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What Is a Reverse Mortgage?
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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.
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.
How does a reverse mortgage work?
A reverse mortgage has very different moving parts compared to a regular mortgage. With a reverse mortgage:
Your age is the most important factor in how much you qualify for. The minimum age may be 62 for a reverse mortgage, but older borrowers have more reverse mortgage borrowing power. There’s a catch for married couples: Lenders consider the youngest borrower’s age for the maximum loan amount.
You must have at least 50% equity in most cases. Lenders want to ensure you don’t end up owing more than your home is worth, so they set a much higher initial equity requirement than regular mortgage programs. A home appraisal is always required as part of the reverse mortgage process to get an unbiased opinion of your home’s value from a licensed real estate appraiser.
You don’t have to meet any debt-to-income (DTI) ratio requirements. No mortgage payment means no DTI ratio requirements, which are a major factor in qualifying for a regular mortgage. However, you will have to prove you have the resources to pay ongoing homeownership costs like homeowners insurance, property taxes and maintenance costs.
Your interest rate will have an impact on how much you qualify for. Because interest charges are added to your loan every month, the lower the interest rate, the more you’ll be able to borrow.
You have more choices for how you can convert your equity into cash. Instead of making payments each month, you can choose from one or a combination of the following six ways to tap your equity:
- 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.
You’ll be required to meet with a housing counselor. To make sure you fully understand all the pros and cons of a reverse mortgage, the U.S. Department of Housing and Urban Development (HUD) requires counseling from a HUD-approved counselor before applying.
Your loan could be foreclosed if you move out of the home. Homeowners with reverse mortgages should know the “triggers” that could result in a reverse mortgage foreclosure, which include:
- The death of one or both of the owners
- Evidence that the borrower is not living in the home as a primary residence
- Notification that property taxes or homeowners insurance have not been paid
- Evidence that the home isn’t being maintained
How you can use a reverse mortgage
Reverse mortgages give you the flexibility to use your home equity in a number of different ways. With a Home Equity Conversion Mortgage (HECM) you can:
- Pay off your current mortgage and other expenses to reduce your monthly expenses
- Remodel your home to accommodate changing health and age limitations
- Keep a line of credit for unexpected expenses and financial emergencies
- Pay for health insurance until you’re eligible for Medicare coverage or Social Security income
- Supplement your retirement income
- Pay for long term care and health needs
- Pay for transportation if you’re unable to drive
- Pay for a child or grandchild’s college or professional education
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 HUD-approved reverse mortgage counselor
Types of reverse mortgages
Most borrowers choose a Home Equity Conversion Mortgage, which is backed by the Federal Housing Administration (FHA). HECMs are the most common type of reverse mortgage, because they provide lenders with protection against losses by charging borrowers mortgage insurance while providing consumers with the safeguard of a required “second opinion” from a neutral reverse mortgage counselor.
There are also private lenders that offer reverse mortgage products, though the guidelines outlined here focus on HECMs. Most homeowners choose from three different types of reverse mortgages:
Home Equity Conversion Mortgages (HECMs). 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 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 money can you get from a reverse mortgage?
You can borrow up to the principal limit on a reverse mortgage based on your age, the interest rate on your loan and the appraised value of your home. You can use a reverse mortgage calculator for a quick estimate of the lump sum amount you might qualify for if you have the following information handy:
- Your age
- Type of property you own (single-family, townhome, condo or multifamily or manufactured home)
- Your home’s value
- Your current mortgage balance (if any)
- Whether the home is your primary residence
- Your home’s ZIP code
To calculate term and line of credit options, it’s best to contact reverse mortgage loan officers who have specialized loan software to do the calculations for you.
According to the Consumer Financial Protection Bureau (CFPB):
- Older borrowers with higher-priced homes and lower rates will get more reverse mortgage money
- Younger borrowers with lower-priced homes and higher rates will get less reverse mortgage money
How much does a reverse mortgage cost?
|Reverse mortgage fees at a glance|
|Monthly interest charges||
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 interest rate is adjustable, which could quickly reduce your available equity if rates are on the rise.
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.
Reverse mortgage pros and cons
Before you sign on the dotted line, consider the reverse mortgage pros and cons:
Note to formatting–please use green checks for pros and red x for cons
You can stay in your home longer with no monthly mortgage payment
You’ll have more choices for how to tap your equity than regular mortgages
You can add to your retirement income and leave other retirement accounts alone
You can pay off debt or have a rainy day fund for unexpected medical expenses
You won’t pay taxes on reverse mortgage money you receive
You’ll protect your heirs from inheriting an underwater home
Your home’s equity will shrink every month
You’ll pay high reverse mortgage closing costs
You may disqualify yourself from other income benefits
Your heirs will inherit less
You could lose your home to foreclosure if you can’t live in the home
You won’t get a tax deduction on the reverse mortgage interest until all or part of the balance is repaid
Is a reverse mortgage a good idea?
A reverse mortgage is a good idea if you fully understand the pros and cons listed above, and don’t have other financial resources to retire comfortably. The table below provides some reverse mortgage food for thought:
|A reverse mortgage may be a good idea if:||A reverse mortgage may not be a good idea if:|
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 loan allows you to borrow as much equity as you need in a lump sum with a fixed-rate payment. Home equity loans often 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 with a new loan that has a higher balance, 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 qualify 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).