What is a reverse mortgage?
Exchange equity for cash in your senior years
Imagine living out your golden years with funds from equity in your home — while not having to make monthly payments. This can be a reality with the use of a reverse mortgage — a type of loan that allows homeowners to convert a portion of their home equity into cash.
However, while this financial move can be helpful, it can also carry risks. Here’s how to decide if a reverse mortgage can help you financially in your senior years and what you should know before shopping for reverse mortgage lenders.
- The funds from a reverse mortgage can be used for any purpose, including home maintenance, repairs and general living expenses.
- Reverse mortgages don’t need to be repaid as long as the borrower lives in the home.
- The homeowner is still responsible for property taxes, insurance and home maintenance.
How does a reverse mortgage work?
A reverse mortgage is almost the opposite of a traditional mortgage — instead of making loan payments to buy a house, homeowners can use reverse mortgages to get paid for their equity. You can receive money in the form of a lump sum, fixed monthly payments or a line of credit, depending on your preferences and the lender you work with.
Your home is collateral for this loan, and the IRS considers your money to be a loan advance rather than income
When you take out a reverse mortgage, you first have to use the funds to pay off any outstanding balance on your existing mortgage. Once that's paid off, you get access to whatever amount is left over. You can use the funds from a home equity loan in a variety of ways and for a variety of reasons, including:
- Lowering your monthly mortgage payment
- Consolidating debts
- Covering medical care
- Investing in home improvements
- Living more comfortably in retirement
Repaying a reverse mortgage
Reverse mortgages do not have to be paid back until the final borrower on the loan moves out, dies or fails to meet certain requirements. This can include not taking care of the home or failing to pay taxes or insurance. Once the loan is due, you or your heirs must pay it back with interest.
Reverse mortgage requirements
Reverse mortgages have stricter requirements than a cash-out refinance or new mortgage loan. These requirements are designed to protect both the homeowner and the lender.
Each lender will set its own requirements, but you can expect similar guidelines to these:
- 62+ age requirement: This is the standard age restriction for most reverse mortgage products, including home equity conversion mortgages (HECMs). Some private lenders might allow borrowers as young as 55.
- Equity requirement: The homeowner must own the property outright or have paid down a substantial amount of their mortgage.
- Primary residence: The property must be the homeowner's primary residence, not a second home or vacation home. The homeowner must live in the home for the majority of the year.
- Property type: The property must be a single-family home, a one-unit dwelling or a qualified manufactured home or condominium.
- Financial and property obligations: Homeowners must be current and able to continue payment on property taxes, insurance and any homeowners association (HOA) fees. The condition of the home must also be maintained.
- Counseling session: Homeowners are required to attend a counseling session with a HUD-approved counselor.
Types of reverse mortgages
There are three types of reverse mortgage loans: single-purpose reverse mortgages, federally insured reverse mortgages and proprietary reverse mortgages. The right one for you usually depends on your financial situation and the cost of your home.
Single-purpose reverse mortgages
This type of reverse mortgage is often the most affordable option for a reverse mortgage because it’s more limited in scope. You can only use the funds from a single-purpose reverse mortgage to pay for a lender-approved expense, like property taxes or home repairs. Interest rates and fees are lower with this option than with other reverse mortgages.
Home equity conversion mortgages
These are reverse mortgages backed by the Federal Housing Administration (FHA), which is why the government requires you to undergo counseling before getting one. HECMs are also the most widely used reverse mortgage option because they theoretically pose less risk to lenders, and borrowers can use the funds for any reason. You can also get a federally backed reverse mortgage specifically to help buy another home — this is called a HECM for purchase.
Proprietary reverse mortgages
These reverse mortgages, also known as jumbo reverse mortgages, are mostly used by homeowners with homes valued over the HECM limit. Like HECMs, the funds are available for a variety of purposes, but the amounts dispersed can be much higher.
Reverse mortgage pros and cons
Reverse mortgages are pretty complicated, and that complexity means they’re not right for everyone.
"A reverse mortgage is a great product for the right situation: there are no monthly payments, your current mortgage (if any) is paid off, you receive tax-free cash from your home equity, and you continue to live in your home,” said Jeff Levinsohn, CEO of House Numbers, which provides resources for homeowners.
“But, it’s important to remember that it’s a loan that is repaid, with interest, when you die or move out of your home. So, you should be comfortable with your heirs selling your home upon your death to repay the debt.”
Even if you qualify for a reverse mortgage, weigh the pros and cons before deciding.
- Age in place: You can take out money you’ve already paid toward your home in order to live more comfortably and stay in your home.
- There are no income taxes: The IRS counts the money from a reverse mortgage as a loan rather than income.
- It’s a nonrecourse loan: Reverse mortgages won’t charge you more than the current value of the property.
- Risk of early repayment: Because your home is collateral on your reverse mortgage, the risks of accidentally triggering repayment are severe.t
- Can leave heirs with mess: Your heir might need to repay the reverse mortgage or sell the home at the time of your death.
- Strict qualifications: Not only do you need to meet age requirements, but there are also limitations on your property, your residency and your ownership status.
What is a "nonrecourse" clause in a reverse mortgage?
A nonrecourse clause means that you, or your heirs, will never owe more than the home is worth when the loan becomes due and the home is sold.
What happens if I outlive my reverse mortgage?
A reverse mortgage has no set term or maturity date, so you cannot outlive your reverse mortgage as long as you comply with its terms, including living in the home as your primary residence.
What happens to my reverse mortgage when I die?
When you die, your heirs will have the option to repay the reverse mortgage and keep the home, sell the home and use the proceeds to pay off the loan or let the lender sell the home to settle the debt.
Can I lose my home with a reverse mortgage?
Yes, you can lose your home if you don’t meet the obligations of the reverse mortgage, such as paying property taxes, homeowners insurance and maintaining the home.
ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
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