What is a reverse mortgage?
If you’re 62 or older, you can convert the equity in your property into cash, a line of credit, or a monthly payment from a reverse mortgage lender. Note: Proprietary products are available to borrowers as young as 55 years old in some states
Why is it called a reverse mortgage? The reason is surprisingly simple: in a traditional mortgage, you make monthly payments to your lender. But in a reverse mortgage, the lender pays you.
That’s what makes this mortgage program an attractive feature for retirees — it provides a supplemental source of income once you retire.
Lenders cannot recall the loan unless the homeowner dies, sells the home, or moves. Under normal circumstances, the loan will be transferred to your heirs once you pass on, and it can be easily repaid from the sale of the house.
Reverse mortgage pros
What are some notable reverse mortgage pros and cons? Many homeowners use reverse mortgages to fund their retirement years and supplement other sources of income, such as Social Security. Here are some other reverse mortgage pros that are worth considering.
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Many Americans reach their retirement years only to discover that their carefully-planned retirement strategy is no match for rising inflation. A reverse mortgage can provide a much-needed source of supplemental income, and many loans are flexible enough to cover a range of needs.
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If your loan balance is already low, a reverse mortgage can help you eliminate it entirely. A reverse mortgage will pay off your existing mortgage. Furthermore, by tapping into your home equity, you can secure a steady source of financing during your retirement years.
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A reverse mortgage allows you to keep your home and enjoy an influx of cash rather than being forced to downsize or move away from friends and family. The loan only comes due when you or your loved ones sell your home, which means you can enjoy some much-needed stability and peace of mind throughout your retirement years.
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It’s technically possible for the value of your loan to exceed that of your home. But even if this happens, your lender is insured by such organizations as the Federal Housing Administration (FHA). Neither you nor your next of kin will have to pay off the balance.
Reverse mortgage cons
Despite several major advantages, there remain some drawbacks that homeowners need to consider before entering a reverse mortgage.
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Americans have traditionally used the value of their homes to pass on wealth in the form of property assets. But with a reverse mortgage, your heirs will likely have to sell your home to repay the debt. This may be mitigated with insurance products and proper financial planning. Speak to a licensed loan officer for details.
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Just like any traditional mortgage, there are borrower responsibilities. To receive a reverse mortgage, you must be financially healthy enough to cover expenses like property tax, homeowners insurance, and other associated costs. If you fail to keep up with these expenses, you could default on the reverse mortgage and lose your home to foreclosure.
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There are closing costs fees to set up your reverse mortgage, not to mention the mortgage insurance premiums that often accompany HECMs.
These fees can generally be financed with your mortgage payments and will consequently lower the amount of funds available to you from the proceeds of the reverse mortgage.
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What happens if you need assistance from government programs such as Medicaid or Supplemental Security Income (SSI)? The government may look at your income and disqualify you based on the money you receive through your mortgage.
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The process of securing a reverse mortgage is complex. How confident are you that you understand the benefits of a HECM versus a proprietary reverse mortgage? You’ll need to compare interest on a reverse mortgage to find the best option, but doing so can be cumbersome due to the extensive application package. This is why it is important to work with a knowledgeable and reputable reverse mortgage lender and licensed loan officer.
Reverse mortgage eligibility
You must meet certain requirements to qualify, including:
- You must be at least 62 years of age (55yrs+ on some proprietary products in certain states)
- You must own your home outright or have decent equity available
- The home must be your principal place of residence
- The home must be in good shape and meet FHA minimum property standards
- You must be free from any federal debt defaults and not currently in bankruptcy proceedings (income taxes, federal student loans)
Finally, before you qualify, you may be asked to meet with a counselor approved by the U.S. Department of Housing and Urban Development (HUD). The purpose of this interview is to highlight the pros and cons of reverse mortgages, discuss your financial preparedness, and consider possible alternatives.
Types of reverse mortgages
Not all reverse mortgages are the same. Different types of reverse mortgages offer unique advantages, though they can also bring different fee structures, interest rates, and more.
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Home Equity Conversion Mortgage (HECM)
One of the most common types of reverse mortgages is the Home Equity Conversion Mortgage (HECM). The main advantage of HECMs is that they’re federally insured and backed by the U.S. Department of Housing and Urban Development (HUD).
HECMs can be quite flexible, with no income limitations or medical requirements.
You should also be prepared to pay mortgage insurance premiums (MIPs). These fees consist of a 2% upfront fee and a 0.5% monthly fee over the life of your loan. You can finance both fees through your loan, though doing so will reduce the amount you receive.
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Proprietary reverse mortgage
Proprietary reverse mortgages are backed by private lenders. Their primary advantage is that these lenders will often appraise your home at a comparatively high value, which can give retirees a larger amount of money to draw from.
Because the federal government doesn’t back proprietary reverse mortgages, recipients aren’t responsible for making upfront or monthly insurance premiums. That usually means you’ll be able to borrow more, which can add to the overall value of the program.
Just make sure you compare mortgage interest rates and other terms between at least three lenders. That way, you can obtain the best rates and terms and avoid hefty origination fees or hidden costs.
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Single-purpose reverse mortgage
A single-purpose reverse mortgage is the least expensive option and one that may be backed by local or state government agencies or nonprofits. But that also means that this reverse mortgage program is not available in all 50 states, so you’ll need to check with a reverse mortgage lender to determine whether this program is available to you.
As the name suggests, single-purpose reverse mortgages are designed to finance one specific need, such as covering taxes or performing a home renovation or repair.
Lenders must approve this need before issuing the reverse mortgage, which means you have much less flexibility than with the previous two options.
Payment options and disbursement
How do you claim the funds from a reverse mortgage? There are several different options. More specifically, you can receive your mortgage payments in one of three ways:
- Monthly payments for a set period (term option)
- Monthly payments for as long as you own the house (tenure option)
- A line of credit
You can also combine some of these options. For instance, you might pair monthly payments with a line of credit for maximum flexibility.
Considerations to make
As you weigh the pros and cons of reverse mortgages, you’ll also need to ask yourself questions related to your financial future.
- Is my home increasing in value? If the value of your home<6.2 home value estimator> is rising, you can take out a reverse mortgage based on your current equity and pass on the remaining value of your home through your estate.
- Do I plan on remaining in my home? Remember, a reverse mortgage is due once you sell your home. If you plan on staying in your home for a long time, a reverse mortgage can be a good way to receive income without having to worry about repayment.
- Can I cover the cost of my current home? A reverse mortgage won’t necessarily help you cover the current costs of homeownership. And if you get behind with taxes or other expenses, you risk foreclosure. That said, if you’re already reasonably secure, a reverse mortgage can help you supplement your current income.
Discuss your reverse mortgage options
Before you make any big decisions, it’s a good idea to sit down with a qualified financial advisor or discuss your financial future with your loved ones. A reverse mortgage can have a certain appeal, but the risks that can come with it shouldn’t be taken lightly.
If you’re looking for ways to tap into additional money after you retire, you might consider alternatives like:
- Personal loans
- A home equity line of credit (HELOC)
- A home equity loan
If your home’s mortgage isn’t paid off, it might also be an appropriate time to consider refinance loan options. Refinancing your home will lock in a lower interest rate, which can reduce your monthly payments during a season of life when your cash flow is limited.
