A reverse mortgage can give older homeowners the funds they need to help cover their costs of living. While this can certainly sound like a good deal, there's a lot to consider before taking the plunge. Here's a look at how reverse mortgages work, who's eligible, and who should (and probably shouldn't) get one.
Reverse mortgages, explained
A reverse mortgage is a type of loan that allows you to "tap your home's equity," Kiplinger explains. Let's say you've invested a lot of money in your home through mortgage payments — either you own outright, or have paid off most of the mortgage — and therefore you have equity. If you're planning to sell your home and downsize, that equity is very useful. But if you plan to stay in your home, as many seniors wish to do, having your net-worth tied up in equity can be limiting. That's where reverse mortgages come in: The borrower already owns the home, and they're borrowing against it while retaining title and ownership of the house. Think of it as "a conventional mortgage where the roles are switched," explains Forbes. The bank will give you money upfront and then you'll eventually pay back that borrowed amount (known as the principal), plus interest.
The difference between a traditional mortgage and a reverse mortgage is that the borrower won't pay interest throughout the loan's term. Instead, the principal and interest will come due all at once at the end of the loan's term. Because of this delayed payback date, reverse mortgage loans often aren't repaid by the borrower; the borrower's heirs often sell the property to pay off the loan after the borrower either moves or passes away.
Reverse mortgages are most commonly issued through government-insured programs, with the most popular type being the Home Equity Conversion Mortgage (HECM), which is backed by the Federal Housing Administration. Private lenders may offer reverse mortgages, but these aren't federally insured and are likelier to expose the borrower to scams, per Forbes.
Who can get a reverse mortgage?
They are only available to homeowners who are at least 62 years old. Borrowers have to meet other requirements, according to the Consumer Finance Protection Bureau. They must:
- live in the home they're borrowing against
- either own the home outright or have a low balance on the mortgage, which they will need to pay off when they close on the reverse mortgage
- not owe any federal debt
- keep their home in good condition
- get counseling from a reverse mortgage counseling agency that's approved by the United States Department of Housing and Urban Development (HUD)
There's also an application process. The bank will want to make sure you have enough equity in your house and that you have sufficient funds to keep paying costs like property taxes, homeowner's insurance, homeowner association fees, and general upkeep of the property.
How much can you borrow with a reverse mortgage?
That depends on interest rates, your age, and the appraised value of your home or the HECM mortgage limit, whichever is lower. According to Kiplinger, "[g[enerally, the older you are, the lower the interest rate, and the higher the house value, the more money you'll be able to tap." Note that it's not possible to tap all of the equity in your home.
You can receive the funds as a one-time lump sum, through monthly payouts, or via a line of credit. You also have the option to use a combination of these methods.
What are the costs involved?
There are a number of noteworthy costs associated with reverse mortgages:
- Mortgage insurance premiums: For federally-backed reverse mortgages, there is a 2 percent upfront mortgage insurance premium, and an annual premium of 0.5 percent thereafter, according to Forbes.
- Origination fee: Additionally, borrowers may pay a loan origination fee. According to HUD, lenders can charge "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." These fees will be no higher than $6,000 though.
- Servicing fee: Lenders can also charge a fee throughout the life of the loan for servicing, which can include tasks like sending account statements and disbursing loan proceeds. This fee will be no more than $30 or $35 per month, depending on how interest is charged on the loan.
- Third-party charges: Other costs can add up, such as charges for an appraisal, a title search, title insurance, a credit check, or a recording fee.
- Interest: The interest rate on a reverse mortgage can be fixed if you take out a lump sum, or variable. Variable rates are based on a financial index, with a margin of one to three percentage points added for the lender, according to Investopedia. You only accrue interest on the amount disbursed to you, not on untapped funds. Still, given you don't have to pay back the loan as long as you stay in the house and keep up with taxes and other costs, interest can accumulate significantly over time.
The costs are usually rolled into the mortgage, meaning borrowers won't have to pay them out of pocket — though this does reduce the loan amount available to them. And the costs can certainly add up. According to LendingTree, "reverse mortgages are more expensive than other home loan types."
Should you get a reverse mortgage?
To figure out if a reverse mortgage is right for you, "start by thinking about what you plan to do with the proceeds," Kiplinger says. If you want to stay in your home as you get older rather than moving to assisted living, for instance, then a reverse mortgage could make sense. You might also consider a reverse mortgage to help cover costs during a market downturn, or if you need additional income during retirement.
If you have heirs you'd like to inherit your property, however, you might want to think twice, LendingTree explains. The same goes if you have family members who live with you and need to stay in the home after the term of the reverse mortgage ends. A reverse mortgage also might not be the right choice if you're planning to move soon, or if your health is uncertain.
There are other potential downsides. For example: You could face foreclosure if you don't keep up with taxes, insurance, or maintenance; you could use up all of your home's equity, making it unavailable later; you may need to sell your house to get out of the loan; and your principal will keep increasing over time as fees and interest get added to the loan.
You'll want to weigh the pros and cons before proceeding. While a reverse mortgage can help you stay in your home longer, bolster your retirement funds, and pay off debt, it's also important to consider the full financial picture.
Becca Stanek has worked as an editor and writer in the personal finance space since 2017. She has previously served as the managing editor for investing and savings content at LendingTree, an editor at SmartAsset and a staff writer for The Week. This article is in part based on information first published on The Week's sister site, Kiplinger.com