A reverse mortgage is a type of loan available to homeowners aged 62 and older that allows them to convert a portion of their home equity into cash while continuing to live in the home. Unlike a traditional mortgage where the borrower makes monthly payments to the lender a reverse mortgage pays money to the borrower and the loan balance grows over time rather than shrinking.
Reverse mortgages can be a useful financial tool for some older homeowners but they are also complex and come with significant risks and costs that are important to understand before proceeding.
How a reverse mortgage works
When you take out a reverse mortgage the lender pays you — either as a lump sum, a line of credit, monthly payments, or a combination — based on the equity in your home. You continue to own the home and can live in it for as long as you meet the loan requirements.
The loan does not have to be repaid as long as you continue to live in the home as your primary residence, keep up with property taxes and homeowners insurance, and maintain the property. The loan becomes due and payable when you sell the home, permanently move out, or die.
When the loan becomes due you or your heirs can repay it by selling the home or using other funds. If the home is sold for more than the loan balance you or your heirs keep the difference. If the home sells for less than the loan balance the Federal Housing Administration — FHA — insurance covers the shortfall under the most common type of reverse mortgage — meaning you or your heirs are not personally responsible for the difference.
Types of reverse mortgages
There are three main types of reverse mortgages:
- Home Equity Conversion Mortgage — HECM — the most common type of reverse mortgage, insured by the Federal Housing Administration and regulated by the U.S. Department of Housing and Urban Development — HUD. HECMs are available to homeowners aged 62 and older and have federally mandated consumer protections including a requirement for independent counseling before the loan is finalized.
- Proprietary reverse mortgage — a private loan offered by individual lenders that is not insured by FHA. Proprietary reverse mortgages may allow higher loan amounts than HECMs and may be available to homeowners under age 62 in some cases.
- Single-purpose reverse mortgage — offered by some state and local government agencies and nonprofit organizations for a specific purpose such as home repairs or property taxes. These are typically the least expensive type of reverse mortgage but are not widely available.
Who is eligible for a reverse mortgage
To be eligible for a HECM reverse mortgage:
- You must be at least 62 years old
- The home must be your primary residence
- You must own the home outright or have significant equity
- You must be current on any existing mortgage or able to pay it off with the reverse mortgage proceeds
- The home must meet FHA property standards
- You must complete a HUD-approved reverse mortgage counseling session before applying
How much can you borrow
The amount you can borrow through a reverse mortgage depends on several factors including:
- Your age — older borrowers can generally borrow more
- The appraised value of your home
- Current interest rates — lower rates allow higher borrowing amounts
- The type of reverse mortgage
The maximum loan amount for a HECM is limited by the FHA lending limit which is updated annually.
How you can receive the money
HECM reverse mortgage proceeds can be received in several ways:
- Lump sum — a single payment of the full loan amount at closing. This option typically comes with a fixed interest rate.
- Line of credit — a credit line that grows over time and can be drawn on as needed. This is the most flexible option and the unused portion of the line of credit grows over time.
- Monthly payments — fixed monthly payments for a set period or for as long as you live in the home
- Combination — a combination of any of the above options
Costs of a reverse mortgage
Reverse mortgages come with significant costs that can substantially reduce the net benefit to the borrower. Common costs include:
- Origination fees — fees charged by the lender to process the loan
- Closing costs — title insurance, appraisal, and other standard closing costs
- FHA mortgage insurance premium — an upfront premium and ongoing annual premium required for HECMs
- Servicing fees — monthly fees charged by the loan servicer
- Interest — interest accrues on the outstanding loan balance over time
Because these costs are typically financed into the loan they can add up significantly over time and substantially reduce the equity remaining in the home.
Obligations of a reverse mortgage borrower
Borrowers must continue to meet certain obligations to avoid defaulting on a reverse mortgage:
- Pay property taxes on time
- Maintain homeowners insurance
- Keep the property in good repair
- Live in the home as a primary residence — typically defined as living there for at least six months per year
Failure to meet these obligations can result in the loan becoming due and payable which could mean losing the home.
When a reverse mortgage becomes due
A reverse mortgage becomes due and payable when:
- The last surviving borrower dies
- The borrower sells the home
- The borrower permanently moves out of the home — including moving to a nursing home or assisted living facility for more than 12 consecutive months
- The borrower fails to meet the loan obligations such as paying property taxes or maintaining insurance
Reverse mortgages and heirs
A reverse mortgage can significantly affect what heirs receive from the estate. When the loan becomes due heirs typically have several options:
- Repay the loan balance and keep the home
- Sell the home and use the proceeds to repay the loan keeping any remaining equity
- Allow the lender to sell the home if they do not wish to repay the loan
Heirs are not personally responsible for any shortfall if the home sells for less than the loan balance on a HECM reverse mortgage due to FHA insurance.
Is a reverse mortgage right for you
A reverse mortgage may be worth considering for homeowners who:
- Need additional income to cover living expenses or healthcare costs
- Want to age in place and have significant home equity
- Do not plan to leave the home to heirs or have other assets to leave
- Have explored other options and found them unsuitable
A reverse mortgage is generally not recommended for people who:
- Plan to move in the near future
- Want to leave the home to their children or other heirs
- Have a spouse or co-borrower under age 62 who is not on the loan
- Are considering a nursing home or assisted living in the near term
Required counseling
Before obtaining a HECM reverse mortgage borrowers are required by law to complete a counseling session with a HUD-approved reverse mortgage counselor. The counselor explains how reverse mortgages work, the costs and risks involved, and alternatives that may be available. This counseling is designed to ensure that borrowers fully understand what they are agreeing to before proceeding.
To find a HUD-approved reverse mortgage counselor visit hud.gov or call 1-800-569-4287.
Key terms to know
- Reverse mortgage — a loan that allows homeowners aged 62 and older to convert home equity into cash without selling the home
- Home Equity Conversion Mortgage — HECM — the most common type of reverse mortgage insured by the FHA
- Home equity — the difference between the market value of a home and the amount owed on any mortgages
- Line of credit — a flexible reverse mortgage payment option that allows borrowers to draw funds as needed
- FHA mortgage insurance — insurance that protects both borrowers and lenders on HECM reverse mortgages
- HUD-approved counselor — an independent counselor required to advise borrowers before obtaining a HECM reverse mortgage
- Proprietary reverse mortgage — a private reverse mortgage not insured by FHA
Sources
- U.S. Department of Housing and Urban Development — hud.gov
- Consumer Financial Protection Bureau — consumerfinance.gov
- Federal Trade Commission — ftc.gov
- USA.gov
This article is for general informational purposes only and does not constitute legal or financial advice. Reverse mortgage terms and regulations are subject to change. Consult a HUD-approved reverse mortgage counselor or licensed financial advisor for guidance specific to your situation.