Whether you’re looking to supplement your retirement income or help alleviate short-term financial challenges, a reverse mortgage could be the answer. In a nutshell, a reverse mortgage is a home equity loan designed for homeowners who are at least 62 years old and have a lot of equity in their homes. A reverse mortgage allows you to access that equity while avoiding monthly mortgage payments.
Generally, you need at least 50% equity in your home to qualify for a reverse mortgage. But that number can depend on your individual situation.
With a reverse mortgage, the lender pays you. These loans are geared toward older homeowners who plan to be in their homes for a long time. They can be helpful for cash-strapped seniors, especially if they don’t want to go the traditional loan route.
Historically, people have relied on some standard things for money in retirement, like conventional savings and investments, IRAs/401(k)s and pensions and/or Social Security, explained Chris Downey, president of Harbor Mortgage Solutions Inc. “The concern is those resources are going to come up short. We’re living longer, and living expenses, especially health care expenses, have gone up. So what they’re looking at are safe ways to be able to tap into home equity,” he said.
There are three types of reverse mortgages: single-purpose, proprietary and one of the most common types: a Home Equity Conversion Mortgage (HECM), which is guaranteed by the Federal Housing Administration (FHA) under the U.S. Department of Housing and Urban Affairs (HUD).
How much equity you need
If you still owe a lot of money on your home, you may not qualify for a reverse mortgage. The good news is many seniors have been in their homes long enough to build up a good chunk of equity. According to HUD, borrowers must also have the funds to pay ongoing property charges, including taxes and insurance.
Downey said HUD’s type of reverse mortgage, the HECM, is the most popular. With an HECM, you can receive money as a line of credit, lump sum or in monthly installments. “The vast majority of reverse mortgages in general, but especially the FHA HECM program, are done as a line of credit, especially nowadays,” he said.
The line of credit comes with a first-year draw limit and overall principal limit, according to the Consumer Financial Protection Bureau (CFPB). You’ll only be charged interest on the amount of money you withdraw. Another benefit is credit line growth, which applies to the remaining funds in your credit line. The line of credit grows at the same rate as interest charged on any money you take out, Downey explained. He said interest rates are currently in the 4% range.
How much equity should you have in your home? “There’s no one answer,” Downey said. “People’s situation can vary widely and we analyze that on a case-by-case basis.”
While there is no magic number, experts often point to at least 50% as a general rule. This is because you must first use your HECM to pay off your current home loan. If you have less than 50% equity, the funds from your reverse mortgage won’t cover it.
LendingTree’s reverse mortgage calculator is one tool that can help you compare estimates. (Student Loan Hero is a subsidiary of LendingTree.)
Downey added that one of the most common misconceptions about reverse mortgages is that they’re “radically different” from other mortgages. That said, one difference is that reverse mortgages are typically payment-optional. “You’re not required to make any payments against it,” he said.
He also explained that a reverse mortgage is not necessarily based on a specific credit history or income level. “It’s an actuarial formula that determines how much you’re eligible for,” he said, “not a debt-to-income ratio.”
Other requirements for getting a reverse mortgage
To qualify for an HECM, the home must be your primary residence. You also must not be delinquent on any federal debt. Before getting the ball rolling, homeowners must meet with a reverse mortgage counselor to discuss eligibility, alternatives and costs.
The minimum age is 62 for HECMs, but Downey said some lenders allow 60-year-old borrowers.
Eligible homes include single-family homes and two- to four-unit homes where the borrower lives in one unit. HUD-approved condominium projects and manufactured homes that meet FHA requirements are also eligible.
In 2017, HUD announced some changes to its reverse mortgage program. The upfront Mortgage Insurance Premium (MIP) rate was changed to a flat rate of 2%. Prior to the change, the rate was based on how much was borrowed, so the less you borrowed, the lower your rate would have been.
However, borrowing limits grew as the national lending limit for HECMs increased in 2019 from $679,650 to $726,525.
Other types of reverse mortgages include proprietary programs, which Downey said emerged in the marketplace about four years ago. “There are a lot of people that need programs other than the FHA programs. I’m dealing with a family right now who have a very valuable home in Newport, Rhode Island, and the HECM program could only give them so much money,” he said.
Options if you don’t qualify for a reverse mortgage
A reverse mortgage should not be a short-term fix to buy someone another year or so in their house, Downey cautioned. Ideally, it should allow them to stay in their home until “they choose to move out, not when the money runs out,” he said. “If we see a situation where someone doesn’t have enough equity in their home to allow them to obtain a reverse mortgage that will provide that type of financial security, maybe it’s time to sell the house and move on.”
If a reverse mortgage isn’t right for you (or you don’t qualify), you have some other options. According to the CFPB, there are alternatives that may be a better fit, including the option to wait. If you take out a reverse mortgage too early, you could run out of money as you get older. Some alternatives to a reverse mortgage include:
- A HEL or HELOC. A home equity loan or home equity line of credit may be a more affordable option. Just keep in mind that these loans usually come with monthly payments.
- Refinancing. By refinancing your current mortgage, you could potentially lower your monthly payments. But consider the term of your new mortgage before proceeding. If you are close to retirement, a shorter term might be better for you.
- A cash-out refinance. With a cash-out refinance, you take out a loan of a higher amount than what’s needed to pay off your existing mortgage. Then the difference gets paid out to you in cash.
- Downsizing. Selling your house could be your best option depending on your situation. Downsizing to a home that’s more affordable can reduce your expenses.
Although a reverse mortgage may sound tempting, do your homework to ensure it makes good financial sense for you. It’s also important to note that your mortgage balance will grow over the years because instead of paying money toward the balance, you’ll be receiving it from the lender.
Ralph DiBugnara, president of Home Qualified, said if your bills are higher than your retirement income can cover, then a reverse mortgage could be a good option. He added that eliminating the monthly mortgage payment, except for taxes and insurance, and receiving what equates to a monthly allowance from the equity in your home, is why many choose a reverse mortgage.