Ever since the federal government initiated the reverse mortgage program in the late 80s, confusion and controversy have surrounded the financial product. On the one hand, lenders employ high-profile spokespeople to convince seniors that reverse mortgages are a great source of tax-free income in their autumn years. On the other hand, detractors claim they are an irresponsible financial decision at best, or a ploy to rob seniors of their houses at worst.
Considering these divisive points of view, let’s take a look at the facts about reverse mortgages.
What is a reverse mortgage?
A reverse mortgage is a type of home loan provided by banks and other mortgage lenders insured by the Federal Housing Administration, a part of the U.S. Department of Housing and Urban Development. They were specifically designed for older homeowners (62+) who have built up significant equity in their homes or own their homes outright and want to convert that equity into cash.
As the name implies, a reverse mortgage differs from a forward mortgage in that the bank makes payments to you instead of the other way around. There are no credit score or income requirements for a reverse mortgage, and they can be a great way for seniors to access much-needed funds if they find themselves struggling at that time of life.
To qualify for a reverse mortgage you must:
Be 62 years of age or older
Continue living in the home as your primary residence
Maintain the property
Pay homeowners insurance, property taxes and HOA fees when applicable
Complete a counseling session with a HUD-Certified Housing Counselor
The counseling session is meant to educate homeowners, and potentially their adult children, on the ins and outs of reverse mortgages, and explain to them exactly what they are getting into.
After all, a reverse mortgage isn’t free money. It is a home equity loan with unique repayment terms. You are not required to pay back principal or interest until you die, leave the home for more than 12 months, or fail to adhere to the requirements noted above.
When the loan is due, you or your heirs will need to repay it if you want to maintain ownership of the home. Since a reverse mortgage is FHA-insured, there are certain stipulations regarding repayment that can benefit the borrower and lender alike.
Therefore there are situations where a reverse mortgage is good, and situations where it is not so good. We will cover both. But first, we’ll look at the different kinds of reverse mortgages.
Types of reverse mortgages
Home Equity Conversion Mortgages (HECMs)
A Home Equity Conversion Mortgage is the official name of the traditional reverse mortgage loan. Homeowners can take out an HECM on the residence in which they are currently living. Costs can include origination fees, closing costs, mortgage insurance and service fees. These are generally financed into the balance of the loan. Additionally, HECMs are offered with fixed or variable rates.
Fixed-rate reverse mortgages can only be disbursed as a lump sum. Generally speaking, you can borrow up to 40% to 60% of your home’s value. The fixed interest rate is applied to the entire amount, so this option provides the peace of mind of knowing what you owe will not change.
Fixed-rate reverse mortgages can be a good option for individuals seeking a substantial cash infusion for a specific purpose. However, a variable rate HECM may be the way to go for those desiring a more diverse range of disbursement options.
While variable-rate reverse mortgages carry the risk of potential interest rate increases over time, they offer much more flexibility in terms of disbursement options and interest rate charges than fixed-rate loans.
With a variable rate you can opt for a lump sum, monthly or term payments, a line of credit, or a combination of any of these. This flexibility proves especially beneficial for things like ongoing home improvement projects. For example, borrowers can receive an initial lump sum payment to address immediate needs, and keep the rest in reserve in a line of credit for future work. What’s more, a variable rate reverse mortgage in this scenario charges interest solely on the withdrawn amount.
HECM for purchase
An HECM for purchase is essentially an option where you take out a reverse mortgage on a new house to help cover its purchase cost. It is ideal for those homeowners seeking to downsize or find a residence better suited to their current needs.
An HECM for purchase requires a substantial down payment, typically ranging from 60% to 65% of the new home’s total cost. This amount can come from selling your existing home or from cash on hand. The reverse mortgage covers the remaining purchase cost. Any surplus funds can be utilized according to the borrower’s discretion.
Proprietary Reverse Mortgages
As of January 1, 2023, the maximum home value you can borrow against for a reverse mortgage is $1,089,300. If you have a home with a value that exceeds this and wish to get a reverse mortgage, you most likely will have to go with a proprietary reverse mortgage.
A proprietary reverse mortgage, also called a jumbo reverse mortgage, allows homeowners to withdraw up to $4 million in equity. Jumbo reverse mortgages are not backed by the FHA, so the risk is incurred by the lender. This leads to higher interest rates and more stringent qualification criteria. However, the age requirement can go as low as 55 depending on the lender and state.
However, they do offer some of the protections of traditional HECMs. As long as you fulfill your obligations to keep up the property and pay taxes and homeowners insurance, you are not required to make monthly payments on your home. Also like a regular reverse mortgage, your heirs are not held responsible for the outstanding balance, even if the loan amount surpasses the home’s current value.
How do you pay back a reverse mortgage?
A reverse mortgage becomes due when the last living borrower dies, sells the home, or permanently moves out. Heirs are not responsible for paying the balance. However, if they wish to retain the house, they must first pay back the reverse mortgage with their own cash on hand.
If the balance of the reverse mortgage exceeds the home’s worth, the heirs are only required to pay the home’s appraised value. Because the program is FHA-insured, the government will pay the loan’s remaining balance to the lender.
If the house is sold, the proceeds are first used to pay back the reverse mortgage. If there are any remaining funds they are split among the heirs.
When is a reverse mortgage a good idea?
Reverse mortgages are a good idea if you plan on remaining in your house long term and/or do not intend to leave it to your heirs. Also, a reverse mortgage is a good decision if you know you’ll be able to continuously meet the requirements established by the program.
Leaving the home to your heirs is not a priority
If you do not intend to leave your house to your heirs, or you don’t have any heirs in the first place, a reverse mortgage is a viable option if you are 62 or older and in need of cash.
Though your heirs are not liable for the debt, if they decide to sell the house the reverse mortgage must be paid off first. If the balance on the HECM is less than the selling price, they can keep the difference.
You plan on staying in your house long term
A reverse mortgage becomes due when you leave your house, so it doesn’t make sense to get one if you plan on moving soon. Like a regular mortgage, there are considerable fees and closing costs associated with a reverse mortgage. Spreading out the loan over the long term ends up making these fees more manageable.
You can meet the reverse mortgage requirements
As a homeowner, you will need to be able to meet the basic reverse mortgage requirements for the loan to be viable. If you cannot keep up on property taxes and homeowners insurance, it represents a risk to the lender, and they could say you defaulted on the terms and demand repayment of the HECM. Similarly, if you do not keep up on maintenance of your property, it could cause it to lose value. This is another situation where the lender can say you didn’t meet the requirements.
When is a reverse mortgage a bad idea?
A reverse mortgage can be a bad idea if it causes hassle and problems for others in your life. Spouses, family and friends can be negatively affected. It could also be a bad move if you are experiencing health issues.
Your spouse is not 62
If your spouse is not yet 62, they cannot be a co-borrower on the reverse mortgage. Although there are protections in place so that your spouse will not have to leave the home if you die before them, they will no longer be able to collect funds from the HECM. This could be a problem if your spouse counts on this money to survive.
In addition, your surviving spouse must continue to meet the requirements including paying property taxes and homeowners insurance and keeping the home properly maintained.
Others live with you
If you have friends and family living with you, they do not have similar protections to a non-borrowing spouse. In fact, they will have to vacate the dwelling should you die or leave the home for more than 12 months.
You have health issues
A reverse mortgage is most beneficial when the borrower can stay in the home for the long term. Seniors with health issues may be tempted to use a reverse mortgage to cover medical expenses. However, they must remember that the reverse mortgage will become due if they leave the home for more than 12 months.
Age-related medical issues can often become serious enough for the senior to have to move to an assisted living facility or with family. If this is the case for more than a year, the reverse mortgage balance must be paid.
You want to avoid complications for your heirs
It is a good idea to keep adult children fully informed of what the reverse mortgage entails. Although it is a financial decision for the homeowner to make alone, heirs should be aware of what will be required of them should they desire to keep the house once their parents have died or moved out permanently.
If heirs want to keep the home, they will be required to pay off the HECM in full first. This could be a heavy lift, especially if the borrower had a variable rate reverse mortgage and had been drawing funds for a considerable time. However, because the loan is FHA-insured, heirs would not have to pay more than the house’s appraised value.
However, if the heirs cannot afford to pay back the reverse mortgage, they most likely will have to sell the house to pay it. And this could significantly reduce the amount of funds they could receive.
Reverse Mortgage Alternatives
There are other ways to tap into your home’s equity if you are in need of money. They differ from a reverse mortgage in that they are all traditional forward loans you must pay back in installments, or as you use a credit line.
Home equity loan
A home equity loan is essentially a second mortgage. You borrow a lump sum of money against the equity you have built up in your house. All the usual fees and costs associated with a traditional mortgage will apply, and you will have to keep up on the monthly home equity loan payment as well as your first mortgage payment. Generally, borrowers will need at least 20% equity in their homes to apply for this product.
Home equity line of credit (HELOC)
Utilizing your home’s equity as collateral, a HELOC allows you to borrow funds similar to a home equity loan. However, a HELOC differs from a home equity loan in that it isn’t disbursed in a one-time sum of cash. It functions as a credit line which the borrower can access during a specified draw period. Like a credit card, repaying the borrowed amount replenishes the available credit. Also, unlike a home equity loan, homeowners only have to pay interest on the amount they’ve borrowed.
Refinancing your mortgage is when you replace your current mortgage loan with a new one, typically with more favorable terms. A cash-out refinance is a refinance that converts your home equity into cash. In it, a portion of your home equity is released to you as cash and bundled into the new refinanced loan. Unlike a home equity loan or HELOC, a cash-out refinance provides the extra funds but allows you to still retain one monthly payment.
Retire with Money
Retire With Money brings the latest retirement news, insights, and advice to your inbox. Jill Cornfield has covered retirement for more than 10 years.
Summary of Money’s Is a Reverse Mortgage a Good Idea?
A reverse mortgage can be a good idea if leaving your home to your heirs is not a priority and you are able to keep up with all the reverse mortgage program requirements. Additionally, you should be aiming to stay in your home for the long term in order to maximize the financial benefits. It might not be such a great idea if you have impending health issues, your spouse is not yet 62, you have friends or family living in the house with you, or you want to pass your home on to your heirs with as little financial burden as possible.