A reverse mortgage is a mortgage loan from a lender that allows the homeowner to borrow against the equity in their home for their retirement years. Reverse mortgages are available to homeowners who are 62 or older with a substantial amount of equity, and who occupy the property as their primary residence.
Through a reverse mortgage, a homeowner can borrow against the property’s value to get funds out of it. In other words: Unlike a typical mortgage, on which borrowers make a monthly payment, a reverse mortgage requires no payments from the borrower. Instead, it pays them in the form of fixed monthly payments, a line of credit, or a lump sum.
When the borrower sells the house, moves away, or dies, the loan balance is due. Reverse mortgages are federally regulated so that the loan amount can’t be more than the home is worth, and the homeowner’s heirs will not be responsible for paying the difference if the loan balance eventually grows larger than the home is worth, such as if the market value slides.
With a typical mortgage, the borrower pays the bank every month, over time paying off the home and eventually owning it outright. But a reverse mortgage works in… well, the reverse. You get a loan and the lender pays you. With a typical mortgage, you earn equity; with a reverse mortgage, you’re taking equity out and it diminishes over time.
Here’s how it works. Reverse mortgages give you money by converting part of the equity you have in your home into payments. The money is typically tax free, and usually the homeowner doesn’t have to pay it back as long as they live in the home.
When the homeowner sells the home, moves out, or dies, the heirs are responsible for repaying the loan—most commonly by selling the home.
There are three types of reverse mortgages: single-purpose, proprietary, and home equity conversion mortgages (HCEMs). The first two make up small fractions of the total reverse mortgage market, while HCEMs make up the bulk of it. Let’s go through each type:
- A single-purpose reverse mortgage is available for low- or moderate-income homeowners, and is the cheapest reverse mortgage. They are available from some nonprofits as well as government agencies at state and local levels. As the name specifies, these loans can only be used for one purpose—such as expenses like home repairs or property taxes—which the lender designates.
- A proprietary reverse mortgage is a loan through a private company. Few reverse mortgages are proprietary. This type of reverse mortgage provides a higher loan amount—that’s why it’s also known as a jumbo reverse mortgage. Unlike single-purpose reverse mortgages, there’s no limitation on how the homeowner can choose to spend the funds.
- An HCEM is the most common type of reverse mortgage loan. These are federally insured and backed by the U. S. Department of Housing and Urban Development (HUD). This means that the government will repay the debt if the borrower doesn’t. Therefore, borrowers must pay insurance premiums to get an HECM; the funds from these mortgage insurance premiums make up the Federal Housing Administration (FHA) reserves.
Funds from this type of loan may also be used for any purpose. Like a proprietary reverse mortgage, HCEMs may be more expensive than the typical home loan, with high upfront costs.
Before applying for a HECM, would-be borrowers must meet with a counselor from a government-approved housing agency. The counselor will explain the financial obligations of the loan, including its costs, so borrowers understand what they’re signing up for. The counselor can also discuss the various types of reverse mortgages and explain how the costs and fees stack up. There is a fee for this counseling service itself, but no one will be turned away if they can’t afford to pay it.
The amount a homeowner can borrow with a reverse mortgage depends on multiple variables. These include the:
- Borrower’s age
- Type of mortgage
- Current interest rates
- Appraised value of the home
- Strength of your position to pay property taxes and homeowner’s insurance.
Generally speaking, older borrowers who have more equity and owe less on their homes can get more money out of it.
As of 2020, HUD raised the reverse mortgage limit to $765,600. But that is much more than the average borrower will take out.
If two spouses are co-borrowers on a reverse mortgage, neither is required to pay back the mortgage until both pass away or both move out. (If one of the spouses moves to a care facility, the reverse mortgage still doesn’t have to be repaid until the remaining spouse in the home dies or moves out.) Therefore, the Consumer Financial Protection Bureau recommends that both spouses sign as co-borrowers.
If one spouse is not a co-borrower, this spouse is responsible to pay back the loan when the borrower moves or passes away.
Rules for HECMs changed on August 4, 2014. For reverse mortgages issued before that date, non-borrowing spouses have six months to either move out of the home or pay off the mortgage; the surviving spouse does not have the right to stay in the house.
For HECMs issued after that date, a non-borrowing spouse can stay if the borrowing spouse dies or moves out, assuming the non-borrower was married to the borrower when it was issued and the non-borrower is named as a spouse in the paperwork. As a third condition, the borrower (if still living) must certify the non-borrowing spouse as eligible annually. If the requirements are all met, the reverse mortgage is not due until the non-borrowing spouse dies or moves.
Reverse mortgages come with both ongoing costs as well as upfront costs.
Upfront, they have origination fees, equal to either $2,500 or 2% of the first $200,000 of the home’s appraised value—whichever is more. Add 1% of your home’s value above $200,000. With HCEMs, the FHA caps origination fees at $6,000.
You’ll also have closing costs—such as for title search, inspection, and appraisal. For HECMs, you’ll pay the fee required for counseling, equal to about $125 (which may be waived if you can’t pay).
Then, there’s the upfront mortgage insurance premium, which is 2% of your home’s value.
Ongoing costs include interest payments (remember, in the case of a reverse mortgage, your balance is getting larger rather than smaller over time). You’ll also pay annual mortgage insurance premiums (which will also go up over time), your annual property taxes, and homeowners insurance.
Reverse mortgages provide borrowers the chance to get money from their home equity without having to make monthly mortgage payments. It can help retirees supplement fixed incomes and stay in their homes as they age. And this type of mortgage can help provide funds needed for home repair, health care, or other essentials.
However, reverse mortgages come with obvious downsides, and should be approached with caution. Instead of paying down your mortgage and gaining more and more equity over time, you’re digging into that equity while you are alive and using it up. Upon your death, you’ll pass a diminished inheritance to your heirs.
There are also substantial costs associated with reverse mortgages. These include closing costs, fees, and insurance. And even though seniors won’t be making monthly payments as with a traditional mortgage, the home can still be foreclosed if the borrower doesn’t pay all the necessary fees (such as property insurance, taxes, etc.).
The FBI and HUD urge seniors to approach reverse mortgages with caution and skepticism, noting that reverse mortgages have increased substantially in recent years, creating major opportunities for fraudsters.
In many cases, scammers offer free homes, investment opportunities, or foreclosure or refinance assistance. They may target seniors through churches, investment seminars, on TV or the radio, or in mailers.
The FBI’s tips for avoiding reverse mortgage scams include:
- Don’t respond to unsolicited ads.
- Be skeptical of any claims that you can own a home without a down payment.
- If you don’t understand a document fully, don’t sign it.
- Don’t accept funds from people for a home you didn’t buy.
- Find your own reverse mortgage counselor.
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