You’re 65 years old, and you’ve been in your home for 25 years. In that time, the market has gone up and up and up — and now you have substantial equity in that property. You also have lots of expenses for everyday living, and some major health care bills, too. And while you’re sitting on a lot of cash in your home, you don’t have quite enough in your pocket. So you’ve started thinking about getting a reverse mortgage.
While someone in this position might be a good candidate for a loan like this, reverse mortgages are complicated products that come with plenty of potential downsides. So if you’re considering a reverse mortgage, you’ll want to take the time to understand what you’re getting into and weigh all of the potential pros and cons. This primer is a good place to start your education.
What’s a reverse mortgage?
A reverse mortgage is a home loan — but it’s not the standard kind most homeowners are shopping for. This type of loan is most typically for homeowners ages 62 or older who have substantial equity in their home.
A reverse mortgage allows these owners to borrow against their home’s value. Think of it as a way for homeowners to tap into the wealth they accumulated in their homes over the years to pay for living expenses during retirement.
Instead of making payments every month to the lender, these homeowners will receive funds from the bank instead, choosing to accept them as a line of credit, a fixed monthly payment, or in a single lump sum.
Still, these loans against home equity will indeed need to be paid back eventually, though not while the borrower is still living in the home. The balance is due when the borrower moves away from the home or sells it, or when the borrower dies.
And this type of loan does not lift all home-related expenses. The borrower must still pay all home insurance, property taxes, utilities, and maintenance on the property.
Federal regulations on this type of loan require that the loan amount not exceed the value of the home, and that the borrower or heirs won’t be responsible for paying the difference if the home’s value ever falls below the loan’s balance.
In order to make sure the borrower truly understands what this type of loan means, would-be borrowers must meet with a counselor before they can get one.
Costs of a reverse mortgage
Reverse mortgages come with a lot of fees, plus interest on the loan. And that can whittle down equity fast. Let’s take a look at what those costs include.
Only the lump-sum option has a fixed interest rate. Otherwise, reverse mortgage rates are variable (so they change throughout the life of the loan).
Just as you might expect with a traditional mortgage, there are various fees associated with a reverse mortgage, too. These include …
This is the fee to establish the loan. You can expect to pay either $2,500 or 2% of the first $200,000 of the home’s appraised value (whichever is more), plus 1% of the home’s value above $200,000, not to exceed $6,000 total.
These are part of a mortgage payment that goes to a mortgage servicer handling payments for the lender. For FHA home equity conversion mortgages (HECMs, which are government-insured reverse mortgages), servicing fees are capped at $35.
Plan for a collection of miscellaneous fees, including credit checks, title insurance, and more.
Initial mortgage insurance premium
You’ll pay 2% upfront, due at closing, plus an annual premium of 0.5% each year after.
This requirement applies to Home Equity Conversion Mortgages (HECMs), the most common type of reverse mortgage.
Borrowers are required to attend mandatory counseling with a third-party U.S. Department of Housing and Urban Development (HUD) counselor, at the cost of about $125 (which cannot be rolled into the loan).
The three main types of reverse mortgages
1. HUD-backed Home Equity Conversion Mortgage (HECM)
This is the most common, most popular type of reverse mortgage loan.
The borrower must be 62 or over to qualify, and you can borrow up to $765,600. These loans are federally insured and backed by HUD. Therefore, to get one of these loans, borrowers must pay insurance premiums, which flow into the Federal Housing Administration (FHA) reserves.
With these loans, there’s a limit to how much borrowers can take out the first year. The borrowing maximum — known as initial principal limit — comes from a combination of the borrower’s age, the interest rate, the home’s value, and the borrower’s overall financial picture.
2. Single-purpose reverse mortgage
This type of loan is the cheapest type of reverse mortgage. It’s available for low- or moderate-income homeowners, and it is designed for one purpose, like a home improvement project, designated by the lender.
They are available through some nonprofit organizations as well as government agencies.
3. Proprietary reverse mortgage
This is a loan through a private company, and it is the most uncommon reverse mortgage scenario.
A borrower can use a proprietary reverse mortgage for any reason, or for multiple reasons. These generally allow for a higher loan amount than the HECM program.
How are reverse mortgages paid out?
Let’s walk through the different ways you can get paid out for your reverse mortgage.
- You can get a lump sum paid all at once. This is the only way to secure a fixed rate for your reverse mortgage.
- You can establish a line of credit to draw from as you need it.
- You can opt to receive equal monthly payments.
- Or, you can choose to combine these options.
Repayment options for reverse mortgages
The borrower does not need to repay the loan as long as they remain living in the house. The loan becomes due after the home is sold or the death of the borrower and any eligible non-borrowing spouse (meaning a spouse who is not on the loan but qualifies to stay in the home until the time of their own passing).
Most commonly, the reverse mortgage is repaid when the home is sold and the proceeds go to pay off the loan in full. This falls to either the homeowner (for instance, after moving from the home) or to the heirs (who would then receive any remaining equity in the home).
If the balance on the reverse mortgage is more than the home’s value, heirs may buy the home for 95% of its appraised value. Heirs have 30 days from receiving notice to buy or sell the home, or to turn it over to the lender to satisfy the debt.
Pros and cons of a reverse mortgage
Yes, a reverse mortgage creates access to cash. But it has plenty of potential pitfalls too. (And that’s why counseling is required for the HUD-backed loans). Let’s dig deeper into those upsides and downsides.
- Reverse mortgages usually come without the credit and income requirements you’d expect to meet before you’d think about qualifying for a traditional loan.
- These loans don’t have to be paid back as long as the homeowner is living in the home.
- Proceeds from reverse mortgages are usually tax-free, which is not the case for many other ways of generating cash (like income or stock sales).
- The non-recourse clause means that borrowers or heirs will never end up owing more on the loan than the home is worth.
- These loans are associated with high costs and fees (such as origination fee, mortgage insurance, service fees, and third-party fees).
- Variable interest rates can be risky.
- You’re dipping into your equity to get these loans. The wealth is already yours, but you’ll pay a lot to access it through this type of loan.
- You can’t get a mortgage interest deduction with this type of loan.
- If you have to move or sell the home, you’ll be on the hook to pay your reverse mortgage back — and that can be a heavy burden to bear.
- If the home isn’t already in good shape, you may have to do repair work in order to secure a reverse mortgage.
- While a reverse mortgage won’t affect a borrower’s Medicare or Social Security benefits, it might affect their eligibility to receive Medicaid benefits.
- Your spouse could be at risk if you die and they’re not on the loan agreement. If the surviving spouse wants to keep living in the home, they’ll have to find a way to repay the loan.
- You may not be able to leave the home to your heirs. You’ll be using up the home’s value now, taking away from heirs’ access to it later. Heirs will have to come up with the money to pay the loan, or sell the home to do so.
Is a reverse mortgage right for you?
A reverse mortgage can be a legitimate tool that helps senior citizens use the wealth they have accumulated over many years of homeownership. The right candidate for a reverse mortgage is someone who plans to stay in their home over the long term. And it’s best matched with someone who has taken the time to understand these complicated loan products, weigh the tradeoffs, and feel confident in their full understanding.
A reverse mortgage might not be a good fit for a homeowner who plans to move in the next few years, since the loan comes due when the homeowner moves out; it just may not be worth it.
It’s also not a good choice for a homeowner who intends to leave the home to heirs, from whom this type of loan takes away equity and passes along the burden of repayment.
Reverse mortgage alternatives
If you decide a reverse mortgage isn’t for you, you can explore a range of other options to generate or save money. Here are some to consider.
- Do a cash-out refinance loan to tap into your home’s equity instead.
- Take out a home equity line of credit (HELOC), or a home equity loan, which can be a less-expensive way to draw from your home’s equity.
- Sell and downsize or rent your home. You can sell at a profit and move to a smaller, less-expensive lodging. Or, you might even rent instead, opting out of the expense and responsibility of home owning, and taking the cash.
- Cash in other assets. Perhaps you own stocks you can sell, or a life insurance policy you no longer need. Investigate your own assets and you might find a solution with fewers risks and costs than a reverse mortgage.
- Rent out part of your home for income instead. You can generate income from your home without either taking out a reverse mortgage or selling that home: Stay in the home while you rent a portion out. (This works especially tidily for properties with detached structures such as in-law units.)
- Talk to an agent about your options. Together, you can dig into your personal financial picture and investigate creative options.
Tips to shop for a reverse mortgage
If you’ve weighed all your options diligently and decided a reverse mortgage is right for you, do proceed with caution, care, and a healthy dose of skepticism. Here are some tips to help you shop for a reverse mortgage.
- Not every lender offers this type of loan, but you should never pay a finder’s fee as part of your search. HUD publishes a list of FHA-approved lenders you can search by state.
- As with any loan (or any other major decision, for that matter), shop around. Compare costs and fees.
- Find your own counselor. Contact an HECM counselor or call HUD at 800-569-4287 for more information.
- Be skeptical of any “no-fee” claims. There are pretty much always fees to these types of loans (though most can typically be rolled into the loan).
- On the flip side, watch out for fees that are way too high.
- Consult a financial advisor before committing to any major investment decisions such as getting a reverse mortgage.
HUD and the FBI note that reverse mortgages have increased significantly in recent years, and that creates opportunity for scammers. So the agencies urge would-be borrowers, and especially seniors, to be on high alert.
In some cases, fraudsters appear to be offering investment opportunities, foreclosure or refinance assistance, or even free homes. They may target seniors in fake investment seminars, in houses of worship, through mailers, or in media, including TV and radio.
The FBI offers these tips to help people avoid getting caught up in reverse mortgage scams:
- Don’t respond to unsolicited ads.
- Be suspicious of anyone who says they can help you own a home with no money down.
- Find your own reverse mortgage counselor.
- Don’t sign any document unless you fully understand it.
If you feel you are a victim of this type of fraud, submit a complaint through the FBI’s electronic tip line or through your local FBI office, file an online complaint with HUD-OIG, or call HUD’s hotline at 800-347-3735.
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