What Is a Reverse Mortgage?
Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It may not have been previewed, commissioned or otherwise endorsed by any of our network partners.
A reverse mortgage is a type of home loan for homeowners age 62 and older, which allows them to tap equity without having to make any mortgage payments on the amount they borrow — and stay in their home as they age.
Reverse mortgages are becoming increasingly popular as a retirement planning tool for homeowners who have significant equity in their homes — or own their properties outright — and want flexible access to their home equity. However, homeowners will pay more in borrowing costs, and reverse mortgage rules make it clear they’re still responsible for ongoing expenses.
What is a reverse mortgage?
A reverse mortgage is a home loan that allows homeowners who are 62 or older to convert home equity into cash. Instead of you making payments to your lender, your lender makes payments to you — the “reverse” of how you’d normally pay a traditional “forward” mortgage.
With a reverse mortgage, your loan balance grows over time instead of shrinking, as it does with a regular mortgage. Most borrowers choose a Home Equity Conversion Mortgage (HECM), which is backed by the Federal Housing Administration (FHA). There are also private lenders that offer reverse mortgage products, though the guidelines outlined here focus on HECMs.
Who is eligible for a reverse mortgage?
Reverse mortgage requirements are very different from those for traditional mortgages. To be eligible for a reverse mortgage, you must:
- Be at least 62 years old
- Own your home outright or have at least 50% equity
- Live in the home you’re financing for most of the year
- Not be delinquent on federal debt, such as student loans or income taxes
- Prove you can pay ongoing property taxes and homeowners insurance premiums
- Maintain your home in good condition, or use reverse mortgage funds for necessary repairs
- Get counseling from a reverse mortgage counselor approved by the U.S. Department of Housing and Urban Development (HUD)
How does a reverse mortgage work?
Many homeowners choose reverse mortgages because they have more options for tapping their equity. Keep in mind that none of these options require a monthly mortgage payment on the amount you borrow.
You can choose from one or a combination of the following six ways to convert your equity into cash with a reverse mortgage:
- One lump sum. This option involves a single large payment made to you after your loan closes, allowing you to pad your cash reserves to use as needed. An added bonus of this choice: Your interest rate will be fixed.
- Tenure. You can choose regular monthly payments for as long as you or a co-borrower live in the home as your primary residence.
- Term. If you need a few years’ worth of extra income, this option lets you choose a set number of months you’ll receive regular monthly payments.
- Line of credit. If you prefer an extra cushion to cover unexpected expenses as you age, the line of credit option may be a good fit. It works similar to a credit card or home equity line of credit (HELOC), giving you access to cash as needed up to the available balance.
- Modified tenure. Choose this option if you want to set up a line of credit in addition to receiving a monthly payment amount for as long as you and a spouse or co-borrower live in the home.
- Modified term. You can add a line of credit to a schedule of monthly payments you receive for a set time you choose.
Types of reverse mortgages
Homeowners can choose from three different types of reverse mortgages:
Home Equity Conversion Mortgages (HECMs). HECMs, insured by the FHA, are the most common type of reverse mortgage. Funds from a HECM can be used for any purpose. HECMs have a “maximum claim amount,” which limits how much a homeowner can borrow. In 2021, the maximum claim amount for a HECM is $822,375 in all parts of the country, as well as Alaska, Hawaii, Guam and the U.S. Virgin Islands.
Proprietary reverse mortgages. Private companies offer reverse mortgage programs offering higher loan amounts than the HECM loan limits set by the FHA. You may be able to borrow more money from the outset than with a HECM, but these proprietary reverse loans don’t have federal insurance backing and may be more expensive.
Single-purpose reverse mortgages. State and local government agencies may offer special reverse mortgages to meet specific homeowner needs, such as paying past-due property taxes or making repairs to keep a home safe and livable. However, not all states offer them.
How much does a reverse mortgage cost?
You’ll pay more for reverse mortgage closing costs compared to those of a traditional home loan — plus, you’ll still be responsible for ongoing costs. Here’s an explanation of common reverse mortgage costs:
You’ll pay an origination fee to cover the lender’s expenses for originating your loan. The fees break out as follows:
- The greater of $2,500 or 2% of the first $200,000 of your home’s appraised value
- 1% of your home’s value above $200,000
- A maximum of $6,000 in total lender HECM fees
Similar to a regular FHA loan, with a HECM, you’ll pay an upfront mortgage insurance premium (UFMIP) and an annual mortgage insurance premium (MIP).
- The UFMIP is 2% of your home’s value and is typically rolled into your loan amount
- The annual MIP charge is 0.5% of your loan balance
- The MIP amount will increase as your loan balance increases
You’ll typically spend $125 for a reverse mortgage counseling session with a HUD-approved agency. Although reverse mortgage rules require the counseling, the fee may be waived in certain cases.
Monthly interest charges
Your monthly interest charges grow as your loan balance grows. Unless you choose the lump sum option, your reverse mortgage rate is adjustable, which could reduce your available equity faster if rates are on the rise.
|Reverse Mortgage Fees At a Glance|
|Monthly interest charges||
Reverse mortgage pros and cons
Qualification is based only on your age and available home equity
No monthly payments are due on the loan balance
Monthly income payments you receive aren’t taxable
Mortgage insurance protects your heirs from paying the loan balance upon your death or relocation from the home
Flexible choices to use home equity as needed as your living needs change
Higher costs compared to traditional mortgages
Loan balance increases over time
Home equity decreases over time
Other government benefits may be reduced if you receive a monthly installment payment
The inheritance value of your home will decline as your loan balance rises
The loan could be foreclosed if you can’t live in the home full time, or stop paying your homeowners insurance or property taxes
Alternatives to a reverse mortgage
If you don’t have enough equity, or you’re not old enough to take out a reverse mortgage, but you do have enough retirement income to qualify, consider these reverse mortgage alternatives:
Home equity loan
A home equity loan allows you to borrow as much equity as you need in a lump sum with a fixed-rate payment. Home equity loans come in terms of five to 15 years, but you’ll need to show you make enough income to qualify.
Home equity line of credit
A home equity line of credit (HELOC) works like a credit card that you can use as needed. You’ll usually make interest-only payments on the amount you draw for a set time, called a “draw period.” After the draw period ends, the balance is paid in installments during the “repayment period.” HELOCs tend to have variable rates.
A cash-out refinance replaces your current mortgage balance with a new loan at a higher loan amount, which allows you to pocket the difference in cash. Conventional and FHA cash-out refinances allow you to borrow up to 80% of your home’s value. Eligible military borrowers may be able to tap up to 90% of their home’s value with a cash-out refinance guaranteed by the U.S. Department of Veterans Affairs (VA).
How to spot a reverse mortgage scam
Below are some tips to avoid becoming a victim of reverse mortgage scams:
- Don’t reply to unsolicited reverse mortgage offers by email or over the phone.
- Never give out confidential personal information over the phone or by email.
- Contact a HUD-approved counselor if you’re not sure an offer is legitimate.
- Don’t sign anything you don’t understand.