What is a reverse mortgage?
A reverse mortgage is a home loan allowing homeowners of age 62 and older to borrow money against part of their home's equity.
The reverse mortgage does not have monthly mortgage payments. The reverse mortgage lenders require repayment as the borrower dies, moves out, or sells their home.
The loan amount you can get on a reverse mortgage depends on the repayment plan. The Federal Housing Administration (FHA) maximum loan proceeds is $1,089,300 in 2023. You cannot borrow 100% of your home's value because of mortgage insurance premiums and the interest you must cover. The older you are, the higher the amount you can receive.
If you take a lump sum payment or a line of credit, you cannot get all your loan balance in the first year. You can borrow only up to 60% of the equity. The credit limit on the line of credit will increase with time.
How do reverse mortgages work?
Once the borrower receives money, they only pay interest on the loan balance. The interest accrues on loan, so it is not due upfront. Over the loan term, the home equity decreases while the debt increases.
Because the home is collateral, the mortgage lender sells it when the borrower dies or moves to cover the loan balance. The exceeding sum from the debt goes back to the homeowner's estate or to the borrower. There is an option for the heirs to pay the mortgage back to keep the property.
The loan amount depends on the age of the youngest borrower, interest rates, the HECM mortgage limit, and the value of the property.
With variable interest rates, the payment options may be the following:
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Equal monthly payments if at least one borrower lives permanently on the property
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Equal monthly payments for a fixed period
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A line of credit that can be accessed up to the approved limit
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A line of credit with monthly mortgage payments for the time the borrower lives on the property
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A line of credit with fixed monthly payments for a set period.
The reverse mortgage with a fixed rate has one disbursement. The borrower receives their loan in one lump sum and pays the property taxes and homeowner's insurance, and upkeeps the home.
The reverse mortgage can be used for home repairs, medical expenses, or other situations where the income does not cover expenses.
Types of reverse mortgages
When taking a reverse mortgage, you can opt for different options:
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Home Equity Conversion Mortgage (HECM)
Home Equity Conversion Mortgage is only available from the FHA-approved lender, and you must get HUD-approved counseling.
It is the most popular type of reverse mortgage. HECMs are federally insured with higher upfront costs. The borrowers undergo financial assessment, but their eligibility does not depend on their credit score.
Home Equity Conversion Mortgages allow receiving money as a lump sum, monthly payments, a line of credit, or a combination of the three options. You can use the borrowed money for any purpose.
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Proprietary reverse mortgage loan
These are private loans you can receive as a larger loan advance if you have more value in your home.
Because proprietary reverse mortgages come from private lenders, they are excluded from FHA regulations. The lenders can lend higher loan amounts.
There is no mortgage insurance requirement, and you can spend money for any purpose. However, most reverse mortgages of this type allow only a lump sum payment.
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Single-purpose reverse mortgage
You can get it from nonprofit organizations and local government agencies to cover home remodeling. It is the least expensive option, but not widely available and has a single purpose.
Single-purpose reverse mortgages are tax-free and available for any income level. However, the lender will verify how you spend the borrowed money.
Pros and cons of reverse mortgages
Pros
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You do not need to make monthly payments toward your mortgage.
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Loan proceeds can be used for personal expenses.
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Non-borrowing spouses can remain in the property after the reverse mortgage borrower dies if they were not listed on the mortgage.
Cons
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Borrowers must maintain the property and pay property taxes and homeowners insurance.
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The reverse mortgage can only be borrowed against the home's equity.
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High fees and closing costs can lower the money you can get.
When to take a reverse mortgage?
A reverse mortgage can help borrowers to get additional income during their retirement. The funds can be used for medical expenses, home renovations, and improvements and supplement Social Security income.
If the home's value increases and is higher than the loan balance, your heirs can receive the difference. However, if the home's value drops, your heir may need to hand the homeownership to the lender.
Unlike a home equity line of credit, a reverse mortgage does not require additional income or a good credit score for qualification. You will not make loan payments while you stay in the property as your primary residence.
A reverse mortgage is the only mortgage loan allowing you to access home equity without selling the home. If you cannot afford monthly payments or cannot qualify for a HELOC, a reverse mortgage can be a good option.
Reverse mortgage requirements
To qualify for a reverse mortgage, the applicants should:
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Be 62 years and older. The loan is only available for seniors.
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Own the property or have a substantial amount of the mortgage paid off. The amount of equity you own should be at least 50%.
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Have the property as a primary residence. The property must be a house, townhouse, or condominium built after 1976. Cooperative housing owners cannot receive reverse mortgages because they do not own the property.
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Participate in the information session with a HUD-approved counselor. The session costs about $125 and takes at least 90 minutes. It states the pros and cons of taking a reverse mortgage based on your personal circumstances.
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Have sufficient finances to pay property taxes and homeowners insurance. The reverse mortgage borrowers must pay the homeowners insurance premiums, servicing fees, and interest rates. There are limits to closing costs amounts the mortgage lenders can charge.
Reverse mortgage costs
The closing costs on reverse mortgages can be rolled into the loan balance. However, it will reduce the loan amount you can withdraw. The other loan costs you will have to cover may include the following:
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Mortgage insurance premium. The mortgage insurance premiums are 2% at closing and 0.5% of the outstanding loan balance annually.
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Origination fee. If you take HECM, your origination fees will be either $2,500 or 2% of the first $200,000 of your home's value and 1% of the rest amount. The cap on origination fees is $6,000.
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Servicing fee. The monthly fees cannot be higher than $30 for fixed- or annually adjusting-rate loans. If your interest rates adjust monthly, the servicing fees can be up to $35 per month.
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Third-party fees. These are appraisal costs, home inspections, credit checks, title searches, title insurance, and a recording fee.
Reverse mortgage scams
Reverse mortgage scams occur quite often. Because reverse mortgages are designed for seniors, and them being a vulnerable group of US citizens, many parties may take advantage of the applicants.
The scams usually include the following:
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Vendors and home improvement contractors target seniors so they would get reverse mortgages to pay for home improvements. The vendors may not do the work but steal the money instead.
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Relatives and caregivers may use a power of attorney to get a reverse mortgage and then take the reverse mortgage proceeds.
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Financial advisors may convince you to take a financial product you can only afford with a reverse mortgage. This can be a life insurance policy. In this case, the financial advisor will profit by getting their portion of the money.
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You may face foreclosure in you cannot meet the conditions. You must live on the property, maintain it, and pay the mortgage insurance premiums and property taxes.
Government-backed reverse mortgage loans are quite safe from lender scams. However, if you work with a private lender, do not respond to unsolicited mailers and ads, do not sign the loan agreement if you cannot fully understand the conditions, do not accept payment for the home you do not own, be careful if you are offered no down payment options.
Reverse mortgage alternatives
A home equity line of credit may be a better option if you are not 62 years old yet. HELOCs allow you to borrow against the equity of your home of up to 85% of the home's value. The payments are required when the draw period on loan expires.
The closing costs and interest rates are lower on home equity lines of credit, so you might benefit from it more.
Another alternative can be a personal loan. However, to qualify, you must have sufficient income and a high credit score. The payments are due every month. It will be a good option if you can qualify for the best offers and need a lower amount of money for the short term.
If you do not want to get a loan, you can sell your current house and buy a less expensive one. Here, you can use the difference to cover urgent expenses or debts.
