What Is A Reverse Mortgage, And How Does It Work?  

A senior couple peruses paperwork as they research “what is a reverse mortgage?”

Key Takeaways

-A reverse mortgage is a loan that allows you to borrow money against the value of your home. You can receive the loan amount as a lump sum, fixed monthly payments or a rolling line of credit.

-To qualify, you must be 62 or older and either own your home outright or have substantial equity in it – usually at least 50%.

-Unlike a “regular,” or forward, mortgage, a reverse mortgage doesn’t require you to make any repayments. The loan only becomes due when you die, sell your home or move away for more than a year.

-The federal government regulates most reverse mortgages to protect borrowers and their families. Still, there are mortgage scammers that target vulnerable or financially distressed seniors. 

-Even a legitimate reverse mortgage may not be the best solution for you. Before you get a reverse mortgage, it’s important to speak with a qualified adviser and carefully weigh all your options.

If you own your home and are 62 or older, you may be eligible for a reverse mortgage. Before you apply, however, you should do plenty of research and speak with a qualified financial adviser. This article is a good place to start. It answers frequently asked questions such as, “What is a reverse mortgage?”, “Who qualifies for a reverse mortgage?” and more.

What Is a Reverse Mortgage?

A reverse mortgage is a loan. It is open to homeowners who are 62 or older and either own their homes outright or have a minimum equity of 50%.

When you take out a reverse mortgage, you borrow money against the value of your home. You can choose to receive the loan amount as a lump sum, fixed monthly payments, a rolling line of credit or a combination of these.

One of the main advantages of a reverse mortgage is that you don’t have to make monthly repayments. Instead, the entire loan balance becomes due when you:

-Die

-Sell the property

-Move or relocate for over a year, including moving in with relatives, into a nursing home or into an assisted living facility

Another benefit of reverse mortgages is that, per federal law, the loan balance can’t exceed the property’s value. That means you or your heirs won’t have to cover the difference if your home’s market value drops or if you live a long time.   

What Is the Difference Between a Reverse and a Regular Mortgage?

A “regular” or forward mortgage enables you to buy a home. In contrast, you can only take out a reverse mortgage if you already own your home or have generated substantial equity in it. Reverse mortgages are also only available to people who are 62 or older, whereas forward mortgages have no age limit.

Another key difference is that with a forward mortgage, you have to make regular loan payments. With a reverse mortgage, the lender pays you, and the loan balance only becomes due when you die, sell your home, or move away for a year or more.

A comparison of regular vs. reverse mortgages

What Is the Difference Between a Reverse Mortgage and a Home Equity Loan?

Reverse mortgages, home equity loans (HELs), and home equity lines of credit (HELOCs) are loans that let you borrow money against your home equity. 

When you take out a HEL, you receive a single lump-sum payment that you then repay in regular installments at a fixed interest rate. 

With a HELOC, you get access to a rolling line of credit. You can borrow money when and as you need it, and only owe interest on the amount you actually use. 

To qualify for a HEL or HELOC, you must qualify with your credit score, loan-to-value (LTV) ratio and debt-to-income (DTI) ratio. In contrast, reverse mortgages don’t have credit score or income requirements.

Who Qualifies for a Reverse Mortgage?

To be eligible for a reverse mortgage, you must be 62 or older and either own your home outright or have considerable equity in it – in most cases, at least 50%.

There are no income or credit score requirements, but you need to live in your home and maintain it in good condition. You will also be responsible for paying property taxes and homeowners’ insurance. 

What Types of Reverse Mortgages Are There? 

There are three main types of reverse mortgages.

Single-Purpose Reverse Mortgage

As the name suggests, you may only use this type of mortgage for one thing, such as to fund home repairs or improvements or pay property taxes. The lender must approve the specific use.

This is the least expensive reverse mortgage option, and is open to people with low or moderate incomes. However, single-purpose reverse mortgages aren’t widely available. You can get them from some non-profit organizations, and some state and local government agencies.

Proprietary Reverse Mortgage

You may qualify for a proprietary, or jumbo, reverse mortgage if you have a higher-value home, which typically means it’s worth more than $765,600. These types of mortgages are private loans. The companies that develop them also back them. 

Home Equity Conversion Mortgage (HECM)

This is the most common type of reverse mortgage. HECMs represent almost all of the reverse mortgages on homes worth $765,600 or lower. In 2020 alone, U.S. homeowners took out more than 40,000 HECMs.

HECMs are federally insured reverse mortgages, backed by the U.S. Department of Housing and Urban Development (HUD). You may use a HECM loan for any purpose

How Much Can You Borrow with a Reverse Mortgage?

Your initial principal limit – or the amount of money you can borrow on a reverse mortgage – depends on the lender, your payment plan and several other factors, including:

-Your age

-The type of mortgage 

-The loan’s interest rate

-The appraised value of your home

-How much you owe on the home

-The amount of equity you have in your home

-Your ability to pay property taxes and homeowners insurance

As a general rule, the older you are and the more equity you have in the property, the more you can borrow.

For a HECM, how much you can borrow depends on:

-The interest rate

-The age of the youngest borrower or, if you’re married, the age of the younger spouse even if they are not a borrower

-Your home’s appraised value or the maximum claim amount as set by the Federal Housing Administration ($822,375 for 2021), whichever is less

In any case, you can’t borrow 100% of your home’s value. Part of your equity will go toward the loan expenses, including the origination fee, interest and mortgage premiums.

Government policy also affects the initial principal limit. In October 2017, the government lowered the initial principal limit to ensure borrowers retain more equity. Unfortunately, that has also made it harder for younger homeowners to qualify for a reverse mortgage.

Reverse mortgage principal limit factors and lending limits in 2021

Furthermore, if you choose to receive the loan amount as a lump sum or line of credit, you can’t borrow the entire initial principal limit in the first year. You can generally borrow only up to 60% - possibly more if you’re using the funds to pay off a forward mortgage.

How Does a Reverse Mortgage Work? 

Here’s what you can expect when you apply for a HECM.

1. You Will Meet with a Financial Counselor

Before submitting your application, you must meet with a mortgage counselor from a government-approved housing counseling agency. Note that some lenders may require counseling when you apply for a proprietary reverse mortgage as well.

These agencies normally charge a fee, usually around $125. You don’t have to pay right away, though, as you can use the loan proceeds to cover the fee at a later date. Agencies cannot turn you away if you can’t afford to pay this fee.

At the meeting, your counselor will explain:

The costs and financial implications of the loan

Possible alternatives, such as single-purpose or proprietary reverse mortgages, or other government and non-profit programs

How different factors – such as payment plans, fees, interest, insurance, and other expenses – will affect the total loan cost over time

You can search for counseling agencies near you on HUD’s website.

2. The Lender Will Carry Out a Financial Assessment

While HECMs usually don’t have income requirements, your lender must still conduct a financial assessment before approving the loan. 

The lender will assess whether you meet the mortgage requirements, as well as your ability and willingness to cover expenses such as property taxes and homeowners’ insurance. In some cases, the lender may choose to deduct funds from the loan amount and make these payments for you. However, you would still be responsible for maintaining the property.

3. You Will Choose a Payment Plan

If the lender approves your application, you can decide how you want to receive the proceeds. You can choose from the following six options.

Lump sum. The lender pays you the entire loan amount upfront. This is the only payment plan with a fixed interest rate. The other five have adjustable rates. Conversely, you typically are able to get less money with this option.

Tenure plan. The lender makes fixed monthly payments for as long as at least one borrower lives in the property.

Term payments. The lender makes fixed monthly payments for an agreed period, such as 10 years.

Line of credit. You can borrow money when and as you need it, and pay interest only on the credit you actually take out.

Tenure plan plus a line of credit. The lender makes fixed monthly payments as long as at least one borrower lives in the property. If the borrower needs more money, they can tap into a line of credit.

Term payments plus a line of credit. The lender makes fixed monthly payments for a set period. If the borrower needs more money during or after that period, they can access a line of credit.

If you want to change your payment plan at a later date, you may be able to do so for a small fee.

Is a Reverse Mortgage Right for You?

A reverse mortgage may be a great solution for some people, but they’re not for everyone. So before applying for a reverse mortgage, you and your family should carefully weigh the pros and cons.

The Pros

Ability to Tap Into Your Home Equity Without Selling

A reverse mortgage can provide you with cash when your net worth is locked up in your property, but you don’t want to sell it or move out. You can continue living in your home and even sell it to your children or grandchildren at the end of the term.

No Income or Credit Score Requirements

You could consider a reverse mortgage if you don’t qualify for other solutions, such as personal or home equity loans. 

No Monthly Payments

With a reverse mortgage, you don’t have to make any monthly payments. The loan balance – including the premium, interest, insurance and loan fees – only becomes due when you die, move out or sell the property.

Proceeds Are Not Taxable

The IRS doesn’t consider the money as income but rather as a loan advance.

The Cons

Risk of Foreclosure

A reverse mortgage uses your home as collateral. That means you risk foreclosure if you fail to meet certain conditions, such as paying property taxes and homeowners’ insurance, or maintaining your home.

No Right to the Property for Others Living in the Home

If you live with someone other than your spouse, such as a relative, friend or roommate, they won’t have any right to live in the property after you die or move out. In some cases, a widow or widower may also lose the home after their spouse’s death.

Scams

Unfortunately, scammers target vulnerable seniors. A common fraud involves offering a “secure” reverse mortgage to help fund home improvements. Once you sign the paperwork, the vendor or home improvement contractor takes off with your money. 

The Bottom Line: Reverse Mortgages Are Not for Everyone

Before applying for a reverse mortgage, consider all your options. There are other ways to access equity in your home. Some of these alternatives – such as Unlock’s Home Equity Agreements (HEAs) – don’t involve loans and may be a better fit for you. 

To learn more about our HEA solutions, click here.