What is a reverse mortgage?
A reverse mortgage is a type of specialty loan for individuals who are 62 or older and have 50% or more equity in their home. There are government-sponsored and private reverse mortgage programs.
With a reverse mortgage, homeowners borrow against their home equity (tax-free). It gives the homeowner access to the equity in their home without having to sell the home or refinance for cash-out. Instead of making a mortgage payment, they receive payment, hence the name “reverse mortgage.”
What are the requirements for a reverse mortgage?
How does a reverse mortgage work?
Just like any other loan, the lender will do an appraisal of the home to determine its value and how much equity the owner has in this property. The new loan will pay off what is left of the current mortgage, and the remaining money goes to the owner(s). Some government-sponsored reverse mortgages have restrictions on how the funds can be used, while other programs and private lenders have none.
Typically, this loan is not repaid by the homeowner. They may move in with family or to an assisted living facility or spend their last days in their home. The heirs then sell the property to pay off the loan. Any remaining proceeds go to the estate. If the heirs would like to keep the home, they can refinance it with a traditional mortgage.
Are there borrowing limits?
A private mortgage lender sets their own limits, but usually there are no set limits on what you can borrow from your equity. Government-backed reverse mortgages limit borrowers to only a portion and not the full value of their property. Limits may be impacted by age, credit, and loan interest rates.
What are the costs?
- Government-backed reverse mortgages require a Mortgage Insurance Premium (MIP) with a 2% upfront fee and 0.5% annual premium. While you can’t default on this loan in a traditional sense, you can default if you fail to pay taxes, insurance, or maintain the property.
- Lender or broker origination fees 1%-2% of the loan amount.
- Property appraisal fee
- Closing cost fees
- Ongoing property taxes and homeowners’ insurance, home maintenance
What kinds of reverse mortgages are available?
Home Equity Conversion Mortgage (HECM): Backed by HUD, these can cost more than a conventional mortgage, but the money can be used for almost anything and received in a variety of ways: Fixed-monthly payments, lump sums, line of credit.
Single-Purpose Reverse Mortgage: Least expensive. Offered by non-profits and state and local governments for purposes determined by the lender (i.e., home repairs or improvements). Like USDA loans, these are available in certain areas.
Proprietary Reverse Mortgage: These are private loans that aren’t backed by the government. Requirements, rates, fees, underwriting process, and terms are set by the lender. These are easier to get and usually a quick process. It’s important to work with a reputable broker or lender. There are people who set up reverse mortgage scams to defraud retirees. These aren’t back by the government and will not protect borrowers in in the same way.
Advantages and Disadvantages
Advantages
- Retire and stay in your home
- The security of paying your bills with your own equity
- Declining home values will not impact you. These are non-recourse loans.
- A spouse who is not a borrower may be able to stay in your home after you die.
Disadvantages
- Outliving the equity against which you borrowed
- Decrease in the equity of your home
- Heirs may not benefit from equity in your home
- Watch out for scams
- You are paying interest on the loan
What other mortgage options do you have?
For homeowners who plan to move soon or would like to leave the home to their loved ones, there are other options. Consider a cash–out refinance. With the equity you already have, you can refinance your mortgage. Borrow more than you owe on the house and receive cash (the difference) to put towards your retirement expenses or plans. This is not a second mortgage.
Summary
When you retire and you have significant equity in your home, you have options. Talk to a trusted broker to find the best way to take advantage of your equity during these years.
