Reverse mortgages: What you need to know

Keeping up with medical bills, day-to-day living expenses, and other costs while living on a fixed income as a senior can be a challenge. If you need money, a reverse mortgage offers a way to receive payments from the equity you’ve built in your home. But before applying for a reverse mortgage, consider the potential drawbacks.

Let’s discuss how a reverse mortgage works, how to qualify, and the pros and cons.

• What’s a reverse mortgage?
• How does a reverse mortgage work?
• Types of reverse mortgages
• How to qualify for a reverse mortgage
• Pros and cons of a reverse mortgage
• How to get a reverse mortgage
• Can you refinance a reverse mortgage?
• Alternatives to a reverse mortgage

What’s a reverse mortgage?

A reverse mortgage is a mortgage available to older homeowners who have low mortgage balances or own their home outright.

Unlike a traditional mortgage, where the borrower makes monthly mortgage payments to reduce the balance, with a reverse mortgage the homeowner receives equity payments from the lender, often in installments or a lump sum. These reverse payments are typically tax-free and don’t affect Social Security or Medicare benefits. You can also live in the home and keep the title to the house while receiving cash.

During the reverse mortgage term, you’re responsible for paying for other home-related expenses like property taxes, homeowners insurance, and home maintenance. If you don’t make these payments or keep your home in good condition, you may lose your home to foreclosure.

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How does a reverse mortgage work?

When you take out a reverse mortgage, the amount you owe on your mortgage increases due to the interest and fees that accrue each month, and your home equity decreases as the lender sends you payments.

You must repay the loan balance when you move or, when you pass away, your heirs must repay the loan. If your spouse is a co-borrower, they can continue to live in the home. A non-borrowing spouse may be able to stay in the home if they meet certain eligibility requirements, pay property taxes, and maintain the home.

The cost of a reverse mortgage and how much you can borrow depend on factors like your home’s value, your equity, the interest rate you qualify for, and the type of reverse mortgage you get. For example, the maximum you can borrow with a government-backed Home Equity Conversion Mortgage (HECM) is $970,800. If you have a high-value home, a reverse mortgage that’s not government-backed may offer you a higher loan limit so you can draw more equity.

Reverse mortgages come with closing costs, including origination fees, that are common for most real estate transactions. But some other ongoing costs may apply as well, like servicing fees that lenders may charge throughout the loan term. You may also have to pay upfront and annual mortgage insurance premiums for an HECM.

Types of reverse mortgages

Three types of reverse mortgages are available to help borrowers draw equity from their homes. Here’s a breakdown of each loan type:

Home Equity Conversion Mortgage (HECM)

HECMs are backed by the Federal Housing Administration (FHA) and limit qualifying homebuyers to a loan amount of up to $970,800. Keep in mind that HECMs can be more expensive than traditional mortgages, thanks to high upfront costs. To qualify, you must meet certain requirements (more on that below).

You may receive loan funds from an HECM in the following ways:

• Lump-sum payment — You can only choose this option for a fixed-rate loan.
• Term payment — You get equal payments for a preset term.
• Tenure payment — You get fixed payments for as long as you’re in the home.
• A line of credit — You get a line of credit where you draw loan funds as needed, in any amount, up to your credit limit. This is a lower-interest option, since you’ll only owe interest on the credit you use.
• A combination of payment methods — You get a line of credit and regular installment payments.

It’s important to note that there’s a limit to how much you can borrow in the first year, which is known as your initial principal limit. Your lender will calculate how much you can take out, but the maximum is typically 60% of your initial principal limit in the first year.

Single-purpose reverse mortgages

Single-purpose reverse mortgages let you take equity from your home for one reason that’s approved by the lender, such as making home repairs or paying property taxes. You can get a single-purpose reverse mortgage from nonprofit organizations and state and local government agencies. You can generally qualify for this type of reverse mortgage even if you have low or moderate income.

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Proprietary reverse mortgages

Proprietary reverse mortgages are offered by lenders without federal backing. You can use this type of loan to borrow more money against a high-value home than the HECM loan would allow.

How to qualify for a reverse mortgage

During the reverse mortgage application process, mortgage lenders will confirm you have sufficient equity in your home to pull from and that you’re financially stable enough to keep up with property taxes and housing maintenance during the term.

Some factors lenders consider when determining whether you qualify for an HECM (the most common type of reverse mortgage) include:

• Age — You need to be 62 or older.
• Residency — The home you’re taking out a reverse mortgage for must be a primary residence where you live for most of the year.
• Mortgage balance — Home equity and loan balance requirements can vary, but in general, you must have a low (or no) mortgage balance to qualify. You must be able to pay off your mortgage loan when you close on the reverse mortgage, either with your own money or funds from the reverse mortgage.
• Home condition — Your home must be in a condition that meets housing standards. If not, your lender will tell you what repairs you must make.
• Financial health — Lenders will check that you have the financial means to keep up with property taxes, homeowners insurance, and maintenance costs. You also can’t have delinquent federal debt.
• Counseling — You’ll have to get counseling from a Department of Housing and Urban Development-approved reverse mortgage counseling agency to make sure you understand how the reverse mortgage works. The counselor will also explain the various costs of the loan so you can make an informed decision on whether it makes sense for your financial situation. Proprietary reverse mortgages may or may not require mortgage counseling.

The property must also be one of the following:

• A single-family home (or a two- to four-unit home with one unit that’s owner-occupied)
• A HUD-approved condominium project or an individual condominium unit that meets FHA requirements
• A manufactured home that meets FHA requirements

Pros and cons of a reverse mortgage

Like most financial products, reverse mortgages have some advantages and some drawbacks to consider:

Pros of a reverse mortgage

• You can cash out equity sooner than later. If you’ve paid down your mortgage or paid it off entirely, a reverse mortgage lets you take advantage of the equity now, when you need it.
• Reverse mortgage payments aren’t taxable. You don’t have to pay taxes on the equity you draw from your home, and the mortgage typically won’t affect Social Security benefits. But it’s not free money, either — this loan will eventually need to be paid back when you move out of the home or pass away. Your spouse or heirs can repay the mortgage in this case.
• The home belongs to you. You keep the title and are still the homeowner while receiving payments.
• You can receive payments in many ways. You can get one lump-sum payment, spread out payments in installments, or receive a credit line to draw from when you need cash. This could give you the flexibility to pay off large medical bills at once or receive a steady flow of cash to supplement your income.

Cons of a reverse mortgage

• Your mortgage balance will increase. As you receive payments and interest is charged on the loan, your mortgage balance will rise. This means you’ll have less ownership stake in the home over time.
• Reverse mortgages can be expensive. Reverse mortgages can have variable interest rates, upfront costs, and ongoing fees that can make them more expensive than other mortgages. If you only need to borrow a small sum, a reverse mortgage may not be cost effective.
• Not fulfilling the agreement can have repercussions. If the home falls into disrepair, or you don’t keep up with property taxes and homeowners insurance payments, the lender may decide you need to repay the loan early and this could put you in a financial bind.
• Taking from equity could disrupt your estate plan. If your spouse or family members have to pay off your mortgage with funds from the home sale or assets from your estate when you pass away, it could reduce the value of assets you have to pass on to your heirs for an inheritance.

How to get a reverse mortgage

If you believe applying for a reverse mortgage could be the right option for you, take these steps:

1. Assess your financial situation. First, figure out what you want to use the cash for. This can help you decide on the right type of loan and the best way to receive reverse mortgage payments. Also make sure you have enough income to cover the costs you’ll need to pay for with this type of mortgage.
2. Shop around. Explore loans and get rate quotes from a few lenders that offer reverse mortgages. Closing costs and interest rates can vary from one lender to the next, so be sure to review and compare the terms of each loan offer.
3. Apply for the loan. Once you find a loan that best suits your needs, move forward with the application process. Don’t be afraid to ask questions about terms and how the loan works. The best mortgage lenders are transparent when discussing the terms of the loan. If you change your mind after applying, you may be able to cancel within three days of closing on the loan without penalty. This cancellation request has to be submitted in writing and sent through certified mail.

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Can you refinance a reverse mortgage?

Yes, you can refinance a reverse mortgage just like any other mortgage. But you’ll need to meet eligibility criteria during the refinancing process, such as passing a credit check and proving you have enough income to make monthly payments if you’re moving from a reverse mortgage to a traditional one.

Refinancing a reverse mortgage could be a good idea if you want to lower your interest rate or turn a variable rate into a fixed one. Shopping around and comparing rate offers can help you find the best lender and deal for your situation.

Alternatives to a reverse mortgage

A reverse mortgage is just one of several ways that you may be able to tap your home equity. If you’re not old enough to qualify or decide that a reverse mortgage isn’t for you, consider these options:

Home equity loan

A home equity loan, or second mortgage, is a way to borrow from home equity in an installment loan. Lenders may offer up to 80% of your home equity in a loan, but how much you can get approved for depends on factors like your credit and home value. Since home equity loans are backed by your house, you risk losing your home if you can’t keep up with payments. Lenders usually charge closing costs to process a home equity loan, which is something to consider when comparing options.

Home equity line of credit (HELOC)

A HELOC is a revolving credit line secured by your home. A difference between HELOCs vs. home equity loans is that HELOCs typically have variable interest rates. HELOCs give you the flexibility to use and pay interest only on the cash you use, which could be beneficial if you’re doing a home repair and aren’t sure how much you need to borrow. Similar to home equity loans, if you can’t repay what you borrow from a HELOC, your home could go into foreclosure.

Cash-out refinance

A cash-out refinance is when you take out a new loan for a higher amount than your old loan, and you pocket the difference in cash. For example, if your current mortgage balance is $100,000, you could refinance to $150,000 and cash out $50,000. Like a home equity loan, you can typically only borrow up to 80% of your home’s value with a cash-out refinance.

Keep in mind that loan closing costs may reduce the amount of cash you actually get in hand. Plus, you may have a higher interest rate on your new loan, since you’re borrowing a larger amount of money — and increasing the risk to the lender.