Several years ago, my then-husband’s family faced a difficult financial decision. With the money from my late father-in-law’s life insurance payout dwindling, and with property taxes taking a big bite of my mother-in-law’s monthly fixed income, no one knew what to do. How could she remain in the home if it was unaffordable?
During a family meeting, someone brought up a reverse mortgage. With a reverse mortgage, it would be possible for grandma to receive monthly payments to cover the property taxes and some of her living expenses. We decided to dig in and research reverse mortgages to see if it was the right step. Here’s the information you need to determine if a reverse mortgage is right for you:
What is a reverse mortgage?
A reverse mortgage is a variation on a home equity loan. However, repayment of the loan doesn’t begin until you move out of the home or you pass away.
The reason it’s called a “reverse” mortgage is that you can receive monthly payments from the lender.
“For most seniors, their home’s equity is their most valuable asset,” said Greg Cook, who has more than 30 years of experience in mortgage banking. “But as long as it’s trapped in the home, that asset has the same value as Monopoly money. A reverse mortgage gives them access to that equity.”
It’s still a loan, though, and it has to be paid back. The loan can be repaid through payments, or you can sell the home securing the loan and pay off the balance.
Reverse mortgages aren’t for the young, however. To qualify for a mortgage backed by the Department of Housing and Urban Development (HUD), you need to be at least 62. However, Cook noted that there are also “private label” reverse mortgages offered by lenders who will let you borrow even if you are in your 50s.
Before you decide to jump into a reverse mortgage (or steer an aging family member toward one), it’s important to get all the information.
Types of reverse mortgages
According to the Federal Trade Commission (FTC), there are three types of reverse mortgages:
- Home equity conversion mortgages (HECMs). These are the reverse mortgages backed by HUD. They can be used for any purpose. HUD-backed mortgages also come with restrictions, as well as specific protections.
- Proprietary reverse mortgages. This type of mortgage is what Cook calls “private label.” There are no restrictions on use of the funds, and you might be able to get one of these loans even if you don’t meet the qualifications set forth in the HECM program.
- Single-purpose. Nonprofits or state and local governments might offer smaller reverse mortgages that can be used for a specific purpose. These have the lowest costs because you might be restricted to using the funds only to pay property taxes or make home repairs. However, single-purpose reverse mortgages aren’t widely available.
“The terms of an HECM are far more favorable to seniors than the private label loans,” said Cook. For the most part, he said, single-purpose loans aren’t worth considering unless you have very specific needs.
HECM reverse mortgages
Much like other federally-insured mortgage programs (such as FHA loans and VA loans), the government doesn’t give you the loan. Instead, you receive the loan from a private bank, and the government guarantees the loan. As a result, said Cook, you are required to pay mortgage insurance.
HECM reverse mortgage requirements
Before you can proceed with an HECM reverse mortgage, you must meet with a government-approved housing counseling agency. HUD offers a list of approved counselors online.
To qualify, you must be at least 62 years old. However, if you are co-signing on the loan with a partner, the age requirement is based on the youngest co-signer, so you will both need to be 62 or older.
Finally, you must own the property and use it as your primary residence. If you leave to move elsewhere (including to a long-term care facility), loan payments are required. There are some exceptions if your partner remains in the home after you move, but in general, once you have been out of the home for a year, it’s no longer considered your residence.
Loan terms for an HECM reverse mortgage
You don’t have to worry about income and home mortgage credit-score requirements with an HECM. Instead, how much you can borrow depends on how much equity you have in the home.
Your mortgage interest rate is based on current market rates, but you might have a higher rate than you would for a “regular” home equity loan. Rates can be fixed or variable, depending on the lender and other terms of your loan.
You are also required to pay an FHA mortgage insurance premium up front, and there are ongoing premium costs as well. Plus, there might be loan origination fees and other expenses.
Getting your money
When you first secure your reverse mortgage, you’ll have to decide on a payment plan. According to the FTC, there are five different payment options:
- Single disbursement: This lump sum is only available to you if you have a fixed-rate reverse mortgage. You get the money all at once. However, you usually won’t be approved for as much money overall if you choose this option.
- “Term” option: You agree to receive monthly payments for a set period. With this option, warned Cook, the term could end before you leave your home, leaving you without regular income.
- “Tenure” option: Instead of receiving monthly payments for a limited period, you receive them until you stop living in the home. The payments you receive might be lower than what you’d see with a term option, acknowledged Cook, but you know they will last indefinitely, so you can plan your fixed income.
- Line of credit: Rather than receive regular payments each month, you have a set line of credit you can draw on as needed. You can reduce interest charges with this approach because you only pay interest on the amount borrowed. With the other options, the interest is part of the loan calculation.
- Combined line of credit and monthly payments: If a smaller monthly payment might be sufficient for your needs, but you’d like a line of credit for emergencies, this approach can work well, according to Cook.
Realize that once you choose a payment option, you might not be able to change it. If your lender does allow adjustments, according to the FTC, you could be charged a fee.
Repaying the HECM reverse mortgage
With a reverse mortgage, you don’t have to make monthly payments while you live in the home. If you pass away before moving out of your home, the loan is paid off by your estate.
In many cases, regardless of how the home becomes vacant, it’s common for the loan to be paid off with proceeds from the sale of the property, according to Jim Quist, the founder of NewCastle Home Loans.
“If you have a HUD-backed home, though, you don’t have to worry about what happens if the home drops in value,” he said. “Heirs aren’t personally liable if the payoff balance exceeds the home value.”
If there’s equity left in the home after the loan balance is paid off, the value is returned to the heirs, said Quist, who has 15 years of experience in the mortgage business, including helping seniors secure reverse mortgages.
Proprietary reverse mortgages
In many ways, a proprietary or “private label” reverse mortgage is very similar to what you get with an HECM, said Cook. Your loan is based on the equity you have in the home, and market rates set your interest. Even your options for receiving your funds are the same.
But things get a little different when you look at some of the terms. It’s possible to get a proprietary reverse mortgage even while you’re in your 50s. On top of that, some lenders don’t require mortgage insurance.
However, Cook noted, the main downside to getting a proprietary reverse mortgage is that these loans lack the non-recourse protection of the HECM. “With a private label mortgage, the lender can be a creditor to the estate if the home is worth less than the amount remaining on the loan,” meaning the balance of the loan would be taken out of other assets intended for your heirs.
Why you should think twice about a reverse mortgage
Both Cook and Quist cautioned against jumping into a reverse mortgage.
“There’s no question the fees to get a reverse mortgage are more expensive than traditional loans,” said Cook. “The single-largest expense with an HECM is the mortgage insurance, and insurance is never free.”
They also warned about the impact a reverse mortgage could have on your heirs. “The value of the estate inheritance may decrease over time as proceeds are spent and interest accrues on the loan balance,” Quist said.
He also pointed out that if your children or other heirs want to keep the house, they have to satisfy the loan terms to do so. For families who can’t afford to pay the loan after the original owner passes away, it means no choice but to sell the home to pay off the loan. If you don’t have kids, a surviving spouse, or other heirs, it might not matter to you if the reverse mortgage takes a large chunk of your home’s value after you pass on.
If there are other ways to fund retirement, said Cook, it can make sense to focus on those before turning to a reverse mortgage.
“When viewed solely as a loan program, a reverse mortgage isn’t going to pencil out as a deal,” he said. “The value comes in if it is a retirement lifeline that makes a difference in your quality of life.”
As for my family, we decided in the end against the reverse mortgage and instead found other creative solutions to support my mother-in-law and keep her in the home until her passing. Other families, though, might benefit from a reverse mortgage. Carefully research the options, and take into account the reality of the situation. Then make a choice based on what’s best for you.