mortgage program if a reverse mortgage was always a bad idea. A reverse mortgage benefits some families, including some retirees. Here are signs you’re a good candidate for a reverse mortgage:
- You have high equity: The more you have, the more likely it is you’d be eligible for the funding you need.
- You’re staying in place: Moving makes the loan due, so only apply if you’re staying put for the long term.
- Heirs don’t want the house: The loan balance is due after you die. The easiest way to pay is often to sell the house. If your loved ones plan to do that anyway, you may be in a better position than a family still living in the house (or with a strong emotional attachment to it).
- You’re comfortable managing your own money: A reverse mortgage can provide a helpful supplemental source of cash or cover unexpected expenses. You need a solid plan to use loan funds wisely, and stay current on expenses like home insurance and property taxes.
A reverse mortgage gradually eats up your home equity, while providing you with a source of cash now. For some people, this can be part of a sensible financial plan. Jumping into a reverse mortgage to escape major financial trouble might backfire if you don’t have a clear sense of how you’ll use the proceeds and repay the loan.
How Does a Reverse Mortgage Work?
If you think a reverse mortgage could help you with your finances, here’s what you need to know to get started.
Reverse mortgage qualification requirements
In order to get a reverse mortgage, you need to meet these requirements:
- Be 62 years old or older
- The home must be your primary residence
- Own home outright or have a “considerable amount” of equity (over 50% is a good rule of thumb)
- Have no federal debt
- Be able to keep up with HOA fees, property taxes, and other home-related costs
Reverse mortgage interest rates
As with a traditional mortgage, you’ll need to pay closing costs and service fees. You don’t need to make monthly payments on a reverse mortgage, but there may be servicing fees throughout the duration of the loan. You may also pay off interest on a regular basis to keep it from accumulating too high.
Interest rates for HECM traditional loans (the most common type of reverse mortgage) typically fall between 4-5%.
How borrowers get the money
Borrowers usually have several options to choose from for how to access reverse mortgage funds:
- Lump sum
- Fixed monthly payments
- Line of credit
- Combination method (e.g., fixed monthly payments with an additional line of credit)
Talk to your prospective lender about what options are available for you. A financial advisor can also help you determine which method will be easiest for you to use wisely.
The maximum reverse mortgage value you can borrow is determined by a principal limit factor (PLF). The lender will calculate your PLF depending on age, credit, home value, and other factors. Expect that the maximum equity you could borrow through a reverse mortgage is around 80%, and most people will be approved for a lower amount.
How to pay back a reverse mortgage
A few circumstances can trigger your reverse mortgage loan to become due:
- Death of the borrower
- Sale of the house
- Borrower moves out of the house (home is no longer principal residence)
- Borrower falls behind on property taxes or other qualifying home expenses
Heirs are responsible for reverse mortgage debt to a certain extent. They have to get an appraisal within a set timeline. They are responsible for satisfying the loan balance with funds from your estate, or by selling the house (the lender may specify that the home has to sell for at least 95% of the appraisal value).
If the heirs don’t follow these steps, the lender can typically start the foreclosure process after about 6 months.
Heirs are not responsible for paying reverse mortgage debt that exceeds the appraised value of the home. Reverse mortgages are a kind of non-recourse loan, meaning the FHA has to cover the extra cost if the loan exceeds the home’s value. So a reverse mortgage won’t sink your family into debt, although they may lose the house.
Reverse Mortgage Example
The best place to start looking for reverse mortgage options is through HUD. You can find more detailed information about requirements, loan amounts, and how to start an application. You can also explore these options:
- AAG: American Advisors Group is one of the most prominent reverse mortgage providers in the country.
- AARP: The American Association of Retired Persons offers guidance on home financing and other financial subjects for seniors.
- AIG: American International Group is a global insurance company that also offers home financing services.
Home financing is a significant decision. It’s always smart to start by talking with a professional to compare the benefits and risks of different financing paths.