What Is a Reverse Mortgage?
Like a standard home loan, a reverse mortgage is a loan that allows eligible homeowners to borrow. Reverse mortgages are reserved for homeowners who are 62 or older and have considerable home equity.
Unlike a mortgage used to purchase a home, a reverse mortgage doesn’t require the homeowner to make any loan payments during their lifetime.
Instead, the loan balance – up to a limit – is due and payable when the borrower passes away, moves out permanently, or sells the house. Federal regulations require Mortgage lenders to structure the transaction so that the loan amount does not exceed the home’s value.
If it does, through a drop in the home’s market value or if the borrower lives longer than expected, the borrower or borrower’s estate won’t be held responsible for paying the Mortgage lender the difference thanks to the program’s mortgage insurance.
Who Is a Reverse Mortgage Right For?
A reverse mortgage might sound a lot like a home equity loan or a home equity line of credit (HELOC). Like one of these loans, a reverse mortgage can provide a lump sum or a line of credit that you can access as needed, based on how much of your home you’ve paid off and your home’s market value.
Reverse mortgages differ from HELOCs because having a high credit score and an income aren’t required. This is due to mortgage payments being optional depending on which reverse mortgage option you go with.
A reverse mortgage is the only way to access home equity without selling the home for seniors who:
- Don’t want the responsibility of making a monthly loan payment
- Can’t afford a monthly loan payment
- Can’t qualify for a home equity loan or cash-out refinance because of limited cash flow or poor credit
Cash in Equity
Reverse mortgages can provide much-needed cash for seniors whose net worth is tied up in their home equity (their home’s market value minus the amount of any outstanding home loans).
Home equity is only usable wealth if you sell, downsize, or borrow against that equity. That’s where reverse mortgages come into play, especially for retirees with limited incomes and few other assets. They are also for retirees who want to diversify their income and reduce investment risk, sequence risk, and longevity risk.
Reverse mortgages provide a source of cash without requiring monthly debt payments.
How a Reverse Mortgage Works
Instead of the homeowner making payments to the Mortgage lender, with a reverse mortgage, the mortgage lender makes payments to the homeowner.
The homeowner gets to choose how to receive these payments and only pays interest on the proceeds received. The interest is rolled into the loan balance so that the homeowner doesn’t pay anything upfront. The homeowner also keeps the title to the home. Over the life of the loan, the homeowner’s debt increases and home equity decreases.
The home is the collateral for a reverse mortgage. When the homeowner moves or passes away, the proceeds from the home’s sale go to the Mortgage lender to repay the reverse mortgage’s principal, interest, mortgage insurance, and fees.
Any sale proceeds beyond what was borrowed go to the homeowner (if still living) or the homeowner’s estate (if the homeowner has died). In some cases, the heirs may choose to pay off the mortgage so that they can keep the home.
Reverse mortgage proceeds are not taxable. While they might feel like income to the homeowner, the Internal Revenue Service (IRS) considers the money to be a loan advance.
Receiving Reverse Mortgage Proceeds
When a reverse mortgage is taken out, the borrower can choose to receive the proceeds in one of six ways:
- Lump sum: Get all the proceeds at once up front. This is the only option that comes with a fixed interest rate. The other five have adjustable interest rates.
- Equal monthly payments (annuity): For as long as at least one borrower lives in the home as a principal residence, the Mortgage lender will make steady payments to the borrower. This is also known as a tenure plan.
- Term payments: The Mortgage lender gives the borrower equal monthly payments for a set period of the borrower’s choosing.
- Line of credit: Money is available for the homeowner to borrow as needed. The homeowner only pays interest on the amounts borrowed from the credit line.
- Equal monthly payments plus a line of credit: The Mortgage lender provides steady monthly payments for as long as at least one borrower occupies the home as a principal residence. If the borrower needs more money at any point, they can access the line of credit.
- Term payments plus a line of credit: The Mortgage lender gives the borrower equal monthly payments for a set period of the borrower’s choosing. If the borrower needs more money during or after that term, they can access the line of credit.
In any case, borrowers will typically need at least 50% equity—based on their home’s current value, not what they paid for it – to qualify for a reverse mortgage.
What Is Required for a Reverse Mortgage?
- Property Type: If you own a house, condominium, townhouse, or manufactured home built on or after June 15, 1976, then you may be eligible for a reverse mortgage.
- Age, Equity, and Fees: While reverse mortgages don’t have income or credit score requirements, borrowers must be at least 62 years old and either own their home free and clear or have a substantial amount of equity (at least 50%). Borrowers must pay an origination fee, an up-front mortgage insurance premium, other standard closing costs, ongoing mortgage insurance premiums (MIPs), loan servicing fees (sometimes), and interest. The federal government limits how much Mortgage lenders can charge for many of these items.
- Counseling: The U.S. Department of Housing and Urban Development (HUD) requires all prospective reverse mortgage borrowers to complete a HUD-approved counseling session. This counseling session, which usually costs around $125, should take at least 90 minutes and cover the pros and cons of taking out a reverse mortgage given your unique financial and personal circumstances.
- Collateral Protection: Your responsibilities under the reverse mortgage rules are to stay current on property taxes and homeowners’ insurance (and homeowners association fees if you have them) and keep the home in good repair.
And if you stop living in the house for longer than one year—even if it’s because you’re living in a long-term care facility for medical reasons—then you’ll have to repay the loan, which is usually accomplished by selling the house.
Reverse Mortgage Interest Rates
Only the lump sum (single disbursement) reverse mortgage, which gives you all of the proceeds at once up front, has a fixed interest rate. The other five options have adjustable interest rates, which makes sense since you’re borrowing money over many years, not all at once, and interest rates are always changing.
How Much Can You Borrow with a Reverse Mortgage?
The proceeds that you’ll receive from a reverse mortgage will depend on the Mortgage lender and your payment plan. For a reverse mortgage, the amount that you can borrow will be based on the youngest borrower’s age, the loan’s interest rate, and the lesser of your home’s appraised value or the FHA’s maximum claim amount.
You can’t borrow 100% of what your home is worth. Part of your home equity must be used to pay the loan’s expenses, including mortgage premiums and interest. Here are a few other things that you need to know about how much you can borrow:
- The loan proceeds are based on the age of the youngest borrower or, if the borrower is married, the younger spouse, even if the younger spouse is not a borrower. The older the youngest borrower is, the higher the loan proceeds.
- The lower the mortgage rate, the more you can borrow.
- The higher your property’s appraised value, the more you can borrow.
- A strong reverse mortgage financial assessment increases the proceeds that you’ll receive because the Mortgage lender won’t withhold part of them to pay property taxes and homeowners insurance on your behalf, as they would with an escrow account on a traditional mortgage.
When Do You Have to Repay a Reverse Mortgage?
The Mortgage lender will require the borrower to repay the reverse mortgage if the borrower does any of these things:
- sells the home
- resides outside the home for more than a year
- passes away
- fails to maintain the property
- stops paying homeowners insurance premiums and/or property taxes
There are some exceptions to these rules for eligible non-borrowing spouses who want to keep living in the home after their borrowing spouse passes away.
Can You Owe More Than the Home Is Worth with a Reverse Mortgage?
Your loan balance could grow higher than your home’s value, but Mortgage lenders can’t go after borrowers or their heirs if the home turns out to be underwater when the loan is due. The mortgage insurance premiums that borrowers pay go into a fund that covers Mortgage lenders’ losses when this happens.
Can You Refinance a Reverse Mortgage?
Yes, you can refinance a reverse mortgage. Because of the origination fee, upfront mortgage insurance premium, and other closing costs, refinancing a reverse mortgage should be reserved for situations where a spouse needs to be added to the loan, more equity is needed, or the interest rate can be lowered substantially.
The Bottom Line
A reverse mortgage can be a helpful financial tool for senior homeowners who understand how the loan works and what tradeoffs are involved. Ideally, anyone interested in taking out a reverse mortgage will take the time to thoroughly learn about how these loans work and find a trusted USA Mortgage local lender to start the process with.