April 29, 2018 by HECM Pro
So, how much equity is needed for a reverse mortgage exactly? Great question! And the answer is: it depends! There’s no set rule that applies to everybody. How much equity is needed for a reverse mortgage depends on how much you can qualify for with a reverse mortgage. And how much you qualify for depends on numerous factors, including home value, age of the youngest borrower, current interest rates, what program you select (variable-rate HECM or fixed-rate HECM), how the program is structured (lump sum, line of credit, term or tenure payments, some combination of these, etc.), income and credit, and how well you’ve kept up with property tax and insurance payments.
Before we get into how much equity is needed for a reverse mortgage to be workable, let’s first cover some basics about what a reverse mortgage is. There are a lot of misconceptions about the reverse mortgage and it’s essential you understand at least a few basics before I can adequately address how much equity you need.
HECM Reverse Mortgage Basics
The most common reverse mortgage product by far in America today is the FHA-insured and regulated 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 reverse mortgage is a type of home loan that enables homeowners 62 or older to convert a portion of the value of their homes into cash without giving up ownership of the home or taking on a mortgage payment. As long as at least one borrower is living in the home and paying the required property charges, no mortgage payments are required and the loan does not have to be paid back.
The reverse mortgage only has to be repaid when the last borrower permanently leaves the home, whether through selling, passing away, or moving into a nursing home.
If the home isn’t worth enough to settle the entire loan balance, FHA picks up the shortage. Any equity that remains in the home after paying off the reverse mortgage will go to borrower’s heirs.
Reverse mortgage proceeds can be received in the form of a line of credit, lump sum, monthly term or tenure “paycheck”, or some combination of all of these options.
Proceeds can be used for just about any purpose, but many borrowers use the reverse mortgage to eliminate existing mortgage payments (which is particularly relevant for what we’re discussing here).
How Much Equity is Needed for a Reverse Mortgage?
Theoretically, you don’t need any equity in your home to qualify for a HECM reverse mortgage. However, if you don’t qualify for enough to pay off your entire existing mortgage balance, you’ll need to bring cash to the closing table to make the numbers work. If you have the available cash, this can make a ton of sense. I had one client bring $120,000 to the closing table to get rid of a $3,000 mortgage payment that was a huge financial headache. He had a pretty big existing mortgage balance and the reverse mortgage didn’t offer enough to pay all of it off. He brought the difference to the closing table to make the reverse mortgage work.
If you don’t have available cash, you’ll definitely need to have enough equity in the home to make the reverse mortgage work. How much equity is needed varies from borrower to borrower based on several factors:
- Interest rates – How much equity is needed for a reverse mortgage is greatly impacted by interest rates. If interest rates are low, you need less equity to make it work than if rates are higher. This is a big reason why now is a great time to get a reverse mortgage; interest rates are still at record lows and probably have no where to go but up in the future.
- Age of the youngest borrower – As you get older, you gradually qualify for more. There’s not a big difference from one year to the next, but an 80-year old typically qualifies for substantially more than a 62-year old. If you’re older, expect to need less equity in your home to make the reverse mortgage work.
- Home value – The higher your home value, the more you qualify for. Note that there are limitations here with the HECM program. If your home is worth at least the FHA loan limit, you won’t qualify for any more no matter how much more your home is worth.
- Loan program – Sometimes the loan program you select (fixed-rate HECM or variable-rate HECM) can impact how much you qualify for. One program may offer more money than the other under certain circumstances.
- Closing costs – If the lender can cover some of your closing costs with a lender credit, it will leave more money to cover a large mortgage balance. You may not need as much equity to make the deal work than if there are a lot of closing costs to be paid.
- How the reverse mortgage is structured – How much of a term, tenure, line of credit, or lump sum you need for the program to make sense for you can impact how much is available to cover a large mortgage balance. The more that is allocated to term or tenure payments, line of credit, or lump sum, the less that is available to pay off an existing mortgage.
- Credit and income – If you have poor credit or low income, the lender may require a LESA to pay property taxes and insurance. This can eat into how much is available to pay off a mortgage balance, which means you’ll need more equity to get the deal done.
- Payment history for property taxes and insurance – If you have a poor payment history for property taxes and insurance (even if your credit and income are good), the lender may require a LESA. Again, this can limit how much is available to pay off a large mortgage balance, which means you’ll need more equity in your home to make the reverse mortgage workable.
- Home repairs – If your home needs repairs, the lender may require a repair set aside, which can eat into how much is available to pay off a mortgage.
- Unpaid property taxes or other liens – If you have unpaid property taxes or other liens against your property, those will likely have to be paid up at closing, which can limit how much is available to pay off an existing mortgage.
A Few Rules of Thumb
As you can see, there are numerous factors that influence how much equity is needed for a reverse mortgage. Having said that, I can at least offer a few rules of thumb based on today’s market conditions. If you have good credit and income and your home is in good condition, you’ll likely need between a 40% to 60% equity position to qualify without bringing cash to closing. If you’re in your 80s, you’ll be closer to just needing 40%. If you’re younger than that, expect to need at least a 50% to 55% equity position.
For a better estimate, feel free to use our free HECM reverse mortgage calculator.
For an even more exact estimate, I’d recommend checking with a few lenders and allowing them to run an updated credit report. Once they know what your credit and income looks like, they can run some solid estimates based on what your home is likely to appraise for.