What is a reverse mortgage? How does it really work? Is it right (or wrong) for you? An experienced industry veteran and published author explains how this unique home loan product can unlock your home equity and empower your retirement.
I’ve helped many seniors get reverse mortgages 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 sell you on the idea of getting one. My goal is to give you an unbiased rundown of how this unique and specialized home loan product can enhance and empower your retirement.
I can tell you right now that much of what you’ve heard about reverse mortgages is either dated or simply not true. Rumors and misconceptions are rampant.
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 separate fact from fiction so you can decide if this product is the right solution for you. Here’s the reverse mortgage explained by an industry veteran in simple and understandable terms.
Table of Contents
What is a Reverse Mortgage?
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 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.
HECM reverse mortgages 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.
What is a reverse mortgage? 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.
How Does A Reverse Mortgage Work?
How it 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 mortgage 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 fund your retirement.
No mortgage payments are required as long as at least one borrower (or non-borrowing spouse) lives in the home and pays the property charges. 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.
What Are the 3 Types of Reverse Mortgages?
There are three types of reverse mortgages on the market, single-purpose, federally-insured, and proprietary:
- Single-purpose: These are offered by state, local, and nonprofit agencies and are generally pretty rare.
- Federally-insured: The HECM is the only federally-insured reverse mortgage. It’s backed regulated and insured by the U.S. Department of Housing and Urban Development (HUD) and the Federal Housing Administration (FHA).
- Proprietary: Also called “jumbo” reverse mortgages because they’re designed for high home values, these are not backed by FHA.
In all the years I’ve worked in the mortgage industry, I’ve never run across a single-purpose reverse mortgage. You’ll likely never hear about them. The most common product by far is the HECM, which is the focus of this site.
Why Get a Reverse Mortgage?
Why would someone use a reverse mortgage? As it turns out, there are a lot of reasons!
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.
You can use the proceeds for whatever you like, including:
- 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
The most common reasons people get reverse mortgages is to eliminate existing mortgage payments, do home improvements, supplement liquid assets, and pay off consumer debt.
Upfront and Ongoing Costs
A reverse mortgage is a home loan, so it has costs associated with it. The costs generally fall into two buckets: interest and closing costs.
Interest and MIP
How does interest work on a reverse mortgage? First of all, it’s a home loan, so it comes with an interest rate. 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.
Closing Costs
Like any home loan, a reverse mortgage typically has closing costs. The closing costs can be pricey (but not always), which is why they’re one of the most common objections raised by applicants. However, I think they’re well worth it for most borrowers.
- 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 HECM reverse mortgages, and make them non recourse, and guarantee the funds even if your lender goes out of business at some point.
Whether the closing costs are cheap or not, they’re usually not paid out of pocket. Most or all can usually be rolled into the new loan.
The exception is a reverse mortgage for purchase, which requires that the closing costs be paid out of pocket along with your down payment.
How to Qualify
In the past, there were very few income and credit qualifying requirements. 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 mortgage is not a loan of last resort for the broke and desperate – contrary to popular perception. You have to qualify. The broke and desperate commonly don’t qualify because they have limited income and severely damaged credit.
A reverse mortgage is best used not as a life raft, but as a safety net. The best candidates are those who are at least reasonably financially stable.
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 a certain amount of 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).
How Much Can I Get?
If you’d like to estimate how much you get from a reverse mortgage, check out the links below.
How much money do you get from a reverse mortgage? If you’d like to estimate how much you can get from a reverse mortgage, check out our reverse mortgage calculator. Purchasing a home? Check out our reverse mortgage for purchase calculator.
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 do a reverse mortgage?
Many people take advantage of a reverse mortgage 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.