What Is a Reverse Mortgage, and How Does It Work?

According to the 2018 Retirement Confidence Survey from the Employee Benefits Research Institute, workers are increasingly confident that they can live comfortably in retirement. However, at the same time, there are concerns from actual retirees about their ability to handle basic expenses going forward.

money or house

So, what happens when you run into a retirement funding gap? If you’re struggling to meet your retirement expenses, one option for homeowners is the reverse mortgage.

What is a reverse mortgage?

At its core, a reverse mortgage is a home equity loan. You receive money, based on your home’s equity and other factors, and you’re expected to repay it. However, instead of making regular monthly mortgage payments to the lender, you receive the money, and you don’t have to pay it back until you move out of the house or pass on.

How does a reverse mortgage work?

In many cases, you can get a loan that complies with Federal Housing Administration (FHA) requirements and that is classified as a home equity conversion mortgage (HECM). There are some lenders that offer reverse mortgages that aren’t insured by the FHA. However, it’s important to be especially careful in those cases because you might not have the same protections.

Once you move out or pass on, your spouse can continue living in the home as long as they keep up with tax and insurance payments. However, when neither of you is living in the home, the loan must be repaid — or the home sold so the lender can recoup the money.

Types of Reverse Mortgages

There are several types of reverse mortgage loans:

  • FHA reverse mortgage: A reverse mortgage loan insured by the Federal Housing Administration (FHA).
  • Proprietary reverse mortgage: A reverse mortgage loan that’s not FHA-insured.
  • Single-purpose reverse mortgage: A reverse mortgage loan offered by state and local governments. 

The most common type of reverse mortgage loan is home equity conversion mortgage (HECM). It’s insured by the FHA, a part of the U.S. Department of Housing and Urban Development (HUD).

Who can get a reverse mortgage?

The FHA insures certain reverse mortgages, as long as borrowers meet certain requirements:

  • Be at least 62 years of age.
  • Live in the home as a primary residence (or your spouse, listed on the mortgage, must live in the home.)
  • Be capable of paying property taxes and homeowners insurance, as well as other maintenance costs and fees while you live in the home.
  • Meet FHA property requirements for the home.
  • Are willing to attend a counseling session about home equity conversion mortgages (HECMs).
  • There are no delinquent federal debts on your account.

You’re more likely to get the money you need if you own your home outright, or if your loan balance is small so that you have a great deal of equity.

How much can you borrow with a reverse mortgage?

When you apply for a reverse mortgage loan, your lender will consider a few factors that will influence the amount of money you receive, including:

  • Your age
  • Value of your home
  • Equity available in your home
  • Interest rate
  • FHA mortgage limit for home equity conversion mortgages
  • Whether your fees are rolled into the loan
  • How you choose to receive your money

The older you are, and the more equity you have in your home, the more you’re likely to be approved for. Keep in mind, too, that fees associated with reverse mortgages are often much higher than fees for other types of home equity loans. That’s going to eat into how much you actually receive — even if you have a lot of equity in your home.

One of the perks of FHA-insured reverse mortgages is the fact that you don’t have to pay back more than the home is worth. So, if the value drops, and you owe more than it’s worth, you (or your heirs) might have to sign a deed in lieu of foreclosure turning it over to the bank. This is one reason many reverse mortgage lenders won’t actually lend you the entire amount of your equity.

You can use the money for whatever you want, whether it’s paying off debt, covering living expenses, or going on a vacation.

How do you get your money?

If you get a fixed-rate reverse mortgage, you’ll receive a lump-sum payment. You can then take that money and do whatever you want with it. However, when it runs out, it’s gone. Some retirees use a lump sum to fund a retirement investment portfolio or purchase an immediate annuity. Others use the money to pay off debts or cover other expenses.

With an adjustable-rate HECM, you have different options available. You can choose to receive set monthly payments for a specific period of time or get payments for as long as you or an eligible spouse live in a house.

If you choose an open-ended payment schedule, you’ll likely get a smaller amount each month. However, you can be reasonably sure that you’ll continue to receive money until you pass on or move into a long-term care facility. With a fixed-term payment schedule, you could see higher cash flow every month. However, you run the risk of outliving the payments and trying to figure out what to do next.

Finally, you can also choose to use your reverse mortgage as a line of credit. You can withdraw funds as needed, up to the credit limit. This is a little more flexible and can be useful if you have other sources of income, and just want the HECM in case you need to fill a gap on occasion.

Pros and Cons of a Reverse Mortgage

If you’re considering a reverse mortgage, it’s a good idea to start with an FHA-approved lender so you receive protection. You can use an online locator to find a counselor who can help you with the process, or you can call 800-569-4287.

Carefully consider the pros and cons, too.

Advantages of a Reverse Mortgage

There are some ways to benefit from a home equity conversion mortgage that you wouldn’t see with a more “traditional” home equity loan.

  • No monthly payments as a borrower
  • Improve monthly cash flow
  • Pay off debt (including an existing mortgage on the home)
  • Non-borrowing spouse can remain in the home
  • Loan is paid off by selling the house when you pass on or move out

Disadvantages of a Reverse Mortgage

While a home equity conversion mortgage might seem like a no-brainer, there are some downsides to consider before you proceed.

  • High closing costs and other fees
  • You might not be able to pass the home on to your heirs
  • Costs associated with property taxes, mortgage insurance, and maintenance must still be paid
  • You’re draining a major asset—and you might still outlive your money

Is a reverse mortgage right for you?

If you know you’ll stay in your home for a long time, and you need a little extra to supplement your retirement income, a reverse mortgage can be one way to use your home as an asset. For borrowers who aren’t too concerned about passing the home to heirs, this can be one way to get financial benefit from the home during retirement. That is, as long as you can keep up with the costs of maintaining the home and pay property taxes.

On the other hand, if you can’t keep up with the costs of the home, or you want your home to benefit your heirs, getting a reverse mortgage loan might not make sense. When you’re no longer living in the home, your heirs will need to sell the home to pay off the loan. If not, they’ll have to pay the loan themselves to keep the house. If there’s enough money in the estate to pay it off, it will reduce how much ready cash they receive when you pass on.

Carefully consider your situation and your priorities before you decide to get a reverse mortgage. Then, make the decision most likely to benefit you in retirement and increase the chance that you’ll outlive your money.

Miranda Marquit
Meet the author

Miranda has been covering personal finance topics for more than 10 years as a freelance writer and journalist. She has contributed to Forbes, NPR, MarketWatch, Yahoo! Finance, U.S. News and World Report, and many other media outlets. Miranda has an M.A. in Journalism and is currently working on an MBA. She lives in Idaho with her son, where she enjoys reading, travel, and the outdoors.