What Is A Reverse Mortgage And How Does It Work?
Worried that you haven’t saved enough money to make it through your retirement years? If you’re at least 62, a reverse mortgage could be an option. However, this loan is a bit more complicated and can come with some drawbacks. It’s important to know how this loan works, how it can help you and whether it’s the right option for your financial situation and retirement goals.
What Is A Reverse Mortgage?
A reverse mortgage is a loan that allows homeowners who are 62 or older borrow against a portion of the equity in their home. A reverse mortgage works differently than a traditional mortgage loan, though. Instead of making payments to your lender, your lender will make a payment to you. The loan first pays off your existing mortgage, if you have one, then you can use the remaining funds for anything you’d like. You must continue to pay your property taxes and homeowners insurance and you are responsible for maintaining the home.
Not everyone can take out this type of loan. Here are the requirements to qualify for a reverse mortgage:
- You must be at least 62 years of age.
- You can only get a reverse mortgage on your primary residence, not a second or vacation home.
- If you are taking out a home equity conversion mortgage (HECM), a reserve mortgage insured by the government, the Department of Housing and Urban Development (HUD) requires that you attend a reverse mortgage counseling session. This is to ensure that you know both the benefits and drawbacks of these loans and other options you may have. You’ll also be required to go through a financial assessment to ensure you’re able to meet the financial obligations of the loan.
These loans are designed for older homeowners who may have retired and want to eliminate their monthly mortgage payments or supplement their income.
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How Does A Reverse Mortgage Work?
A reverse mortgage might sound like free money. It isn’t. In such a mortgage, you are borrowing against your home’s equity, the difference between what you owe on your mortgage and what your home is currently worth.
To determine how much money you can receive from a reverse mortgage, your lender will order an appraisal of your home. Say your home is worth $350,000 and you owe $100,000 on your mortgage. You have $250,000 worth of equity. Most lenders won’t allow you to borrow the full $250,000 in a reverse mortgage, but rather a percentage. This leaves you with some equity still in the home.
The money from the loan first pays off your existing mortgage and no monthly mortgage payments are required after. Depending on what you choose, you may receive payment from your lender in a lump sum, monthly payments or a line of credit – or any combination of the three. You can use this money for whatever you’d like. This money is not taxable. However, a reverse mortgage can impact certain need-based assistance programs, so it’s recommended to speak to a financial advisor before taking out this type of loan.
While you are receiving payments, your lender will add interest to your existing loan balance. This means that the amount of money you’ll eventually owe will increase during the lifespan of your reverse mortgage.
A reverse mortgage also doesn’t eliminate certain payments. You’ll still have to pay your yearly property taxes and homeowners insurance bills. You’ll also be responsible for any origination fees and closing costs on your reverse mortgage. You must also continue to maintain the home.
You don’t have to pay the loan back until you sell your home, move out or pass away. If you sell your home, you’ll have to pay back what you owe then, using the funds from the sale to do so. Any remaining proceeds are yours to keep. If you pass away, the loan will also come due. Your heirs will have some options. They may buy the home for what is owed on the loan or for 95% of the appraised value – whichever is lower. They could sell the home and keep any remaining proceeds after paying the loan balance. Or, they can simply turn it over to the lender to satisfy the debt.
This leads to the major drawback of a reverse mortgage: If your children or other family members want to keep your home, they would have to buy the home to pay off the reverse mortgage. If they can’t do this, they will have to sell the home or sign the deed over to the lender.
If your reverse mortgage is a HECM, which is insured by the federal government, it is a nonrecourse loan. That means you’ll never owe more than what your home is worth. If you sell your home for less than what you owe on your reverse mortgage, you won’t have to pay back the difference.
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Types Of Reverse Mortgages
There are three main types of reverse mortgages. But how do they differ?
Home Equity Conversion Mortgage (HECM)
The most common type of reverse mortgage is the home equity conversion mortgage (HECM). This type of reverse mortgage is insured by the Federal Housing Administration (FHA). The most you can borrow with one of these loans is $1,089,300 in 2023. If you must borrow more than that, you’ll need to apply for a jumbo reverse mortgage.
Single-Purpose Reverse Mortgage
A single-purpose reverse mortgage is typically less expensive than a HECM. But it also comes with limits. As the name suggests, you can only use the funds from this type of reverse mortgage for one purpose. Your lender might approve you for the loan but stipulate that you can only use the funds to cover home repairs, insurance premiums or your property tax bills. Typically, these loans are offered by charities and local governments to homeowners with lower to moderate incomes who are struggling to pay their bills. They are not available everywhere.
Jumbo Reverse Mortgage
You will need to take out a jumbo reverse mortgage, also known as a proprietary reverse mortgage, for any amount more than $1,089,300 in 2023. Because a larger loan is considered riskier, your lender might charge you higher fees and a higher interest rate for a jumbo reverse mortgage. Unlike a HECM, this type of reverse mortgage is not insured by the FHA. That means it does not come with as many protections. It also doesn’t require a HUD-approved counseling session or financial assessment.
As with many financial products, there are benefits and drawbacks to reverse mortgages.
Advantages Of A Reverse Mortgage
- You get to stay in your home. If you’re struggling to pay your mortgage or other bills, a reverse mortgage will eliminate your monthly mortgage payment and provide you with an extra income stream. This might provide enough financial relief so that you can afford to stay in your home. Just remember, you’ll still have financial obligations with this loan. That includes paying your homeowners insurance and property taxes.
- Reverse mortgages are immune to devaluation. If you take out a HECM, you don’t have to worry about declining home values because you’ll never owe more than the home is worth.
- Your spouse may be able to remain in the home. If you pass away, your spouse might be able to stay in your home instead of selling. This can bring you peace of mind later in life.
How Do You Pay Back A Reverse Mortgage?
How you pay back a reverse mortgage varies depending on two main factors:
- If you have a HECM and sell your home: If owners decide to sell their home after taking out a reverse mortgage, they must use the proceeds from this sale to pay off their loan. If the home sells for less than what the owners owe on the loan, they won’t be responsible for making up the difference as long as they have a HECM.
- If you have a HECM and pass away: Your reverse mortgage must be paid off if you pass away. In this case, your heirs can sell your home and use the proceeds to pay off the reverse mortgage. They can also give the home to your lender. If they want to keep your home, they’d have to purchase the home.
- If you move out of the home: You must live in the home as your primary residence for more than half the year. If you move out of the home, the reverse mortgage will come due. You’ll need to pay back the loan even if you wish to keep the home. That could be done with your own funds or by refinancing the loan.
Reverse Mortgage FAQs
A reverse mortgage is a complex lending tool. It’s normal to have some questions. Here are some of the most common.
Can I owe more than my home is worth with a reverse mortgage?
If you take out a HECM, the most popular type of reverse mortgage, you won’t have to pay back more than what your home is worth when you pay off the loan. If you owe more on your mortgage than what your home is worth – meaning that you are underwater on your mortgage – but sell your home for its appraised value, mortgage insurance covers the difference.
Can I reverse my reverse mortgage?
You can get out of a reverse mortgage, though doing so can take time and money. You can always sell your home, using the proceeds to pay off your reverse mortgage. But if you want to stay in the home, you might need to refinance your reverse mortgage into a traditional mortgage loan. This will take money, with refinances typically costing 2% – 6% of the loan amount in closing costs.
How do I sell my home with a reverse mortgage?
Once you sell your home, you’ll use the proceeds from the sale to pay off your reverse mortgage. If you sell your home for its appraised value, but owe more on your mortgage than this sales price, you won’t have to make up the difference if you have a HECM. Instead, your mortgage insurance will cover the gap between what you owe and the price you were able to nab when selling your home. If you sell your home for more than what’s owed, you can keep the remaining proceeds.
How much money can I get from a reverse mortgage?
The amount you can borrow with a reverse mortgage depends on the age of the youngest borrower, current interest rates and the amount of equity you have in the home.
Can I refinance a reverse mortgage?
You can always refinance a reverse mortgage to get a lower interest rate or move to a different type of mortgage loan. You’ll have to pay closing costs, though, and you’ll need enough equity in your home to qualify for a refinance.