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

Reverse mortgages can be an attractive option for seniors who want to supplement their retirement income, pay off debts, or make home improvements. However, they should be carefully considered as they can have significant financial and legal implications.

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Here’s how reverse mortgages work, the pros and cons, and what to consider before deciding if it’s right for you.

What is a reverse mortgage?

A reverse mortgage offers a unique financial option for homeowners aged 62 and older, enabling them to utilize the equity in their home without the obligation to make monthly mortgage payments.

Through this arrangement, homeowners have the flexibility to receive funds in several ways: a single lump sum, as ongoing monthly payments, or through a line of credit that can be accessed as needed. The defining characteristic of a reverse mortgage is its payment structure; rather than the homeowner paying the lender, the lender pays the homeowner based on the equity built up in the home.

This type of loan is specifically designed for seniors looking for additional income streams during retirement, leveraging the equity they have accumulated in their property over the years. The loan balance, including interest and fees, is deferred until the home is sold, the homeowner permanently relocates, or in the event of the homeowner’s death, at which point the estate is responsible for repayment.

Understanding How a Reverse Mortgage Works

Reverse mortgages enable senior homeowners to access their home’s equity in a flexible and strategic manner. This financial tool is especially beneficial for those who wish to remain in their home while supplementing their retirement income, covering healthcare expenses, or funding home improvements, all without the requirement to make monthly loan repayments. The process is straightforward and designed to provide seniors with financial relief by tapping into the value of their most significant asset—their home.

Step 1: Assess Your Eligibility

To kick things off, confirm your eligibility for a reverse mortgage. Requirements include being at least 62 years old, owning your home (or at least having a significant amount of equity in it), and using the home as your primary residence. You’ll also need to demonstrate that you can handle ongoing costs like property taxes, homeowners’ insurance, and regular maintenance.

Step 2: Calculate Your Home Equity

Your home’s equity is central to determining your reverse mortgage potential. Simply, it’s the difference between your home’s market value and any outstanding mortgage balance. The greater your equity, the more you might receive from a reverse mortgage.

Step 3: Select the Right Reverse Mortgage Product

Explore the different types of reverse mortgages available, including the federally insured Home Equity Conversion Mortgage (HECM), proprietary reverse mortgages for higher-value homes, and single-purpose reverse mortgages from certain state and local governments. Each type caters to specific needs and financial scenarios.

Step 4: Get a Professional Home Appraisal

An essential step in the process is obtaining a professional appraisal of your home. This assessment determines your home’s market value based on factors such as location, condition, and the sale prices of similar homes nearby.

Step 5: Undergo Counseling

It is essential to seek counseling from a HUD-approved agency. This ensures you fully understand the reverse mortgage process, its financial implications, and how it fits into your overall estate planning.

Step 6: Decide How You’ll Receive the Funds

Reverse mortgages offer several options for receiving your funds: as a lump sum, in monthly payments, as a line of credit, or a mix of these methods. Your choice should align with your financial objectives and needs.

Step 7: Know When and How Repayment Works

No monthly payments are required with a reverse mortgage. The loan is repaid when the last borrower dies, sells the home, or the home is no longer used as the primary residence. Typically, the home is sold, and the proceeds are used to pay off the loan balance, including interest and fees.

Real-Life Example: Maximizing Loan Amount Through Equity

Imagine homeowners John and Mary, who own a home worth $300,000 clear of any mortgage. They qualify for a reverse mortgage that grants them access to $150,000. Opting for monthly payments, they supplement their retirement income, demonstrating how equity determines borrowing capacity and the flexibility in receiving funds.

Choosing the Right Type of Reverse Mortgage

When considering a reverse mortgage, make sure you understand the different types available to you. Each type comes with its own set of features, benefits, and limitations.

Here, we’ll explore the three primary types of reverse mortgages: the Home Equity Conversion Mortgage (HECM), proprietary reverse mortgages, and single-purpose reverse mortgages. By comparing these options, you can make a more informed decision that aligns with your financial situation and retirement goals.

Home Equity Conversion Mortgage (HECM)

Pros:

  • Federally insured, offering a layer of security.
  • Flexible payout options, including lump sum, line of credit, or fixed monthly payments.
  • Can be used for any purpose, without restrictions.

Cons:

  • Higher upfront costs, including mortgage insurance premiums.
  • Requires counseling from a HUD-approved agency, which may be seen as an extra step.
  • The loan amount is capped, which may limit access to equity for homeowners with higher-valued properties.

Proprietary Reverse Mortgages

Pros:

  • Designed for higher-valued homes, potentially offering access to more significant loan amounts.
  • May have lower upfront costs than HECMs.
  • Not subject to the same insurance and borrowing limits as HECMs, offering more flexibility.

Cons:

  • Not federally insured, which might pose additional risks.
  • May come with higher interest rates and fees.
  • Less regulatory oversight, requiring thorough due diligence by the borrower.

Single-Purpose Reverse Mortgages

Pros:

  • Typically the lowest cost option available.
  • Offered by state and local government agencies and some non-profits, intended for a specific purpose like home repairs or property taxes.
  • Interest rates may be lower than other reverse mortgages.

Cons:

  • Limited availability, as not all states and municipalities offer them.
  • The loan must be used for a specific, lender-approved purpose.
  • Not suitable for those looking for flexibility in how they use their funds.

Making the Right Choice

Choosing the right type of reverse mortgage depends on several factors, including your financial needs, the value of your home, and how you plan to use the funds. HECMs offer flexibility and security, but come with higher costs.

Proprietary reverse mortgages can provide access to larger sums for those with high-value homes but lack the insurance and sometimes the stability of HECMs. Single-purpose reverse mortgages are cost-effective for specific needs but offer limited flexibility.

Before deciding, it’s recommended to consult with a financial advisor or a HUD-approved counselor. They can provide personalized advice based on your financial situation and help you make sense of each option, ensuring you choose the reverse mortgage that best fits your retirement planning needs.

Eligibility Criteria for Reverse Mortgages

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 you 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.

Reverse Mortgage Borrowing Limits

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.

Accessing Your Reverse Mortgage Funds

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.

Pros

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

Cons

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

How to Spot and Avoid Reverse Mortgage Scams

Scams related to reverse mortgages are a serious concern, as they often target vulnerable seniors who may be seeking financial relief or have cognitive impairments. These scams can come in the form of dishonest vendors or contractors who promise home improvements in exchange for a reverse mortgage. However, they then either fail to deliver quality work or outright steal the homeowner’s money.

Similarly, family members, caregivers, and financial advisors may use a power of attorney to obtain a reverse mortgage on a senior’s home and then steal the proceeds. They may also try to convince seniors to buy financial products that they can only afford through a reverse mortgage, which may not always be in the senior’s best interest.

It’s important to be cautious and do thorough research to protect yourself from these types of scams.

Is a reverse mortgage right for you?

With a reverse mortgage, you can use your home as an asset if you know you’ll stay in it for a long time and need a little extra income for retirement. Borrowers who don’t intend to pass the home to heirs may benefit financially 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.

In contrast, getting a reverse mortgage loan might not make sense if you can’t afford home maintenance or if you wish to leave your home to your heirs. 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.