Reverse Mortgages for Dummies
A reverse mortgage is a type of mortgage in which a homeowner borrows money against the value of their house, either in the form of a monthly payment or a line of credit. The borrower isn’t required to pay back the money, until he or she moves away, sells the property, or dies.
Traditional residential mortgages operate in the opposite way from reverse mortgages: a home buyer pledges their new house to the bank, and makes regular payments over a set period until the loan is fully repaid. Regular mortgages can have fixed interest rates or adjustable rates, which are stable for a period, but then fluctuate according to the market.
Reverse mortgages are a debt instrument designed for people who are “house rich but cash poor,” or in other words, have a considerable amount of equity inaccessibly tied up in their home. This is especially true for senior citizens, who oftentimes need to supplement their retirement income or pay for long-term care.
Throughout the life of the reverse mortgage, borrowers keep the title to their house, which serves as collateral for the loan. Interest in only charged on the money they receive, with both fixed and variable rates available tied to short-term indexes. Interest then accumulates over the life of the loan, until repayment occurs.
What Types of Reverse Mortgages Are There? What Are the Differences Between Them?
There are three main reverse mortgages: single purpose, proprietary, and federally-insured, also known as home equity conversion mortgages (HECMs). Most people don’t know it, but you can also finance a new home with a reverse mortgage, through a fourth type: the home equity conversion mortgage for purchase (H4P). The differences between them will be outlined below, but they mainly differ in terms of purpose for which they can be used and who insures them.
Single Purpose Reverse Mortgage - Offered mainly by state and local agencies and some non-profit organizations for seniors with extraordinarily low incomes, this type of mortgage isn’t federally insured, which means that the insurance premiums don’t need to be paid. While this can save you more than $10k during the life of the loan, it’s important to mention that this mortgage can only be used for the lender-specified purpose (i.e. home repairs or property taxes).
Proprietary Reverse Mortgage - These mortgages, on the other hand, are underwritten by private lenders. Though subject to government regulation, they’re not eligible for federal insurance. These tend to be more expensive and cater to homeowners with higher property values.
Home Equity Conversion Mortgages (HECM) - By far the most well-known type of reverse mortgage, these are federally insured by the FHA and account for 90% of reverse mortgages in the U.S. The amount you can borrow is based on the appraised value of your home, and though interest accrues on the outstanding loan balance, the rates are generally lower that with the other two types. Since the property itself is offered as security, no credit check is made on the borrower. The money can be paid out as a line of credit, lump sum, or monthly payment. Interest rates can be adjustable or fixed (only available as an option for the lump sum payment).
Home Equity Conversion Mortgage for Purchase (H4P) - Odds are, most people aren’t aware you can buy a property using the equity from your current home in the form of a reverse mortgage. Not having to make a monthly payment on the new house reduces your fixed costs and can offer you the choice of downsizing or conversely, even upsizing, during retirement. This can also free up assets from the sale of the previous home, which in turn can be invested for future use. We have a whole article on this which I suggest you check out if you think this might be a good option for you.
Qualifying for a Reverse Mortgage
Reverse mortgages have a few requirements, but these shouldn’t faze you. The process is generally much simpler than taking out a first mortgage, and if you’re considering a reverse mortgage, it should all be pretty much old hat.
Age - To qualify for an HECM you must be at least 62 years old. Though some private lenders offer Proprietary Reverse Mortgages for seniors as young as 60, 62 is generally the start-off point for any program.
Ownership - You must either own your home outright or have a low mortgage balance that would be paid off with the reverse mortgage. Said property must be a single-household home or a 2-4 unit home with one unit occupied by the you, the borrower.
How much can I get? - The amount of money you can get from your home depends on the age of the youngest borrower, current interest rate, and the lesser of the appraised value or the HECM FHA mortgage limit of $625,500.
When Does a Reverse Mortgage Make Sense?
A reverse mortgage can be incredibly convenient for seniors who need to boost their retirement income, and have a considerable amount of equity tied up into their house. It's a sad truth that many Americans are unprepared for their retirement. Retirees may find themselves unable to enjoy their new free time, without having to make severe cutbacks in their way of life. Since reverse mortgages don't require payments, the money is not only instantly accessible, but can also be used to pay down debt, eliminate any recurring payments, and enhance the borrower's lifestyle.
Seniors who are having trouble meeting their mortgage payments, but have paid off most of the original loan, can also benefit. In many cases, homeowners use the proceeds from their reverse mortgages to settle their existing mortgage debt or home equity line of credit. This also relieves pressure from family members or friends who have been helping cash-strapped seniors get by.
For retirees, another advantage of a reverse mortgage is that it can help delay their need to access their Social Security, which accrue into bigger allowances the more they wait. People in a 401(k) plan have to pay taxes when they begin drawing down on their retirement savings, and a reverse mortgage can also delay the need for that, thereby reducing the taxes owed to the government.
Finally, the counseling required to obtain a reverse mortgage can be greatly beneficial to people who aren't that financially literate. During the session, the borrowers learn about the different loan products and their costs, discuss their household budget, and also receive information about reverse mortgage alternatives.
When Is a Reverse Mortgage a Bad Choice?
If you want to leave your house to your heirs scot free, then a reverse mortgage may not be the best choice for you, as in the event of your death, they would have to pay the balance on your loan. The same applies if you live with someone. Since one of the conditions of the mortgage is that you must be the primary resident of the home, the loan becomes due once that’s no longer the case, and whoever is living with you would have to move out if they did not co-sign the loan with you. To find out more, check out our foreclosure article.
Perhaps you need the money for medical bills. While this is certainly a viable way to obtain some cash for medical expenses, if your condition is such that it may require you leaving the home for a care facility for 12 months or more, then the mortgage automatically defaults. If it isn’t paid, the lender forecloses and sells.
If you’re thinking of moving soon and aren’t taking out an H4P mortgage, the upfront costs for a reverse mortgage can mount up quickly, including an origination fee, up-front mortgage insurance and its ongoing premiums, as well as closing costs, which include property title insurance, a home appraisal fee and a home inspection fee.
As we mentioned at the beginning of the article, reverse mortgages can be a valuable addition to your retirement-income portfolio, if you make the decision wisely. When a reverse mortgage is taken in the interest of long term planning, especially since the initial credit limit is set, it grows exponentially each year by the current interest rate on the loan and 1.25 percentage points (the loan’s annual mortgage-insurance charge). This can be a danger if your house falls in value, since the credit line grows regardless of those market changes.
Just like with any major financial decision, we recommend you first consider what you need the money for, and the study your options carefully. See if a home equity loan makes more financial sense. Making a sample budget for different types of mortgages at different rates can help you gain insight into the viability of a reverse mortgage. For more on what happens to a home in the event you leave it, this article explores the subject in depth.
What Should You Look for in Your Reverse Mortgage Lender?
Before even shopping around for a lender, make a list of your requirements, and find out just which banks and institutions even offer reverse mortgages. A good place to begin is the National Reverse Mortgage Lenders Association (NRMLA) Lender Locator and the U.S. Department of Housing and Urban Development's Lender List.
If you work with or know any financial professionals, such as a money manager or CPA, ask them for general recommendations and opinions about credibility of the lenders you've found so far. If you can't get a personal suggestion, another source of reviews is the Consumer Financial Protection Bureau’s Consumer Complaint database. Your local Better Business Bureau can also be a good resource to tap. Lastly, you can also seek out the services of a fee-based reverse mortgage counselor, who can't recommend specific lenders, but will serve as a helpful guide for navigating the reverse mortgage process.
Any lender you choose should have the relevant accreditations by the Federal Housing Administration (FHA) and the U.S. Department of Housing and Urban Development (HUD). Reputable lenders should also be members of the National Reverse Mortgage Lenders Association (NRMLA), and this is easy to verify on their searchable database.
Once you've narrowed down the choices, we encourage you to do the necessary research. Visit their websites. See how many ways they have to communicate with their customers. Go through their marketing with a fine-toothed comb, in search of red flags like misleading claims. For instance, some lenders boldly proclaim that their reverse mortgages are insured by the FHA, as though this were a benefit to you, when really, it protects the lender itself. Another common method is to present glowing testimonials. Though a company certainly isn't about to promote negative material about themselves, be wary of overly enthusiastic reviews, and don't rely on these to convince you.
Once you begin to meet with representatives from different lenders, make sure to ask them about the following:
- Experience level - How familiar are they with reverse mortgages? How many have they closed?
- Options - Ideally, the lender will be able to explain various other alternatives to a reverse mortgage, what the benefits and possible disadvantages are, and suggest you consult with an advisor.
- Fees - All reverse mortgages have associated closing costs. Lenders should have no problem providing you with an estimated breakdown of these, according to your homes value.
Finally, although dealing face-to-face with a person may have advantages, don't rule out looking into online lenders. The industry as a whole has experienced a sea change in recent years, and an online reverse mortgage lender can often provide better offers.
We always encourage you to consult with a financial professional for advice on what makes the most sense in your own personal situation. However, if you’re at the right age and you think you’d make a good candidate for a reverse mortgage, our editors have done the work of rating the 10 best reverse mortgage companies of the year, which you can use to help find an ideal match based on your needs.