For many retirees, their largest asset is their home — but they might not be ready to sell or move to cash in on their equity. That’s where a reverse mortgage can come into play. A reverse mortgage allows people age 62 and older to continue to live in and own their home while they take out a loan against their home equity, which can be used to help fund their life in retirement. If you’re considering using this tool, make sure you understand exactly how it works, as well as if a reverse mortgage is a wise move for your financial situation.
How Does a Reverse Mortgage Work?
Reverse mortgage solutions, also known as Home Equity Conversion Mortgages or HECMs, are available through FHA-approved lenders. When you take out a reverse mortgage, the lender makes payments to you, the homeowner, rather than the other way around. The loan is paid off when the home is sold, with the lender receiving the principal plus interest. Any additional proceeds from the sale go to the homeowner or survivors.
Unlike a conventional mortgage or home equity loan, an HECM offers a flexible repayment feature so you can better control your monthly expenses and cash flow. No minimum monthly loan payment is required; you can choose to pay as much or as little as you like each month. The loan doesn’t have to be repaid until you sell the home, pass away or move out. But you can also pay down the loan at any time, with no penalty — the choice is yours.
If you have an existing first or second mortgage on your home, you can use a reverse mortgage to pay off your existing mortgage. Retirees can use the HECM as a way to continue owning and living in their home with greater financial flexibility.
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Who Can Get a Reverse Mortgage?
You must meet these requirements in order to qualify for a reverse mortgage:
- Be age 62 or older
- Live in your home
- Own your home
- Pass a financial assessment to ensure that you can keep current with property taxes, insurance and maintenance
Also, your home must be your primary residence and meet U.S. Department of Housing and Urban Development minimum property standards. Houses and most condos qualify.
How to Get a Reverse Mortgage
Aside from meeting the aforementioned requirements, getting a reverse mortgage has other conditions. To get a reverse mortgage, you must:
- Fill out an application.
- Have a pre-loan consultation with an independent, FHA-approved reverse mortgage counselor.
- Undergo a financial assessment.
The consultations ensure that prospective borrowers understand whether a reverse mortgage is appropriate and allow them to confirm their ability and willingness to meet loan obligations. Prospective borrowers should feel comfortable asking any questions so they can get information that helps them to understand exactly how a reverse mortgage works and to determine if it is actually the best product for them.
Here are some questions to ask yourself before taking out a reverse mortgage:
- How would a reverse mortgage help me accomplish my retirement goals?
- How would a reverse mortgage strengthen my retirement security?
- How long do I plan to live in my home?
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Pros and Cons of Reverse Mortgages
A reverse mortgage can help senior homeowners get access to funds to cover living expenses while also remaining in their homes — but there are some drawbacks to taking out this kind of loan. Before you decide to move forward with an HECM loan, make sure you fully understand the pros and cons of a reverse mortgage.
Pros of a Reverse Mortgage
Reverse mortgages offer a number of positive features, including the fact that you can continue to own and live in your home. Understand all the advantages of this financial plan so you can better see how it might work for you. These advantages include:
- Accessibility: You can get your funds in a way that works best for you — a lump sum or a continuously accessible line of credit, for example.
- Existing mortgage payoff: You can use HECM funds to pay off your existing mortgage.
- No monthly payments: No monthly mortgage payments are required as long as you live in the home, continue to pay property taxes and homeowners insurance, and maintain the property.
- No extra taxes: Generally, loan proceeds aren’t considered taxable income. Consult a tax professional to make sure your situation meets the requirements.
- Beneficial to heirs: If used properly, an HECM could increase the amount of a client’s retirement savings that could transfer to their heirs.
- Access to more funds: If the value of your home increases, you might consider refinancing your reverse mortgage to access even more loan proceeds.
- Equity ownership: After the loan is repaid, any remaining home equity belongs to you or your heirs.
- Delay using retirement savings: As you use money from a reverse mortgage to pay for expenses, you can keep other funds in stocks and other investments that appreciate in value over time. Along that same vein, you might be able to hold off on collecting Social Security benefits by living off the HECM loan. For people born after 1942, each year that you delay receiving Social Security benefits, your benefits increase 8 percent up to age 70.
Cons of a Reverse Mortgage
To determine whether an HECM is the right solution for you, you should understand the challenges that come along with this kind of loan. Here are some disadvantages to expect with a reverse mortgage:
- Increasing balance: The loan balance increases over time as interest on the loan and fees accumulate.
- Decreasing assets: A lien on your home will apply for the outstanding HECM amount, and as you use home equity, fewer assets are available. You can still leave the home to your heirs, but they’ll have to repay the loan balance.
- Higher fees: Fees might be higher than with a traditional mortgage.
- Effect on benefits: Eligibility for need-based government programs, such as Medicaid or Supplemental Security Income, could be affected. Consult a benefits specialist to find out details.
- Sooner due date: The loan becomes due and must be repaid when a “maturity event” occurs. Maturity events include the last surviving borrower — or non-borrowing spouse meeting certain conditions — passing away; the home no longer being the borrower’s principal residence; or the borrower vacating the property for more than 12 months. The loan will also become due if the homeowner fails to pay his property taxes or homeowners insurance, or fails to maintain the property.
- Insurance: Per FHA requirements, HECMs require mortgage insurance.
- Complex terms: This type of loan agreement can be complicated, so it’s important you fully understand what you’re agreeing to before signing on the dotted line.
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Reverse Mortgage Costs
As with any loan, there are a variety of fees that come along with a reverse mortgage. However, you don’t have to pay these fees upfront — you can finance them and pay with the proceeds of your loan. If you do finance HECM costs, they will reduce the net loan amount available to you.
The fees and charges associated with an HECM loan include:
- Mortgage Insurance Premium: The MIP guarantees that you will receive the expected loan advances. The initial MIP, charged at closing, is 2 percent. After that, you’ll be charged an annual MIP that equals 0.5 percent of the outstanding mortgage balance over the life of the loan.
- Third-party charges: These costs can include fees for appraisal, title search and insurance, surveys, inspections, recording, mortgage taxes and credit checks.
- Origination fee: The lender charges a fee for processing your loan, which can be the greater of $2,500, or 2 percent of the first $200,000 of your home’s value plus 1 percent of the amount over $200,000. This fee is capped at $6,000.
- Interest: Interest is paid on the loan at either an adjusting or fixed rate. As of January 2019, the average ARM interest rate for HECM loans was 5.11 percent, and the average fixed interest rate was 4.74 percent, according to HSH.
- Servicing fee: Lenders and agents may charge a monthly servicing fee. This fee can be as much as $30 for annually adjusting or fixed interest rates, and as much as $35 for monthly adjusting interest rates. This fee can also be rolled into the interest rate.
Fees will vary by provider, so be sure to shop around. The two most popular HECM loans are the AAG reverse mortgage and the Finance of America Reverse loans, according to HousingWire.
Keep in mind that if you have a high-priced home, you might not be able to take out a loan for the entire value — the HECM FHA mortgage limit is $726,525. The maximum amount an individual can borrow is based on age, current interest rate and the appraised value or sales price of the home.
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David Peskin contributed to the reporting for this article.