A reverse mortgage is a type of loan that allows homeowners who are at least 62 years old to borrow against their home equity and receive cash or a line of credit. Unlike a regular mortgage, they don’t have to make monthly payments until they move out, sell the house, or die. The loan balance grows over time, while the home equity decreases.
Reverse mortgages can be a useful way to supplement retirement income, eliminate monthly mortgage payments, and stay in the home for as long as possible. But they also have some drawbacks and risks that seniors should be aware of before applying.
How Does a Reverse Mortgage Work?
Reverse mortgages are designed for older adults who already own a home. They’ve either paid it off completely or have significant equity—at least 50% of the property’s value(ncoa.org). There are different types of reverse mortgages with various payment methods, but most are Home Equity Conversion Mortgages (HECM), which are backed by the federal government.
To qualify for a HECM, seniors must meet the following requirements(investopedia.com)(reverse.org):
• Be at least 62 years old
• Live in the home as their primary residence
• Have sufficient home equity
• Have no delinquent federal debts
• Be able to pay for property taxes, homeowners insurance, and maintenance
• Complete a financial assessment and counseling session with a HUD-approved counselor
The amount that seniors can borrow, known as the principal limit, depends on several factors, such as(investopedia.com)(bankrate.com):
• The age of the youngest borrower or eligible non-borrowing spouse
• The current interest rate
• The appraised value of the home or the HECM mortgage limit ($1,089,300 in 2023), whichever is lower
• The initial mortgage insurance premium
Seniors can choose how they want to receive the loan proceeds from a HECM, such as(investopedia.com)(bankrate.com):
• A lump sum payment
• Fixed monthly payments for as long as they live in the home or for a set period of time
• A line of credit that they can access until it runs out
• A combination of any of the above options
Seniors don’t have to pay back the loan as long as they live in the home and meet the ongoing obligations, such as paying property taxes, homeowners insurance, and maintenance. However, the loan becomes due and payable when any of the following events occur(investopedia.com)(bankrate.com):
• The last surviving borrower dies
• The last surviving borrower moves out permanently
• The last surviving borrower sells the home
• The last surviving borrower fails to pay property taxes, homeowners insurance, or maintenance
• The last surviving borrower violates any other terms of the loan agreement
When the loan is due, seniors or their heirs have several options to repay it(investopedia.com)(bankrate.com):
• Sell the home and use the proceeds to pay off the loan balance
• Keep the home and pay off the loan balance with other funds or refinancing
• Give up the home to the lender through a deed-in-lieu of foreclosure
If the loan balance is less than or equal to the value of the home, seniors or their heirs will not owe more than that amount. If the loan balance is more than the value of the home, seniors or their heirs will not owe more than 95% of that amount. The FHA insurance will cover any shortfall between the loan balance and the sale price of the home.
What are the Pros and Cons of a Reverse Mortgage?
Reverse mortgages have some advantages and disadvantages that seniors should weigh carefully before applying. Here are some of them:
• More cash in retirement. Reverse mortgages can provide seniors with an additional source of income that can help them cover their living expenses, medical bills, home improvements, or other needs(investopedia.com)(hud.gov).
• No monthly payments. Reverse mortgages don’t require seniors to make monthly payments to the lender until they leave their home. This can free up some cash flow and reduce their financial stress(investopedia.com)(hud.gov).
• No negative equity. Reverse mortgages are non-recourse loans, which means seniors or their heirs will not owe more than what their home is worth when they repay the loan. The FHA insurance protects them from owing more than 95% of their home’s value(investopedia.com)(hud.gov).
• No impact on Social Security or Medicare benefits.