How Does a Reverse Mortgage Work?

If you’re a senior homeowner with some equity in your home, you may be able to use that equity to increase your retirement income. You might have heard the term reverse mortgage before, but how does a reverse mortgage work?

A reverse mortgage is not a regular loan. There are significant differences between a reverse mortgage and other financial products like a traditional mortgage or home equity loan. Learn the finer details of reverse mortgages to help you decide if one could be a good option for you.

How Do Reverse Mortgages Work?

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Reverse mortgages are only available to seniors 62 and older who have accumulated equity in their primary residence. A reverse mortgage will allow you to access a portion of your home equity without incurring additional monthly mortgage payments. However, reverse mortgage recipients are still responsible for paying insurance and taxes on the house. The other caveat is that you must be using the property as your primary residence for the duration of the reverse mortgage.

You may not have to repay a reverse mortgage during your lifetime, provided that you remain in your home and maintain it under the requirements of the Federal Housing Administration (FHA). The mortgage will be repaid when you pass away or sell your home. 

While a reverse mortgage sounds like an easy solution, the truth is that they are very complicated. In fact, they are one of the most complicated financial products on the market.

Who Is Eligible for a Reverse Mortgage?

To be eligible for a reverse mortgage, the youngest borrower on the home’s title must be at least 62 years old. This is a strict rule, so someone younger than 62 will not qualify — even if they are permanently disabled and receiving Social Security benefits.

In addition, you should own the home free and clear. If you don’t pay off your mortgage before applying, you’ll have to use the proceeds from the reverse mortgage to pay off the original loan at the time of closing. Usually, the minimum required equity is around 50%, but it can vary by lender. With some reverse mortgages, applicants must meet the Department of Housing and Urban Development (HUD) financial eligibility and receive HUD-approved counseling.

Types of Reverse Mortgages

There are three main types of reverse mortgages, each of which serves a different financial purpose:

  • Home equity conversion mortgages (HECMs): HECMs are federally insured and backed by HUD. Only FHA-approved lenders can offer them. These reverse mortgages offer the most flexibility and allow you to use the proceeds for any purpose. Initial mortgage insurance premiums on HECMs are limited to 2% of the property value or the maximum claim amount, whichever is less. Before closing, borrowers are required to undergo a HUD-approved counseling session.
  • Single-purpose reverse mortgage: These are not as common as the other types of reverse mortgages. They are primarily offered by state and local government agencies or non-profit organizations. Single-purpose reverse mortgages are the cheapest option, but they are also the most restrictive. You can only use proceeds to pay for a specific lender-approved item, such as property taxes or home repairs.
  • Proprietary reverse mortgages: These are private loans that are not government-backed. They’re not as restrictive, but they lack some of the protections you get with a government-backed loan. If you have a high-value home, you’re more likely to receive a larger loan amount. 

A personal finance professional can ultimately help you determine which type of reverse mortgage is right for your needs.

Potential Pros of a Reverse Mortgage

There are numerous potential benefits to a reverse mortgage. Some of these include:

  • The IRS typically does not tax the funds you receive in a reverse mortgage because they treat it as a loan.
  • A reverse mortgage shouldn’t affect your Medicare or Social Security benefits.
  • You can remain in your primary residence, and you continue to own your home.
  • You can pay off your existing mortgage and not have monthly mortgage payments.
  • You can finance fees and closing costs with your reverse mortgage, which keeps your out-of-pocket expenses lower.
  • Your heirs are generally not responsible or personally liable for any amount of the mortgage that exceeds your home’s value when the loan is repaid.
  • Any remaining equity after you repay the loan will belong to you or your heirs.

Potential Cons of a Reverse Mortgage

A reverse mortgage is not for everyone. There are some potential downsides, such as:

  • Not everyone will qualify for a reverse mortgage.
  • Your loan balance will increase as time passes due to accumulating interest and fees.
  • Reverse mortgage fees are often higher than fees for a traditional mortgage.
  • Your lender could still foreclose on your home in some instances if you fail to pay property tax and HOA fees.
  • A reverse mortgage could affect your eligibility for needs-based programs like Supplemental Security Income (SSI) and Medicaid.
  • The more home equity you use, the less you leave behind for your heirs.

Failure to meet the requirements of a reverse mortgage means that it will become immediately due. If you cannot pay the reverse mortgage back, you may have to sell your home to pay off what you owe. This is a critical detail of reverse mortgages that you need to keep in mind.

If the negative aspects of a reverse mortgage outweigh the positive ones, there are other financial alternatives that might work better for your situation.

Does a Reverse Mortgage Work for Everyone?

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Though a reverse mortgage may sound like a good idea, it may not work for everyone. Some situations make a reverse mortgage impossible, even if you meet eligibility requirements. For example, if you are looking to move soon, or you may need to transition into a nursing home, a reverse mortgage wouldn’t make sense. Reverse mortgages aren’t assumable either, which means the loan can’t be transferred along with the property. The amount owed would need to be paid off when you pass away. 

One alternative option is to leverage your home’s equity by using a home equity investment to unlock your home equity without making monthly payments. You can use that money to fund home renovation projects, pay bills, or take care of other needs you have.

We recommend speaking with a home equity expert who can help you determine what options are best for your situation. To learn more about home equity alternatives, contact the team at Point. We can explain your available options and help you resolve your immediate financial needs.

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