When you buy a home, you agree to a mortgage; a reverse mortgage allows homeowners to receive fast-access money, placing a lien on a portion of a home’s equity. Some seniors choose a reverse mortgage to access their home’s value without moving; others use it for quick cash following a medical emergency or necessity.
Reverse mortgages started in 1961, following an attorney’s efforts to keep a windowed woman in her home. The program became a key component of President Ronald Reagan’s Housing and Community Development Act in the 1980s. Today, homeowners have more rules, protections, and options, while important lender rights and allowances have also gained traction.
What is a Reverse Mortgage, and How Does it Work?
To best understand reverse mortgages, we should start with the basic forward mortgage. When a prospective homeowner agrees to buy a property, the lender grants a loan to the buyer. Once payments start, all public property records reflect the homeowner’s name. As more mortgage payments go through, the “ownership”’ of the home transfers from the lender to the homeowner. The transferred “property” is then considered home equity, which the homeowner completely owns.
What is a reverse mortgage? Reverse mortgages offer qualifying homeowners the option to make fast cash by putting their home’s equity under a new lien. However, the homeowner must pay all necessities for the property maintenance, like property tax, Home Owner Association fees, and others. At the end of the loan’s life, it goes into repayment.
How Does a Reverse Mortgage Work?
Reverse mortgages take a home’s equity, give it to the homeowner, and place the equity back under a lien. During this time, the homeowner agrees to maintain the home and keep it as a primary residence. The homeowner remains responsible for all fees associated with the home even during this period; however, the new equity lien does not require monthly repayment.
Homeowners cannot access all their equity at once; they can only exchange the value equal to or below their principal limit. This limit caps the amount of money accessible to the borrower. Principal limits are dictated based on the age of the youngest borrower, interest rates, the home’s value, and the HECM, the government-funded reverse mortgage program. When the borrower dies, the loan balance becomes due when they move out or sell the home.
Types of Reverse Mortgages
Qualified homeowners have four options to choose from for their reverse mortgages:
The Home Equity Conversion Mortgage (HECM) is federally insured. The loans tend to have high up-front costs but allow no restrictions on what you do with the money. In contrast, there are also single-purpose reverse mortgages. These loans have restrictions on what the borrower can do with the money. The lenders are usually nonprofit organizations or state-level agencies.
There are also private loans called proprietary reverse mortgages. Borrowers tend to have a higher principle limit with these loans and higher interest rates. They are always at the mercy of the stock market. Some proprietary reverse mortgages are made specifically for the homeowners of expensive estates. Also called jumbo reverse mortgages to allow borrowers to take up to $4 million of their home’s equity. These high-figured loans come with special regulations and requirements, with fewer protections for the borrower.
How do borrower payments work in a reverse mortgage? The borrower and lender will work together to arrange a payment program to benefit the borrower. The available payment options change depending on the rate type and loan amount. Borrowers can choose from the following:
- Fixed or variable rates: some lenders offer monthly or annual adjusting
- Equal monthly payments: these will come over a specified length of time
- A credit line: this credit can be accessed anytime and can potentially grow
- A one-time lump-sum: for some lenders, this option is their only possibility
Who Is a Reverse Mortgage Right For?
A reverse mortgage is a perfect solution for some homeowners. In the case of those who get a HECM reverse mortgage, the proceeds can be used for anything:
- The payments can double as supplemental retirement income.
- A line of credit can cover big-cost home repairs or necessary remodels.
- A lump sum can pay off out-of-pocket medical expenses.
Although the benefits of a reverse mortgage are clear, it is important to note that there are other solutions for some senior homeowners. More specifically, a reverse mortgage is right for seniors who:
- Can’t afford a month-to-month loan payment
- Can’t qualify for a home equity loan otherwise
- Have poor or little to no credit
Reverse Mortgage Requirements
Reverse mortgages are only a financial solution for some; a lender will only consider the conversation after preliminary requirements are met. Homeowners themselves also have a long list of eligibility requirements:
- The primary homeowner must be 62 or older.
- The primary homeowner must own their property outright or hold a significant amount of equity; some loans require an equity as low as 51%.
- The borrowers cannot be delinquent on any federal debt.
- The property must be occupied as the main residence of the borrower. If the borrower stops living in the home for over a year, the loan comes into repayment.
- Borrowers seeking a HECM reverse mortgage must complete a financial impact counseling session provided by a U.S. Department of Housing and Urban Development (HUD) approved entity.
Pros and Cons of Reverse Mortgages
There are potentially huge benefits to a reverse mortgage:
- The borrower doesn’t make monthly payments like a forward mortgage or loan.
- The resulting income from the reverse mortgage is also non-taxable.
- Best of all, if the home increases in value and surpasses the reverse mortgage loan balance, the borrower’s heirs may receive the difference. Of course, the opposite can also be true, where heirs must pay off the loan to keep the home.
There are potential problems with a reverse mortgage, as well:
- Reverse mortgages accrue interest every month, like a normal loan. The longer the borrower waits to repay the loan, the bigger the overall cost.
- There are also safeguards to ensure the homeowner keeps as much of their property as possible; most reverse mortgages hit closer to 15-80% of the total equity.
- As with all property loans, foreclosure is possible if the loan is not repaid or when the borrower fails to meet specified conditions.
How Much Does a Reverse Mortgage Cost?
Don’t be fooled; a reverse mortgage does cost money—just because it’s a home’s equity doesn’t mean there aren’t fees associated with accessing it. The rates will vary depending on the lender, the borrower’s credit score, and other factors. The most expensive costs come from insurance, servicing, and contract origination.
Each plays a part in the reverse mortgage plan, so their total costs vary widely depending on annual adjustments. Additionally, many homeowners may be blindsided by third-party fees accrued after inspections, checks, filings, and property title searches.
Learn About Reverse Mortgages, Property Rights, and More
Topics like reverse mortgages are rare knowledge; they require someone (hopefully an expert) to guide the general public through the process. For help with your options for a reverse mortgage, look for a qualified specialist; for everything else, there’s our blog.