A reverse mortgage is a type of loan that is used by homeowners at least 62 years old who have considerable equity in their homes. By borrowing against their equity, seniors get access to cash to pay for cost-of-living expenses late in life, often after they’ve run out of other savings or sources of income. Using a reverse mortgage, homeowners can get the cash they need at rates starting at less than 3.5% per year.
What Is A Reverse Mortgage?
Think of a reverse mortgage as a conventional mortgage where the roles are switched. In a conventional mortgage, a person takes out a loan in order to buy a home and then repays the lender over time. In a reverse mortgage, the person already owns the home, and they borrow against it, getting a loan from a lender that they may not necessarily ever repay.
In the end, most reverse mortgage loans are not repaid by the borrower. Instead, when the borrower moves or dies, the borrower’s heirs sell the property in order to pay off the loan. The borrower (or their estate) gets any excess proceeds from the sale.
Most reverse mortgages are issued through government-insured programs that have strict rules and lending standards. There are also private, or proprietary, reverse mortgages, which are issued by private non-bank lenders, but those are less regulated and have an increased likelihood of being scams.
How Does A Reverse Mortgage Work?
The process of using a reverse mortgage is fairly simple: It starts with a borrower who already owns a house. The borrower either has considerable equity in their home (usually at least 50% of the property’s value) or has paid it off completely. The borrower decides they need the liquidity that comes with removing equity from their home, so they work with a reverse mortgage counselor to find a lender and a program.
Once the borrower picks a specific loan program, they apply for the loan. The lender does a credit check and reviews the borrower’s property, title, and appraised value. If approved, the lender funds the loan, with proceeds structured as either a lump sum, a line of credit, or periodic annuity payments (monthly, quarterly, or annually, for example), depending on what the borrower chooses.
After a lender funds a reverse mortgage, borrowers use the money as provided in their loan agreement. Some loans have restrictions on how the funds can be used (such as for improvements or renovations), while others are unrestricted. These loans last until the borrower dies or moves, at which time they (or their heirs) can repay the loan, or the property can be sold to repay the lender. The borrower gets any money that remains after the loan is repaid.
Reverse Mortgage Eligibility
In order to qualify for a government-sponsored reverse mortgage, the youngest owner of a home being mortgaged must be at least 62 years old. Borrowers can only borrow against their primary residence and must also either own their property outright or have at least 50% equity with, at most, one primary lien—in other words, borrowers can’t have a second lien from something like a HELOC or a second mortgage. If the borrower doesn’t own their house outright, they usually have to pay off their existing mortgage with the funds received from a reverse mortgage.
Typically only certain types of properties qualify for government-backed reverse mortgages. Eligible properties include:
- Single-family homes
- Multi-unit properties with up to four units
- Manufactured homes built after June 1976
- Condos or townhomes
In the case of government-sponsored reverse mortgages, borrowers also are required to sit through an information session with an approved reverse mortgage counselor. They also have to stay current on property taxes and homeowner’s insurance and keep their property in good condition.
Private reverse mortgages have their own qualification requirements that vary by lender and loan program.
Reverse Mortgage Borrowing Limits
If you get a proprietary reverse mortgage, there are no set limits on how much you can borrow. All limits and restrictions are set by individual lenders.
However, when using a government-backed reverse mortgage program, homeowners are prohibited from borrowing up to their home’s appraised value or the FHA maximum claim amount ($765,600). Instead, borrowers can only borrow a portion of their property’s value. Part of the property’s value is used to collateralize loan expenses, and lenders also typically insist on a buffer in case property values decline. Borrowing limits also adjust based on the borrower’s age and credit and also the loan’s interest rate.
Reverse Mortgage Costs
There are two primary costs for government-backed reverse mortgages:
- Interest rates: These may be fixed if you take a lump sum (with rates starting under 3.5%—a rate comparable to conventional mortgages and much lower than other home equity loan products). Otherwise, they’ll be variable based on the London Interbank Offered Rate (LIBOR), with a margin added for the lender.
- Mortgage insurance premiums: Federally backed reverse mortgages have a 2% upfront mortgage insurance premium and annual premiums of 0.5%.
Mortgage insurance is meant to protect lenders in case of borrower default. While reverse mortgages can’t usually default in the same ways as conventional mortgages—when borrowers fail to make payments—they can still default when owners fail to pay property taxes or insurance or by failing to properly maintain their properties.
In addition to these costs, lenders also will charge their own origination fees, which vary by lender, but typically range from 1% to 2% of the loan amount. Lenders also typically charge other fees, including for property appraisals, servicing/administering loans, and other closing costs, such as credit check fees.
However, all costs are typically rolled into the balance of the mortgage, so lenders don’t need to pay them out of pocket.
Types Of Reverse Mortgages
Most reverse mortgages are government-insured loans. Like other government loans, like USDA or FHA loans, these products have rules that conventional mortgages don’t have because they’re government-insured. These include eligibility criteria, underwriting processes, funding options, and, sometimes, restrictions on the use of funds. There are also private reverse mortgages, which do not have the same strict eligibility requirements or lending standards.
Single-Purpose Reverse Mortgage
Single-purpose loans are typically the least expensive type of reverse mortgage. These loans are provided by nonprofits and state and local governments for particular purposes, which are dictated by the lender. Loans may be provided for things like repairs or improvements. However, loans are only available in certain areas.
Home Equity Conversion Mortgage
Home equity conversion mortgages (HECMs) are backed by the U.S. Department of Housing and Urban Development and can be more expensive than conventional mortgages. However, loan funds can be used for just about anything. Borrowers can choose to get their money in several different ways, including a lump sum, fixed monthly payments, a line of credit, or a combination of regular payments and a line of credit.
Proprietary Reverse Mortgage
Proprietary reverse mortgages are private loans that aren’t backed by a government agency. Lenders set their own eligibility requirements, rates, fees, terms, and underwriting processes. While these loans can be the easiest to get and the fastest to fund, they’re also known to attract unscrupulous professionals who use reverse mortgages as an opportunity to scam unsuspecting seniors out of their property’s equity.
Who A Reverse Mortgage Is Right For
Reverse mortgages aren’t good for everyone. Only certain borrowers qualify, but their structure also only makes them appropriate for certain borrowers. A reverse mortgage may make sense for:
- Seniors who are encountering significant costs late in life
- People who have depleted most of their savings and have considerable equity in their primary residences
- People who don’t have heirs who care to inherit their home
Who Should Avoid A Reverse Mortgage
While there are some cases where reverse mortgages can be helpful, there are lots of reasons to avoid them. A reverse mortgage isn’t a good option if:
- You can’t find a trustworthy lender or a reputable loan program
- You have outside savings or life insurance that you can tap to cover expenses
- You have heirs who want to inherit your property or family members who live with you and who need to stay in the property after the term of a reverse mortgage
How And When To Repay A Reverse Mortgage
Most people who take out reverse mortgages do not intend to ever repay them in full. In fact, if you think you may plan to repay your loan in full, then you may be better off avoiding reverse mortgages altogether.
However, generally speaking, reverse mortgages must be repaid when the borrower dies, moves, or sells their home. At that time, the borrowers (or their heirs) can either repay the loan and keep the property or sell the home and use the proceeds to repay the loan, with the sellers keeping any proceeds that remain after the loan is repaid.
You may need to repay a mortgage either with cash or by selling the home if:
- You have to move into an assisted living facility or have to move in with a family member to help take care of you
- You have family who lives with you who want to keep your property, and you have the money to pay back the loan (for example, by borrowing against a life insurance policy or having your heirs use the death benefit to pay off the loan)
Avoiding Reverse Mortgage Scams
Government-backed reverse mortgages are generally very safe. But many of the ads that consumers see are for reverse mortgages from private companies. When working with a private lender—or even a private company that claims to broker government loans—it’s important for borrowers to be careful.
Here are some things to look out for, according to the FBI:
- Don’t respond to unsolicited mailers or other ads
- Don’t sign documents if you don’t understand them—consider having them reviewed by an attorney
- Don’t accept payment for a home you don’t own
- Be wary of anyone who says you can get something for nothing (i.e., no down payment)
In many cases, these scams get unwitting homeowners to take out reverse mortgages and give the money to the scammer. In other cases, scams try to force homeowners to take out reverse mortgages at onerous interest rates or with hidden terms that can cause the borrower to lose their property.
Reverse Mortgage Alternatives
Reverse mortgages aren’t for everyone. In many cases, prospective borrowers may not even qualify, for example, if they aren’t over 62 or don’t have considerable equity in their homes. If a reverse mortgage isn’t right for you, there are plenty of other routes you can go to get the funding you need. Alternatives include:
- Conventional mortgage
- Home equity loan
- Home equity line of credit
- Sell or lease the property
- Borrow against a life insurance policy
- Tap savings, such as in retirement accounts
Pros & Cons Of Reverse Mortgages
- Provides cash to cover important medical expenses late in life
- All costs can be rolled into the loan balance
- Interest rates are competitive with other types of mortgages
- Loans don’t have to be repaid out of pocket
- Total loan costs, inclusive of fees, can be considerable
- The loan must be repaid for heirs to inherit your property
- Must own the property outright or have at least 50% equity to qualify
- You have to avoid scams
- Most loans require mortgage insurance