What Is a Reverse Mortgage?

Imagine if your mortgage lender paid you instead of you paying your lender. With a reverse mortgage, that’s exactly what happens. However, you don’t just get free money each month. There are some important caveats to be aware of with reverse mortgages, and these loans are only available to select borrowers.

If you’re considering a reverse mortgage, here’s how they work, the types available, and their pros and cons.

How does a reverse mortgage work?

A reverse mortgage draws funds from your home equity and pays you in regular installments. These payments are tax free and can supplement your retirement income if your savings are limited. However, reverse mortgage payments result in a loss of home equity. Also, most reverse mortgages need to be repaid in full once the borrower dies, sells their home, or leaves it permanently.

Reverse mortgages are available to borrowers age 62 and older who have significant equity in their homes. According to Rocket Mortgage (which at the moment is not offering its reverse mortgage product), you typically need at least 50% equity to qualify for this type of loan, though requirements may vary by lender.

Types of reverse mortgages

There are a few types of reverse mortgages. The most common option is a loan insured by the Federal Housing Administration (FHA). Here’s what to know about each type.

Federally insured

Home equity conversion mortgages (HECMs) are reverse mortgages insured by the FHA. These loans use your home as collateral, like a traditional mortgage, and you receive tax-free payments from your lender each month. Payments are disbursed as a lump sum, line of credit, or a combination of the two, depending on your preference. You can use the funds for any purpose, including home maintenance and living expenses.

Several eligibility requirements apply for borrowers and properties, and you’ll pay high up-front fees, closing costs, and mortgage insurance premiums. You’ll also be required to speak with an HECM counselor before you apply. If you decide to move forward, you’ll work with a lender approved by the U.S. Department of Housing and Urban Development (HUD) to secure your loan.

HECMs are federally insured and have protections if your balance exceeds your home’s market value when you or your heirs need to repay the loan.

Single purpose

Single-purpose reverse mortgages are loans available through some state and local governments. As their name suggests, these loans can only be used for the purpose defined in the loan agreement. For instance, a homeowner might use funds from a single-purpose loan to maintain their property.

Single-purpose reverse mortgages may not be widely available, and your income may need to fall under a certain amount to qualify. The loans aren’t federally insured, so they don’t have the same protections you’d get with an HECM.

Proprietary

If your home's market value exceeds a certain amount, you may qualify for a proprietary reverse mortgage. Lenders generally only offer this type of loan to borrowers with significant equity in a relatively expensive home. Unlike HECMs, these loans aren’t federally insured, so there are no protections in place.

Reverse mortgage pros and cons

Advantages of a reverse mortgage

Can supplement your retirement income

A reverse mortgage could supplement your income if your retirement savings are limited, helping to preserve them.

Payments aren’t taxed

Payments you receive with a reverse mortgage aren’t subject to taxes, as the Internal Revenue Service (IRS) doesn’t classify them as income. Instead, these funds are classified as “loan proceeds.”

May let you age in place

A reverse mortgage could help you stay in your home, allowing you to make accommodations that allow you to age in place. For instance, you could use the funds to improve your home’s accessibility or add features that make it safer.

Built-in protections for heirs (with HECMs)

HECM borrowers get built-in protections for heirs if they die. If your loan balance exceeds the market value of your home when your heirs need to sell, they’ll only need to repay 95% of the home’s appraised value. Any remaining balance will be repaid to the lender by the FHA. However, if your heirs want to keep your home, they’ll need to repay the loan in full using their savings or another source of funds.

Disadvantages of a reverse mortgage

Fees and closing costs apply

Whether you opt for an HECM or another type of reverse mortgage, fees and closing costs will likely apply. Depending on your home’s value, the lender, and other factors, these could be quite high. With an HECM you’ll also need to pay mortgage insurance premiums.

Borrower required to live in the home

If you take out a reverse mortgage, you must live in your home. If you need to leave your home permanently, you will need to repay the loan in full. However, if you move into an assisted living facility for more than 12 months or have a co-borrower or Eligible Non-Borrowing Spouse remain in the home, you may not have to pay back the loan immediately.

May impact eligibility for other programs

The monthly payments you receive from your reverse mortgage could increase your income and impact your eligibility for means-tested government programs, such as Medicaid. It should not affect your Social Security or Medicare payments.

Home equity decreases

Reverse mortgage payments are made against your home equity, which increases your loan balance and reduces the amount of equity you have in your home. This reduces the profit you receive if you sell and, potentially, the amount your heirs receive if you die.

Other home expenses still apply

While you don’t need to make regular payments on a reverse mortgage, you’ll still need to pay your property taxes, homeowners insurance premiums, homeowners’ association dues and fees, and other expenses associated with your home. Lenders also require that you keep up with home repairs and maintenance as a condition of reverse mortgages.

What are reverse mortgage requirements?

The eligibility criteria for a reverse mortgage may vary depending on the type of loan you get. For HECMs, the most common reverse mortgage option, requirements are as follows:

Borrower requirements

• Be 62 or older.
• Have significant equity in your home or own it outright.
• Occupy it as your primary residence.
• Be current on any federal debt payments.
• Have adequate savings or income to cover other home expenses.
• Participate in an educational session with a HUD counselor.

Property requirements

• Owner-occupied single-family or 2 to 4 unit multifamily.
• Condominium that meets HUD requirements.
• Manufactured home that meets HUD requirements.

Costs of a reverse mortgage

Fees and closing costs for reverse mortgages may also vary depending on your lender, but costs for HECMs are as follows:

• Mortgage insurance. You’ll pay 2% of your total loan as an up-front mortgage insurance payment, plus premiums totaling 0.5% of the balance over the life of your loan.
• Origination fees. You’ll also pay an origination fee to your lender, which is capped at $6,000 but may be less, depending on your home’s value.
• Loan servicing fees. A monthly loan servicing fee of up to $35 also applies.
• Closing costs. You’ll also pay closing costs with a reverse mortgage, just as you would with a traditional mortgage. These costs may amount to 2% to 6% of the total loan.

Reverse mortgage example

Let’s say you are 62 years old, owe $25,000 on your existing mortgage, and own a home valued at $600,000. If you apply for a reverse mortgage with a 5% interest rate, you could receive a lump-sum payment of $154,700, a line of credit of $66,300, or a monthly payout of $737 (figures arrived at using MoneyGeek’s reverse mortgage calculator). Borrowing amounts may vary depending on your lender and situation.

Is a reverse mortgage right for you?

A reverse mortgage may be right for you if you have limited retirement savings and plan to live in your home for several years. The proceeds you receive from your loan could help you afford home maintenance or everyday living expenses. Before deciding on a reverse mortgage, it’s essential to understand the drawbacks of these loans.

Alternatives to a reverse mortgage

Homeowners with significant equity, sufficient income, and decent credit may want to consider these alternatives to a reverse mortgage. Remember that fees or closing costs will likely apply with the following options.

Home equity loans and home equity lines of credit (HELOC)

These two loan types use your home equity as collateral.

Home equity loan

A home equity loan provides a lump-sum payment. You can generally borrow up to 80% of your home equity and use the loan proceeds for home improvements or another large expense. Monthly payments are required on the amount you borrow, and your loan will typically have a fixed interest rate.

Home equity line of credit (HELOC)

A HELOC lets you access a line of credit, which can be useful if you aren’t sure exactly how much you need to borrow for a renovation or other expenses. It comes with a draw period, during which you can borrow against the line of credit, and a repayment period.

Once you enter repayment, you’ll need to pay back the amount you’ve borrowed with interest, and your HELOC will typically have a variable interest rate.

Cash-out refinance

With a cash-out refinance, you replace your existing mortgage loan with a larger one. The new mortgage is used to pay off the balance on your old one, and you receive the difference in cash. This type of refinance effectively converts your home equity into cash, which you can use as needed for home projects or other large expenses. A warning: Your new mortgage’s monthly payments may be larger than those on your old one.

TIME Stamp: A reverse mortgage can be a source of retirement income, but it isn’t for everyone

Reverse mortgages can help supplement your retirement savings, but these loans aren’t free from drawbacks and risks. They often come with high fees, and reverse mortgage balances need to be repaid in full if you leave your home permanently or sell it. A home equity loan, HELOC, or cash-out refinance may be a better alternative to a reverse mortgage for many. If you’re considering a reverse mortgage, weigh the pros and cons and ask a HUD counselor for more information.

Frequently asked questions (FAQs)

When do you have to repay a reverse mortgage?

A reverse mortgage must be paid in full if you sell your home or leave it permanently. Your heirs will need to repay it if you die, either by selling your home or, if they don’t want to sell, using another funding source.

Can you refinance a reverse mortgage?

It’s possible to refinance a reverse mortgage if you meet the borrowing criteria set forth by your preferred lender. For instance, you might opt to refinance if the market value of your home has increased significantly since you obtained your existing reverse mortgage.

How do you avoid reverse mortgage foreclosure?

You must keep paying your property taxes, homeowners insurance premiums, and homeowners association fees while maintaining your home in good physical condition to avoid reverse mortgage foreclosure.

How do I find a reverse mortgage lender?

As federally insured HECM reverse mortgages are the most common option, searching the HUD's lender list is the easiest way to find a reverse mortgage lender. This search tool will provide a list of HUD-approved lenders offering these loans.

How can you avoid reverse mortgage scams?

To avoid reverse mortgage scams, be sure you fully understand this type of loan and work with a trusted lender. If you have questions or concerns, speak with a HUD counselor, a financial advisor, or an attorney before moving forward with a loan or providing any sensitive information to a potential lender.