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What is a reverse mortgage and how does it work?

With a reverse mortgage, your lender pays you

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by Michele Lerner Mortgage & Real Estate Contributing Editor
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When you have a regular mortgage on your house, you’re building equity every time you make a mortgage payment—when you enter a reverse mortgage, you’re consuming equity. If you’re considering a reverse mortgage loan for yourself or researching for a family member, make sure you understand all of your available options. Talk to a financial advisor before anyone signs paperwork. There are substantial risks involved in reverse mortgages, including foreclosure.

What is a reverse mortgage?

A reverse mortgage is when you receive payments from your mortgage lender instead of making monthly payments to them. By taking out a reverse mortgage, you can access either a lump sum or installments of funds against the equity you’ve built in your home. You’ll still have to keep up with property taxes and mortgage insurance premiums.

Unlike other types of home equity loans, a reverse mortgage doesn’t require that you pay off the loan until you move out of the house permanently or die, in which case your family or estate is responsible for the loan. You only need to worry about repaying the loan if you change your permanent residence while you’re still alive. Often the borrower’s children will sell the house to pay back the loan. They may choose to pay it back themselves if they want to keep your house in the family.

How does a reverse mortgage work?

A reverse mortgage works similar to a home equity loan in that a reverse mortgage requires that you use your home as collateral. You keep the title to your house when you take out a reverse mortgage, but you’re forfeiting the equity you’ve already gained in your home in exchange for more immediate funds or a line of credit.

The amount you’ll be able to borrow with a reverse mortgage will depend upon your age, your creditworthiness, the real market value of your home, current interest rates and the type of reverse mortgage you select. As with a traditional mortgage, you’ll be responsible for paying a lender’s origination fees and other third-party costs associated with inspections and appraisals before you can close on a reverse mortgage. You can receive reverse mortgage funds as a lump sum, short-term recurring payments or long-term recurring payments.

  • Lump sum payment: The borrower receives one check with the entire loan payment.
  • Short-term recurring loan: The borrower receives a monthly check for a specified period of time.
  • Long-term recurring loan: The borrower receives a monthly check until he or she moves out of the house or passes away, whichever comes first.

No matter how you access reverse mortgage funds, Social Security and Medicare will consider the funds a loan, and so a reverse mortgage won’t affect your total income. You won’t be responsible for paying the loan back as long as you’re living in the residence, but you will be required to keep up with property taxes and mortgage insurance premiums or your lender’s servicing fees. Generally, as long as the borrower keeps up with maintaining the home and property taxes, the reverse mortgage loan is only due for repayment once the borrower moves out or dies.

If the borrower dies while still owning the home, his or her estate is liable for the cost of repayment. Under certain conditions, such as the borrower renting out part of the home, the loan can become repayable while a borrower is still living in it.

If you’re married, your spouse will be able to keep living in your home after you die if you included them on the reverse mortgage documents. They will be required to maintain property taxes and mortgage insurance premiums as long as they stay in the house, but they won’t be able to access the reverse mortgage funds.

When the loan becomes due, your estate retains the title of the house and will be responsible for the repayments. Often, this requires surviving children to sell the home to pay back the loan obligation.

Reverse mortgage requirements

Regulations and rules for reverse mortgages are more strict now than they were a few years ago. It used to be a lender just wanted to know your age and how much equity you have. These days, reverse mortgage eligibility is still contingent upon your age and how much equity you’ve built. Lenders are now required to evaluate each applicant’s financial situation more fully. Reverse mortgage eligibility requirements include:

  • Reverse mortgage age requirement
    The minimum age to be eligible for a reverse mortgage is 62 years old. If you’re married, lenders will consider the youngest person’s age listed on the loan to confirm minimum age eligibility requirements. If your spouse is younger than 62, you could still qualify by taking them off the reverse mortgage paperwork, but there’s a good chance they will lose your house if you die first.
  • Reverse mortgage ownership status requirements
    You must have enough equity built up in the home to make the loan worth it to you and the lender. Generally, this requires you to own your house free and clear or have only a relatively small amount remaining on your mortgage balance.
  • Reverse mortgage property requirements
    Single-family houses, including manufactured homes, are eligible for reverse mortgages, as well as multiple-unit homes as long as the borrower lives in one of the units. The property must adhere to FHA standards and flood requirements.
  • Reverse mortgage occupancy requirements
    The home you take out a reverse mortgage on must be your primary residence.
  • Reverse mortgage credit requirements
    There’s no hard minimum credit score to qualify for a reverse mortgage across lenders. Credit requirements for a reverse mortgage are far less strict than traditional mortgages, but you’ll still have to prove to your lender that you intend to make right on the loan. For example, you’ll be disqualified for a reverse mortgage if you are currently delinquent on another federal debt.
  • Reverse mortgage financing fees
    You’ll be required to pay your lender’s various financing fees. The reverse mortgage lender also charges financing fees based on the borrower’s home equity and the costs of providing the loan. Borrowers can wrap most of these fees into the balance of the reverse mortgage.
  • Reverse mortgage financial counseling
    Modern reverse mortgage guidelines also stipulate that you meet with a HUD-approved reverse mortgage counseling agency. The agency will help you to determine if a reverse mortgage is a feasible loan option for you and ensure that you fully understand how your reverse mortgage interest rate accumulates over the lifetime of the loan.
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Reverse mortgage pros and cons

As with any mortgage or loan product, it’s important to fully understand the benefits and disadvantages before adding your signature to any paperwork. On the plus side, reverse mortgages can give you access to much-needed funds and come with flexible repayment terms. But they are also difficult to understand and come with risks to your finances and assets.

Reverse mortgage benefits

  • Access to funds
    Some people take out a reverse mortgage to take care of an immediate financial need, others consider their reverse mortgage a strategic tool in their retirement planning. Reverse mortgage funds can be used for any purpose. You can use the extra money to supplement fixed income or extend savings after retirement, cover health expenses, pay off another debt and anything else to help you age in place more comfortably.
  • Flexible terms and tenure options
    You can decide if you want to receive funds as a lump sum, monthly payments, a line of credit or some combination. Reverse mortgage interest rates can be fixed or variable depending on how you receive payment. As with other mortgage products, you’ll accrue interest year over year. When the loan is due, your estate will be responsible for paying off the loan plus interest on the loan.
  • Children aren’t financially liable to repay the loan
    A reverse mortgage is a kind of “non-recourse” loan, meaning that borrowers can’t owe more than the house is worth. This means that if you have children, your kids will inherit your loan repayment obligations if they inherit your estate, but will not the held personally or financially liable for the loan balance. Most of the time the surviving family will sell the home to pay back the loan, so keep in that in mind if you want to keep your house in the family.
  • Doesn’t require monthly mortgage payments
    Repayments only kick in if the borrower permanently moves or fails to keep up with maintaining the house’s taxes and codes. Just like any other type of home equity loan, you must secure your reverse mortgage with your house. You aren’t responsible for paying the reverse mortgage loan back in your lifetime as long as you’re able to keep up with property taxes and mortgage insurance premiums.

Reverse mortgage disadvantages

  • High up-front costs
    Reverse mortgage fees can add up quickly. You’ll be responsible for paying appraisal costs, title searches and other inspections, plus an origination fee to the lender and a servicing fee to your lender or agent. The amount you’ll have to pay will depend upon your location and a variety of other factors.
  • Mortgage insurance premiums
    Borrowers must pay for mortgage insurance throughout the life of the loan to ensure the lender will be repaid if the borrower defaults on the loan. If you take out a HECM, you’ll also be responsible for paying off a mortgage insurance premium, or MIP, when the loan repayment is due. MIP accumulates at 0.5 percent of the loan’s outstanding balance every year.
  • Limited cancellation rights
    Borrowers have limited rights to cancel a reverse mortgage once they enter it. In most cases, borrowers have three business days to cancel a loan; many lenders count Saturday as one of these three days. Most lenders provide a form borrowers can fill out to cancel the loan, or borrowers must write a letter requesting the loan be canceled.
  • Difficult to understand
    Even among legitimate lenders, terms and conditions can be confusing to navigate. For example, many lenders include clauses in their reverse mortgages that require payments when the borrower permanently moves out of the residence. Often a medical emergency that requires long-term, ongoing treatment can trigger this “permanent move” clause, which would then trigger repayment obligations.

Bottom line: Is a reverse mortgage a good idea?

A reverse mortgage can be a good idea if you need access to funds, meet all the eligibility requirements and accept all the risks involved. The loan amount that can be borrowed through a reverse mortgage depends on your age, the appraised value of the home and other factors. Almost anyone over the age of 62 who owns their home can qualify for a reverse mortgage, but that doesn’t mean that they should.

If after you understand the benefits and disadvantages of a reverse mortgage you think it’s the best option for you and your family, you should compare the best reverse mortgage lenders to make sure you don’t pay more than you have to in origination, closing and service fees.

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by Michele Lerner Mortgage & Real Estate Contributing Editor

Michele Lerner, author of “HOMEBUYING: Tough Times, First Time, Any Time”, has been writing about personal finance and real estate for more than two decades. Michele writes for regional, national and international publications in print and online for a variety of audiences including consumers, real estate investors, business owners and real estate professionals.