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.
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 is a financial product that allows homeowners, 62 years or older, to borrow money using the equity in their home as collateral. Instead of making monthly payments to the lender, the lender makes payments to the borrower. This can be in a lump sum, as a line of credit, or in the form of monthly payments.
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. 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. Alternatively, the home can be 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 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.
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
Avoiding 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.