What is a reverse mortgage? How does it really work? Is it right (or wrong) for you? An experienced industry veteran explains the ins and outs of how this unique product can potentially empower your retirement.
I’ve helped many seniors get reverse mortgage loans over the years, including a very close relative. I’ve also published a book about the product. I’m a big fan, but I’m not here to try and talk you into getting one.
My goal is to give you a straightforward reverse mortgage explanation so you can see how a reverse can potentially enhance and empower your retirement. Once we’re done here, you’ll have information you need you need to decide if it’s worth looking into further.
Much of what you’ve heard about reverse mortgages is either dated or simply not true. Rumors and misconceptions abound. You’ve probably heard that you give up ownership of your home, the rates are sky high, and that only the broke and desperate get reverse mortgages.
But are these rumors actually true?
In this guide, we’ll cover the basics of a reverse mortgage and separate fact from fiction. We’ll equip you with the information you need to decide if it’s the right solution for you. Here’s the reverse mortgage explained by an industry veteran in simple and understandable terms.
Table of Contents
Reverse Mortgage Basics
A reverse mortgage is a unique home loan designed to give you access to a portion of your home’s value without a mortgage payment and without giving up ownership of your home.
The most popular reverse mortgage for seniors in America is the home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders).
Congress created the HECM as part of the Housing and Community Development Act of 1987, which was signed into law by President Reagan.
HECMs are funded by private lenders, but insured and regulated by the Federal Housing Administration (FHA).
The minimum qualifying age for a HECM is 62. If you’re married, only one of you needs to be at least 62. The younger spouse can qualify as a non-borrowing spouse.
The HECM is not the only option available. Proprietary or “jumbo” reverse products are also available. Jumbos have minimum ages as low as 55, but they’re designed for homeowners with home values of $1 million or more. The HECM is by far the most common reverse product, so it’s what we’ll focus on here.
How Does a Reverse Mortgage Work?
How a reverse mortgage works is simple, but the opposite of what you’re probably used to.
With a traditional “forward” mortgage, you borrow a large amount and pay it back on a monthly basis over time. Your loan balance decreases and your home equity increases over time.
A reverse works in the opposite direction. You borrow over time and pay it back in one lump sum when you’re no longer living in the home. The idea is to convert home equity into cash that you can use to protect and enhance your retirement lifestyle.
No mortgage payments are required as long as at least one borrower (or non-borrowing spouse) lives in the home and pays the property taxes, homeowner’s insurance, and HOA dues (if applicable).
The loan becomes due and payable when the last borrower or non-borrowing spouse permanently leaves the home.
You remain the owner of your home and you’re free to leave it to your heirs. Your heirs can keep the home by paying off or refinancing the loan balance. If your heirs don’t want the home, they can sell it, pay off the loan, and keep the remaining equity.
Your heirs can also let the lender sell it if they don’t want to keep the home or mess with selling it.
The HECM is a non-recourse loan, which means the most that will have to be repaid is the value of your home. FHA covers the shortage if your home isn’t worth enough to pay off the entire balance.
Reverse mortgage definition: A type of home loan that enables homeowners to convert home equity into cash without a mortgage payment or giving up ownership of the home.
Payout Options
The HECM is highly flexible and customizable, which means it can be used for a lot of different things. Proceeds can be taken as a lump sum, line of credit, term/tenure income, or some combination of all of these options. Seniors commonly use it to:
- Eliminate existing mortgage payments
- Eliminate consumer debt payments (credit cards, auto loans, personal loans, etc.)
- Pay for medical bills
- Finance home improvements
- Supplement retirement income
- Supplement retirement assets
- Rainy day or emergency fund
You can use the proceeds for pretty much whatever you like.
What is the Reverse Mortgage Best Used For?
Many people still think a reverse is only for the broke and desperate who have no other options. We’ll cover why this isn’t true shortly.
In my opinion, a HECM is best used not as a life raft, but as a safety net. The best candidates are those who are at least financially stable. The idea is to protect and enhance your retirement lifestyle and financial security by eliminating monthly expenses, supplementing income and assets, covering home repairs, upgrades, and maintenance, etc.
Reverse Mortgage for Purchase
Many seniors also use a HECM to finance a home purchase without a mortgage payment. In my opinion, this is one of the best-kept secrets of the mortgage industry. There are two great reasons to finance a home purchase this way:
- Increased purchasing power – You don’t need to pay cash to avoid a mortgage payment. The lender can finance part of the purchase price, which means you can purchase more home than you could otherwise afford with just cash.
- Keep more cash in the bank – Because you can finance part of the purchase price, you don’t need to pay 100% cash to avoid a mortgage payment. This keeps more cash in the bank to fund your retirement.
How this works is pretty simple: you bring your down payment (plus any closing costs) and the bank finances the rest with no monthly mortgage payment. Your obligation is to live in the home and pay your property charges.
The down payment for a purchase HECM varies depending on age, home purchase price, and current interest rates. If you’d like to estimate a down payment, check out our purchase calculator.
Reverse Mortgage Pros and Cons
The HECM is a great mortgage product, but it’s not always the perfect solution. There are some situations where it may not be a good fit.
In our opinion, any perceived reverse mortgage cons are usually just issues of suitability. In other words, it’s just not the right solution for the situation. If you’re at least 62 and have a lot of equity in your home, you can probably benefit in at least some way.
Feel free to check out our article about potential reverse mortgage pros and cons.
How Much Can I Get?
If you’d like to estimate how much you can get, check out our reverse mortgage calculator.
Upfront and Ongoing Costs
A reverse mortgage is a home loan, so there are some upfront and ongoing costs. The costs generally fall into two buckets: interest and closing costs.
Interest and MIP
HECM interest rates are usually comparable to traditional “forward” mortgage rates.
The interest is calculated the same as any other type of home loan: it accrues monthly based on an annual percentage rate.
The difference, of course, is that you don’t have to make payments on the interest (or the principal for that matter). Any unpaid interest simply accrues onto the loan balance over time. Your home equity pays the mortgage “payment” so you don’t have to make a mortgage payment out of your pocket.
FHA also assesses it’s own mortgage insurance premium on top of the initial interest rate. This premium, which is called annual mortgage insurance premium (MIP), works just like the initial interest rate. It’s based on an annual rate with accruals on a monthly basis.
The annual mortgage insurance premium is important because it helps make the HECM non-recourse.
Some lenders may also charge monthly servicing fees, but they’re less common than they used to be.
Closing Costs
HECM closing costs can be pricey, but they’re not always pricey. These are the most common closing costs you may encounter:
- Third party costs: These are the services the lender has to hire to get the loan. Such services include title insurance, escrow, appraisal, government recording, attorney fees, etc.
- Origination: Lenders often charge origination fees to cover the costs associated with processing and completing your loan.
- Initial mortgage insurance premium (IMIP): This is a one-time fee charged by FHA at closing. FHA uses IMIP premiums to insure HECMs and make them non recourse, and guarantee the funds even if your lender goes out of business at some point.
Regardless of whether the closing costs are cheap or not, the vast majority are usually not paid out of pocket. Most lenders will allow the closing costs to be rolled into the new loan balance. The exception is HECM for purchase; if you’re buying a home with a HECM, the closing costs are paid out of pocket as part of your cash to close.
Closing costs vary widely depending on loan scenario, interest rate conditions, and your property value and location. Most online information likely won’t include closing costs estimates. If you’d like to get a closing cost estimate, you’ll need to contact a lender.
How to Qualify
In the past, there were very few reverse mortgage requirements with regard to income and credit. You could have terrible credit and zero income and still qualify.
FHA has since implemented new qualifying guidelines to limit defaults due to nonpayment of property taxes, homeowner’s insurance, and HOA dues (where applicable). These days, lenders are required to evaluate your credit and income as part of the application and approval process.
This is why a reverse is not a loan of last resort for the broke and desperate. You have to qualify. The broke and desperate commonly don’t qualify because they have limited income and/or severely damaged credit.
The lending guidelines are tighter today than in the past, but it’s still relatively easy to qualify. You don’t need to have a lot of income and you don’t need to have perfect credit. In fact, lenders don’t even care about your credit scores.
Lenders are mainly concerned with the following:
- Payment histories on debts and property charges: It’s OK to have a few late payments here and there as long as there aren’t too many of them. Lenders are most concerned with your payment histories for property taxes, homeowner’s insurance, and HOA dues (if applicable). It’s extremely important that you’ve paid your property charges on time.
- Residual income: Your lender wants to make sure you have enough residual income left over at the end of the month after paying your property charges, debt payments, and estimated utilities.
You may still qualify if you don’t meet the payment history or residual income requirements. Lenders have flexibility to still approve your loan by documenting certain compensating factors or extenuating circumstances that offset the derogatory credit and/or income shortfall, respectively.
If you don’t have any valid compensating factors or extenuating circumstances, you may still qualify with a life expectancy set-aside (LESA).
Counseling
Counseling is required by HUD when you apply for a HECM reverse mortgage. The purpose of counseling is to ensure that you understand basic concepts and information about reverse mortgages.
The counseling session is conducted by an independent third-party HUD-licensed counselor and usually costs between $125 to $175. Once the counseling is complete, you’ll be issued a certificate that you’ll need to provide to your lender.
You can easily find counselors in your area or across the nation using our reverse mortgage counselors directory. Your lender may also be able to provide a list of counselors.
How to Find Lenders
Finding lenders to work with is pretty easy. I would suggest first asking for referrals from friends, colleagues, neighbors, and relatives. A trusted real estate agent, financial adviser, or CPA may also be a good referral source. A lot of people have reverse mortgages, so it’s a good bet you know somebody who can give you a lender recommendation.
If you don’t know anybody who give a referral, try Googling top lenders or searching our reverse mortgage lender directory. Note that you don’t necessarily need to work with a lender located in your area. There are many good national lenders licensed in your state.
A reputable lender will thoroughly cover the basics of reverse mortgages and take the time to learn about your financial goals.
If the lender you’re working with seems impatient or pushy, we recommend finding another one.
Frequently Asked Questions
Who owns the house in a reverse mortgage?
You always retain title ownership of your home. It’s a common misconception that the bank owns the home.
Can you lose your house with a reverse mortgage?
You obligation is to live in your home, maintain it like normal, and pay your property taxes, homeowner’s insurance, and HOA dues (if applicable). If you do these things, it’s very difficult to lose your home.
Can I reverse my reverse mortgage?
Yes, you can pay off or refinance the balance at any time. There is no prepayment penalty and no limitations on selling your home.
Can you owe more than the home is worth with a reverse mortgage?
It’s possible that the loan balance can exceed the home value if home values fall. However, FHA covers the shortage. You or your heirs will never have to repay any more than the value of the home.
When do you have to repay a reverse mortgage?
The balance doesn’t have to be repaid until the last borrower or non-borrowing spouse no longer lives in the home and pays the property charges.
Why would someone get a reverse mortgage?
Many people use the proceeds to eliminate existing mortgage or consumer debt payments, do home improvements, pay for medical bills, supplement income or retirement assets, or plan for future end of life or long term care expenses.
