Reverse Mortgage: What It Is and How It Works

Odds are that you have heard about reverse mortgages before without really knowing what they are. However, not knowing about this mortgage solution could mean missing out on accessible funds. Read on to learn everything you need to know about reverse mortgages to determine whether it’s the right option for you. 

What Is a Reverse Mortgage?

A reverse mortgage is a unique mortgage solution that allows older homeowners to borrow part of their home’s equity as tax-free income. Instead of having to make mortgage payments to a lender, with a reverse mortgage, the lender actually makes payments to the homeowner. These payments can then be used to cover a wide range of different expenses -- from things like home renovations to medical costs. 

How Does a Reverse Mortgage Work?

While the overall concept of a reverse mortgage may initially seem quite simple, there’s more to it than meets the eye. This is because borrowers cannot borrow the full value of their home equity. Instead, the limit is calculated using a variety of different factors that we will cover in detail a bit later. 

At the most basic level, a reverse mortgage uses a portion of your home equity to pay off your existing mortgage. The loan balance does not become due until the final borrower moves out of the home, passes away, or doesn’t meet the requirements of the reverse mortgage. During this time, the homeowner is not technically required to make monthly mortgage or interest payments -- although doing so could prove worthwhile in the end by counteracting the accrual of interest. 

The homeowner then gets to choose how they are paid by the lender -- choosing between a lump-sum payment, monthly payments, or lines of credit. Over time, a reverse mortgage causes the equity in the home to decrease while the debt of the homeowner increases. So although the homeowner gets to keep the title of the home and maintain ownership, there are both benefits and drawbacks to taking out a reverse mortgage. 

What Can a Reverse Mortgage Be Used for?

One of the greatest benefits of reverse mortgages is that they can be used for a wide range of purposes. However, here are some specific examples of things that you can pay for using funds from a reverse mortgage: 

• Consolidate other non-housing-related debts
• Pay for medical care and treatments not covered by insurance or Medicare
• Pay for in-home medical care or services
• Make home improvements, for instance, making ADA modifications 
• Put money into an emergency fund to increase savings
• Eliminate or lower monthly mortgage payments 
• Supplementing retirement income

Who Is Eligible for a Reverse Mortgage?

Sure, a reverse mortgage sounds great -- but not everyone is eligible for one. In order to receive a reverse mortgage, you as a borrower have to meet certain requirements and your property needs to meet a separate set of requirements. Here’s what you need to know in order to determine your eligibility: 

To be eligible for a reverse mortgage, the borrower…

• Must be at least 62 years of age or older
• Must have enough equity built up in the home -- generally around 50% although the exact amount varies by lender
• Must attend a counseling session given by a U.S. Department of Housing and Urban Development (HUD) approved counselor so that you can learn more about this unique lending option
• Must undergo a financial assessment and meet additional financial requirements to ensure that you are in a good financial standing

To be eligible for a reverse mortgage, the property…

• Must be your primary residence 
• Must be in a good overall condition and meet standards set forth by the Federal Housing Administration (FHA)
• Must not be a mobile or manufactured home
• Must be on the HUD/FHA approved list if it is a condo

What Are the Pros and Cons of a Reverse Mortgage?

Before you take out a reverse mortgage on your home, you need to consider both the pros and the cons of such an important financial decision. 

Pros

The pros of taking out a reverse mortgage include:

• You get to remain the owner of the home and your name stays on the title
• Even if you die, a non-borrowing spouse who is not listed on the mortgage can remain in the home
• On the other hand, if you die, there’s no remaining spouse, and the loan becomes due -- there are options for your heirs. They can choose to purchase the home for 95% of its appraised value or the balance of the home -- whichever is lower. They can also choose to refinance the remaining balance into a traditional mortgage. Finally, they can choose to sell the home. 
• You get to access the equity that you’ve built up in your home without having to sell it or even make monthly mortgage payments
• Depending on the type of reverse mortgage you choose, you may be able to do whatever you want with the funds with no restrictions
• You can use the funds for important expenses like healthcare expenses, debt repayment, renovations, etc. 
• You do not have to qualify for a reverse mortgage with a specific credit score, instead, a general financial assessment will be performed
• You are protected from declining home values since your reverse mortgage is a non-recourse loan
• You are able to use a reverse mortgage as a way to avoid foreclosure, as it allows you to pay off the existing mortgage 

Cons

The cons of taking out a reverse mortgage include: 

• You must maintain the home and continue to pay property taxes and homeowners insurance in order to receive a reverse mortgage
• You must borrow against the equity in your home which decreases it, increases your amount of debt, and prevents that equity from being used for other purposes down the road
• You might encounter high closing costs and additional fees associated with a reverse mortgage that will decrease the overall amount of money that you’re actually able to use
• The loan could come due for a variety of different reasons that you need to be aware of:
• If you do not maintain the home as your primary residence for more than six months, the loan could come due
• If you do not pay property taxes and homeowners insurance for the home, the loan could come due
• If you move out of the home or pass away, the loan could come due
• Your heirs may be limited in terms of what they can do with the home after your passing
• You may end up outliving your proceeds depending on the type of reverse mortgage you choose

How Much Money Can You Get From a Reverse Mortgage?

While a reverse mortgage gives you access to your home’s equity, it still doesn’t allow you to access all of it. The exact amount of money that you can get from a reverse mortgage will depend on a variety of different factors, for instance:

• The age of the youngest borrower or the younger spouse. The older the borrower is, the more they will be able to borrow.
• The higher the property’s value is based on the appraisal, the more you will be able to borrow. 
• The more equity you have built up in the home, the more you will be able to borrow. 
• The lower the mortgage interest rate is offered, the more you will be able to borrow. 
• The stronger your reverse mortgage financial assessment is, the more you will be able to borrow. 

Clearly, these are just general specifications that don’t actually help you determine how much money you can get from your specific property. Here are some actual numbers to help you out:

• The average reverse mortgage borrower was able to access about 58% of their home equity. 
• The average initial principal limit was $211,468 in January 2018. 
• The average maximum claim amount was $412,038 in January 2018. 

What Are the Different Types of Reverse Mortgages?

There are three different types of reverse mortgages that you may want to consider: home equity conversion mortgages, proprietary reverse mortgages, and single-purpose reverse mortgages. 

1. Home Equity Conversion Mortgage (HECM)

A home equity conversion mortgage, or HECM, is the most popular type of reverse mortgage. This is because they offer the best terms compared to private reverse mortgages. For instance, HECMs generally offer lower interest rates. On the other hand, this type of reverse mortgage may come with higher upfront costs as well as slightly higher monthly payments due to the mortgage insurance premium requirement. However, at the end of the day, these mortgages can make sense for a lot of borrowers. 

This type of reverse mortgage is federally backed by the FHA and is widely available by FHA-approved lenders. They also have more restrictions in terms of requirements, uses, and loan amounts. Since these mortgages are federally backed, you are required to complete HUD-approved counseling before closing. 

2. Proprietary Reverse Mortgage

A proprietary reverse mortgage is a private mortgage loan that is not backed by the federal government. Since they do not involve the federal government, they come with fewer regulations and requirements. This type of reverse mortgage is commonly used by borrowers looking to take out more than the limit set by the FDA. As a result, elderly owners of homes valued at more than $765,000 are the most common recipients of a proprietary reverse mortgage. 

3. Single-Purpose Reverse Mortgage

A single-purpose reverse mortgage is the least common of the three -- making up less than 10% of the reverse mortgage market. It is usually offered by non-profit organizations or government agencies at the federal, state, and local levels. This type of reverse mortgage can be used for a single purpose that is approved by the lender. Lenders may approve single-purpose reverse mortgages for things like paying property taxes or maintaining the home. 

What Are the Different Payment Options for Reverse Mortgages?

In addition to the different types of reverse mortgages, there are also different payment options to choose from. Learn more about these different options so that you can choose the one that best fits your financial needs: 

1. Lump-Sum Payment

When you opt for a lump-sum payment for your reverse mortgage, you get all the funds at once upon closing. A lump-sum payment is the only payment option available for fixed-rate reverse mortgages. 

2. Equal Monthly Payments

When you opt for equal monthly payments for your reverse mortgage, you get regular and equal payments from the lender. These payments, also known as a tenure plan, will continue so long as at least one borrower maintains the property as a principal residence. 

3. Term Payments

When you opt for term payments for your reverse mortgage, you get regular and equal payments for a set period of time. For instance, you may choose to receive payments for a period of 10 years. 

4. Line of Credit

When you opt for a line of credit for your reverse mortgage, you essentially receive a “credit card” that you can use to take out money as needed. So instead of taking out a large amount of money and paying interest on that amount, you only pay interest on the amount that you actually use. This is a good option if you’re looking for funding for small or periodic purposes rather than large and continuous purposes. 

5. Equal Monthly Payments + Line of Credit

When you opt for equal monthly payments plus a line of credit for your reverse mortgage, the lender will start off by providing you with steady and equal monthly payments so long as you maintain the property as a principal residence. If you determine at any point that you need additional funding in a timely manner, you can then access the line of credit. 

6. Term Payments + Line of Credit

When you opt for term payments plus a line of credit for your reverse mortgage, the lender will provide you with equal monthly payments for a specific period of time. If you determine at any point that you need additional funding apart from this regular payment schedule, you can then access the line of credit. 

How Much Does a Reverse Mortgage Cost?

No loan is ever free -- they always come with closing costs and reverse mortgages are no different. So before you assume that a reverse mortgage is a cost-free way to get money without a second thought, you need to do the math to ensure that it actually makes sense for you financially. 

Here are some of the costs and fees that are associated with a reverse mortgage:

• Origination fee: To pay for the processing of your loan, lenders will either charge a flat fee of $2,500 or 2% of the first $200,000 of your home’s value plus 1% of the amount over $200,000 -- whichever is greater. However, the origination fee is capped at $6,000. 
• Servicing fee: To pay for the continuous servicing of your loan, lenders often charge a monthly fee that cannot exceed $30 for fixed-rate loans or $35 for monthly adjustable-rate loans. 
• Third-party fees: There may also be additional fees associated with the process, for instance, an appraisal fee, a home inspection fee, a credit check fee, a title search fee, a title insurance fee, and a recording fee. 
• Mortgage insurance premiums (MIP): As a part of your reverse mortgage loan, you are required to pay both an initial and an annual mortgage insurance premium at a rate of 2% and 0.5% annually, respectively. Although the MIP can be financed into the loan amount, that decreases the funds available to you. 

Is a Reverse Mortgage Right for You?

At the end of the day, only you can decide if a reverse mortgage is right for you. However, if you’re over the age of 62 and are looking for some extra cash to cover outstanding costs, then taking out a reverse mortgage might make a lot of sense. If you want more personalized advice about your options, feel free to reach out to the lending experts at Vaster. 

What You Need to Know About Reverse Mortgage Scams

Unfortunately, reverse mortgage scams are used to take advantage of senior citizens who may not know any better. One common reverse mortgage scam is referred to as a “contractor loan.” Contractors may try to convince you to take out a reverse mortgage on your home in order to pay them for renovation and home improvement services. However, they may perform shoddy work or not perform the work at all and simply take your money. 

Another common type of reverse mortgage scam is referred to as “veteran loans.” While the U.S. Department of Veterans Affairs does offer traditional mortgages to veterans and active service members, they do not offer reverse mortgages. So be wary of anything advertising great deals for veterans that doesn’t directly involve the VA.

So what can you do to avoid falling victim to a reverse mortgage scam? You should always be aware and vigilant when considering a reverse mortgage product. Only work with reputable lenders and perform extensive research to ensure that they are legitimate and trustworthy. If anyone tries to pressure you into taking out a reverse mortgage on your home, this is a major red flag. 

If you are concerned about a reverse mortgage scam, you can reach out to AARP’s Fraud Watch Network Helpline for guidance and assistance. 

What Are the Alternatives to a Reverse Mortgage?

If you’re not yet eligible for a reverse mortgage or have determined that it’s not the best option for you, there are alternatives that you may want to consider: 

• Home equity loan: If you’re not yet 62 and need to access your home’s equity, another option for you to consider is a home equity loan. A home equity loan is a second mortgage taken on your property so long as you have built up at least 20% equity. Most lenders will allow you to borrow up to 80% of your equity with favorable interest rates. A home equity loan can be used for things like renovations, medical expenses, or education expenses. 
• Home equity line of credit (HELOC): Again, if you’re not yet 62 and need to access your home equity but are wary of taking out a large sum of money all at once, you may want to consider a home equity line of credit or HELOC. A HELOC functions like a credit card wherein you only borrow what you need and you only pay interest on what you actually borrow. 
• Refinancing: Depending on your current mortgage interest rate and the going market rates, refinancing may be able to help you save money on housing costs. When you refinance, you take out a new mortgage loan to pay off your existing one. This option only makes sense if you have built up enough equity to lower your monthly payments or are receiving a lower interest rate that will also work to lower your monthly payments. That being said, these new loans aren’t free and come with closing costs just as your original mortgage did. 

Final Rundown on Reverse Mortgages

Overall, a reverse mortgage can be a great way to access the equity in your home while eliminating or lowering your monthly mortgage payments in the process. You can then use these funds as you so desire. For more information about reverse mortgages and other lending solutions, reach out to the experienced mortgage brokers at Vaster. 

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