The reverse mortgage is a fantastic product, but it’s not the right solution for everybody. Is it right (or wrong) for you? In this article, we’ll cover key reverse mortgage information to help you decide if a reverse mortgage is the right solution for you.
There is quite a bit of reverse mortgage information in this article, so we’ve included the following table of contents to make it easier to navigate through the content. We’ve also included “Back to Top” links throughout the article so it’s easier to return to the top of the page. We hope you find this information helpful! If you have any questions, feel free to post them in our Q&A.
Table of Contents
- Why the Reverse Mortgage?
- What Is a Reverse Mortgage?
- HECM Reverse Mortgage Basics
- Common Myths and Misconceptions
- How the Reverse Mortgage Works
- Payout Options
- How to Calculate Reverse Mortgage Proceeds
- Closing Costs
- Reverse Mortgage Requirements
- Reverse Mortgage Counseling
- Finding Reverse Mortgage Lenders
- Reverse Mortgage Calculators <— Click here for reverse mortgage calculator links
- Summary of What We’ve Covered
Note that this article is not intended to be a comprehensive source of information about reverse mortgages. Where relevant, we’ve linked to other articles on this site where you can get more in-depth information about a given topic.
Why the Reverse Mortgage?
According to US Census data, the median household net worth for seniors 65 or older is $201,500. At first blush, that sounds like a good statistic, but here’s the problem: almost 70% of that number is in the form of home equity. Now, don’t get me wrong, home equity is a good thing to have. But it’s not liquid, which means it has little practical impact on your retirement lifestyle. If you have no plans to sell your home, it doesn’t matter whether you have a dollar or one million dollars in home equity. It’s essentially just a number on paper. Case in point: there are seniors with million-dollar paid off homes in the San Francisco area who are practically living on cat food. They’re technically millionaires, yet they’re barely scraping by on a meager Social Security income. Yes, home equity is great to have, but it has no impact on your retirement lifestyle unless you can convert it into cash.
In the past, there were just two ways to convert home equity into cash: 1) sell the home, or 2) get a “cash out” mortgage. The first option makes no sense if you want to continue living in your home. The second option, a “cash out” mortgage (including HELOCs), somewhat defeats the purpose of converting equity into cash. If your goal is to free up cash, it doesn’t make sense to add another payment to the financial picture.
The reverse mortgage was created to offer a third and better option. It was created to give seniors access to their largest asset – home equity – without selling or taking on a mortgage payment.
What Is a Reverse Mortgage?
The first and most important thing to understand is this: a reverse mortgage is simply a home loan. However, it’s 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 common reverse mortgage in the United States is the home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). If somebody you know recently got a reverse mortgage, it’s likely they got a HECM.
The HECM program was created and signed into law by President Ronald Reagan as part of the Housing and Community Development Act of 1987. The HECM is overseen and regulated by the Federal Housing Administration (FHA) under the authority of the Department of Housing and Urban Development (HUD).
Over 50,000 HECMs are written every year in America today. That number is likely to grow in the future as more seniors learn about the reverse mortgage.
HECM Reverse Mortgage Basics
There is a lot of misinformation floating around about reverse mortgages. Let’s get some basic reverse mortgage information down first before we dig into some deeper topics later.
- The minimum qualifying age is 62. If you’re married, only one spouse needs to be at least 62. The younger spouse can qualify as an eligible non-borrowing spouse (NBS).
- No mortgage payments are required as long as at least one borrower or non-borrowing spouse is permanently living in the home, maintaining it, and paying the required property charges.
- You remain the owner of the home and you’re free to leave it to your heirs. Your heirs can keep the home by paying off or refinancing the reverse mortgage balance. If your heirs don’t want the home, they can choose to sell it. Once the home is sold, the reverse mortgage balance is paid off and the remaining equity goes to your heirs. If your heirs don’t want to keep the home or hassle with selling it, the lender will sell it for market value (as documented by an appraisal). Any remaining equity goes into your estate once the reverse mortgage is paid off.
- The HECM is non recourse. The most that will ever have to be repaid is the value of the home. FHA will cover the shortage if the home isn’t worth enough to pay off the entire balance.
- HECM proceeds are not subject to income taxes. Because there is an expectation of repayment at some point, HECM proceeds are not subject to income taxes.
- HECM proceeds have no impact on Social Security retirement or Medicare benefits. However, proceeds can potentially impact Medicaid and Social Security disability benefits. If you receive these benefits, be sure to research how a reverse mortgage could affect them.
Common Myths and Misconceptions
Unfortunately, much of the reverse mortgage information you’ve probably heard is based on myths and misconceptions. Many seniors miss out on the great benefits of a reverse mortgage because they get scared by the things they’ve heard. The following summarizes the most common myths and misconceptions you may have heard:
“I’m giving up ownership of my home.” Not at all. A reverse mortgage is simply a home loan. You always retain title ownership of the home.
“The reverse mortgage is only for broke and desperate people.” Not at all. In fact, many so-called broke or desperate people often don’t even qualify. Many wealthy people take advantage of a reverse mortgage because it gives them additional cash management options they wouldn’t otherwise have.
“The reverse mortgage will use up all of my equity.” Not necessarily. It’s true that the reverse mortgage converts equity into cash, which means your loan balance rises over time. However, it’s also designed to preserve equity. Remember, the reverse mortgage is non-recourse. If your home isn’t worth enough to cover the entire balance, FHA covers the shortage. Obviously, the HECM is not a financially viable program if it uses up your equity quickly because FHA would end up covering a lot of shortages.
“I’ll be leaving a big debt to my heirs.” Again, the reverse mortgage is non-recourse, which means that a debt can never be passed on to your heirs. If there’s not enough value in the home to pay off the entire balance, you or your heirs are not responsible to cover the shortage.
“Reverse mortgage interest rates are sky high.” Not at all. In fact, HECM reverse mortgage rates are often very comparable to traditional mortgage rates.
“The fees are really expensive.” This is true sometimes, but not all the time. If you live in a high value home, it’s possible the fees can be steep because of the IMIP charged by FHA. However, the fees are not typically paid out of pocket. The exception is HECM for purchase, in which case the fees are paid as part of your down payment.
“The bank takes my house when I die.” Not at all. You are always the owner and you’re free to leave the home to whomever you wish. If your heirs wish to keep the home, they can either pay off or refinance the balance. If they don’t wish to keep the home or mess with selling it, the bank will sell the home and pay back the reverse mortgage balance. Any remaining equity goes into your estate and to your heirs.
“I can’t take any long trips or temporarily go into a nursing home or I might lose my house.” Not at all. Yes, you need to live in the home, but you can still take a long trip or staying in a nursing home for a few months and remain in good standing. As long as you live in the home at least part of the year and it remains your primary residence (not a second home or rental), you have met the residency requirements of the program.
“I can’t ever sell my house. I’m locked in for the rest of my life.” Not at all. The reverse mortgage is better suited for people who don’t plan to sell anytime soon. However, if circumstances change and you need to sell, you can. You simply sell the home, pay off the balance with the proceeds of the sale, and the remaining equity is yours to keep. The HECM has no prepayment penalty, either.
How the Reverse Mortgage Works
Now that we’ve covered the basics and some myths and misconceptions, let’s dig deeper into how the reverse mortgage works. The HECM is a home loan, so naturally, it comes with an interest rate. HECM interest rates vary depending on conditions in the financial markets, but they’re typically comparable to or slightly higher than traditional 30-year fixed mortgage rates.
The note rate on a HECM is called the initial interest rate (IIR). The initial interest rate is an annual rate, but interest accrues monthly. Remember, you’re not required to make mortgage payments, so any unpaid interest simply accrues onto the loan balance over time.
To see how interest and MIP accruals work, let’s check out an example. Let’s assume an initial interest rate of 4.5% and a loan balance of $100,000 to keep the numbers simple. MIP is currently 0.50% annually, so the total interest rate (initial interest rate plus MIP) is 5% annually. To calculate total interest and MIP accruals for the current month, we need to first calculate the monthly total interest rate:
5% (IIR + MIP) / 12 months = 0.41667% (monthly rate)
The monthly total interest rate is then multiplied by the loan balance to calculate the monthly total interest due:
0.41667% (monthly IIR + MIP) * $100,000 (balance) = $416.67 (interest due)
As you can see, the monthly total interest, which equals $416.67, is calculated exactly the same as it is for traditional “forward” mortgages. The difference, of course, is that you’re not required to make payments on the HECM as long as you live in the home and pay the required property charges. The unpaid total interest is simply added to the loan balance:
$100,000 (starting balance) + $416.67 (interest and MIP due) = $100,416.67 (new balance)
The new loan balance of $100,416.67 is then used to calculate interest accruals for the following month.
If you’re concerned about the loan balance increasing over time, you may consider making occasional interest payments. You would still likely be paying far less than what a traditional mortgage payment would be and you would be keeping the loan balance down.
The HECM reverse mortgage is highly flexible and can be structured in a variety of ways depending on your goals and needs. If you’ve already been researching information about reverse mortgages, you may already be familiar with at least a few of the following payout options. HECM proceeds can be received in the following ways:
You can receive the proceeds using any one or a combination of these options. You can also restructure your HECM in the future as your financial needs change. Because the HECM is so versatile, it can be used to accomplish many different financial goals. HECM borrowers commonly use the proceeds to:
- Eliminate existing mortgage payments
- Eliminate other debts, such as credit cards, medical bills, and auto loans
- Finance home improvements
- Supplement retirement income
- Increase liquid retirement assets
- Set up a rainy day or emergency fund
As you can see, the HECM can be used for just about anything you like. Again, no mortgage payments are required (as long as you meet the program obligations) and you always remain the owner of your home.
Believe it or not, you can also purchase a home with a HECM. HECM for purchase is a fantastic loan program that enables you to finance a home purchase without a mortgage. Check out this article for more information.
How to Calculate Reverse Mortgage Proceeds
Now that we’ve covered some basics, let’s dig into some more in-depth information about reverse mortgages. We’ll next cover how to calculate reverse mortgage proceeds, but the intent is not for you to calculate them on your own. A reverse mortgage is a complex product and the calculations are complex as well. The goal is to show you how the calculations work so you’re familiar with terms and concepts that may come up when working with reverse mortgage lenders and counselors. You can always use our reverse mortgage calculators to run scenarios later.
The total amount of money available from a HECM reverse mortgage is called the principal limit (PL). The principal limit is the total bag of money available before mandatory obligations are paid. To calculate the principal limit, we need to first establish two values: the maximum claim amount (MCA) and the principal limit factor (PLF).
The maximum claim amount equals the lesser of the home value or the FHA lending limit. For most seniors, the maximum claim amount equals the home value because most seniors own homes valued less than the lending limit. If the home value is more than the lending limit, the maximum claim amount equals the lending limit. The lending limit effectively caps the home value for purposes of calculating the principal limit.
The principal limit factor is derived from a table published by HUD. The lender determines the correct principal limit factor to use based on the age of the youngest borrower (or non-borrowing spouse) and the expected interest rate (EIR).
The expected interest rate is used solely to determine the principal limit factor and calculate the principal limit. The expected interest rate is calculated by adding a base index rate (currently the 10-Year CMT) and a margin set by the lender. For example, if the index is 1.00% and the margin is 2.50%, the expected interest rate equals 3.50%.
Once the maximum claim amount and principal limit factor are established, they’re simply multiplied together to get the principal limit. As an example, let’s assume a home value of $200,000 and a principal limit factor of 0.50 based on age and expected interest rate. Because the home value is less than the lending limit, the maximum claim amount equals the home value. The principal limit is then calculated as follows:
$200,000 (MCA) * 0.50 (PLF) = $100,000 (PL)
As you can see, the principal limit factor is basically a loan-to-value percentage determined based on age and expected interest rate. In this example, the principal limit factor is 0.50, or 50% of the home value.
Note that the principal limit is not your “walk away” money. Mandatory obligations such as existing mortgage balances, closing costs, set-asides, etc., are paid out of the principal limit. The remaining money after mandatory obligations are paid can then be allocated to line of credit, lump sum, and term/tenure income.
If your head is spinning after reading this, don’t worry! You don’t need to thoroughly understand the calculations to benefit from a reverse mortgage. The intent is simply to expose you to reverse mortgage information and concepts you may encounter during the application process.
Like most mortgage products, a HECM reverse mortgage typically comes with closing costs. You may have heard that reverse mortgage closing costs are high. In fact, this is one of the most commonly raised objections about the HECM reverse mortgage. Yes, closing costs can be high, but they are not always high. Reverse mortgage closing costs generally fall into three categories:
- Third party closing costs – These are the services the lender has to hire to get your reverse mortgage done. Such services include title insurance, escrow, appraisal, government recording, attorney fees, etc.
- Origination fee – Lenders often charge origination fees to cover the costs associated with processing and completing your reverse mortgage.
- Initial mortgage insurance premium (IMIP) – This is a one-time fee charged by FHA at closing and helps make the HECM non-recourse. IMIP premiums go into the FHA mortgage insurance fund to cover shortages when homes don’t sell for enough to cover HECM balances.
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 about reverse mortgages likely won’t include closing costs estimates. If you’d like to get a closing cost estimate, you’ll need to contact a reverse mortgage lender.
Many closing costs are negotiable. If you’d like to get a reduction in closing costs, simply ask your lender. The worst they can say is no, right?
Reverse Mortgage Requirements
To qualify for a HECM reverse mortgage, at least one borrower must be at least 62. You must also own and live in your home. A reverse mortgage can (theoretically) work if you have zero equity, but it makes the most sense when you have a large amount of equity in your home.
Prior to 2014, there were very few credit and income requirements to get a HECM reverse mortgage. It was possible to qualify with even zero income and terrible credit. Unfortunately, this contributed to a growing default problem (due to nonpayment of property charges) that resulted in losses for the FHA insurance fund. To address the problem, HUD implemented new lending guidelines called financial assessment. Today, you must meet certain income and credit requirements to qualify for a HECM.
Note that this article is not intended to be a comprehensive source of information about reverse mortgages. The qualifying guidelines are complex and beyond the scope of this article. The goal isn’t turn you into an underwriter, so we’ll cover just the most important concepts to be aware of.
Though HECM lending guidelines are tighter than they used to be, they’re still generally less stringent than traditional “forward” mortgage guidelines. You don’t need perfect credit and tons of income to qualify for a HECM. Your income and credit are likely fine as long as you pass two financial assessment “tests” called financial ability and financial willingness.
The financial ability assessment is based on income. As long as you meet the residual income requirements, then you pass the financial ability “test”. If your residual income (the money left over after your bills are paid) is not enough, then you may still be able to qualify if you have certain compensating factors.
The financial willingness assessment is based on credit. Do you have a history of paying your bills at least reasonably well? Are there any serious derogatory credit items on your credit report, such as bankruptcies, foreclosures, charge offs, or collections?
It’s important to understand that you do not need to have perfect credit to qualify for a HECM. If you don’t meet the financial willingness standards, you may still be able to qualify by documenting an extenuating circumstance.
If your income and/or credit don’t meet the guidelines and you can’t document compensating factors or extenuating circumstances, you may still be able to qualify. The lender may still approve your file with a life expectancy set aside (LESA).
If you have any concerns about your credit, you may wish to pull a credit report on yourself before applying for a reverse mortgage. Per federal law, you can obtain a free credit report once per year at annualcreditreport.com.
Reverse Mortgage Counseling
Reverse mortgage counseling is required by HUD when you apply for a HECM reverse mortgage. The purpose of counseling is to ensure that you understand basic reverse mortgage information and concepts. The counseling session is conducted by an independent third-party HUD-licensed counselor and usually costs around $125. Once the counseling is complete, you’ll be issued a certificate that you’ll need to provide to your lender.
You can easily find reverse mortgage 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.
Finding Reverse Mortgage Lenders
Finding reverse mortgage 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 be a good source of reverse mortgage information and will take the time to learn about your financial goals. If a particular lender seems impatient or pushy, we recommend finding another one to work with.
Reverse Mortgage Calculators
If you’d like to get an estimate of how much you can get from a reverse mortgage, check out our fantastic reverse mortgage calculator. We may be a little biased, but we think our calculator is the best on the web. No contact information is required!
If you’re interested in a HECM for purchase, check out our reverse mortgage for purchase calculator.
If you’d like to calculate a simple principal limit, then check out our principal limit calculator.
Summary of What We’ve Covered
We hope you’ve found this reverse mortgage info helpful! The HECM reverse mortgage is a fantastic product, but it’s not perfect for everybody. Our hope is that this information will help you decide if a reverse mortgage is the right solution for you.
Let’s summarize what we’ve covered. Again, a HECM reverse mortgage is simply a home loan. It’s a unique home loan designed to unlock home equity without a mortgage payment or selling the home. You always remain the owner of your home and you’re free to leave it to your heirs. No mortgage payments are required as long as you meet your program obligations. Proceeds can be received as a line of credit, lump sum, term/tenure, or some combination of these options.