What is a Reverse Mortgage And How Do They Work?


If you’re 62 years old or older you may be able to convert your home’s equity into a stream of income with a reverse mortgage.

This article takes an in-depth look at reverse mortgage loans, who qualifies, and the pros and cons.

Current Mortgage Rates (December 2020)

Loan Term

Interest rate

APR

30-year fixed-rate

3.05%

3.28%

15-year fixed-rate

2.91%

3.06%

5/1 adjustable-rate

3.05%

3.25%

What is a reverse mortgage?

A reverse mortgage is a loan you get for the equity you have in your home. A reverse mortgage is also known as a HECM, a home equity conversion mortgage. HECM loans can be acquired from any lender and are insured by the Federal Housing Administration.

If you have built up a large equity stake in your home, you can use that equity to get a loan that does not have to be repaid until after death. Any existing mortgages on the home need to be repaid with the funds received from a reverse mortgage.

Reverse Mortgage Requirements

2020 HECM Requirements

• Be 62 years of age or older

• Own the property outright or have significant equity

• You must occupy the property as your principal residence

• Not be delinquent on any federal debt

• Financial resources to continue making payments of ongoing charges such as property taxes, homeowner's insurance, and HOA dues.

• Participate in a consumer information session by a HUD- approved HECM counselor

Property Requirements

2020 HECM Property Requirements

• Single family home or 2-4 unit home with one unit occupied by the borrower

• HUD-approved condominium project

• Individual Condominium Units that meet FHA Single Unit Approved requirements

• Manufactured home that meets FHA requirements

Maximum Loan Amounts

• Age of the youngest borrower or eligible non-borrowing spouse

• Current interest rate; and

• Lesser of:appraised value;

• The HECM FHA mortgage limit of $765,600; or

• The sales price (only applicable to HECM for Purchase)

How does a Reverse Mortgage Work?

A reverse mortgage works by using the equity in your home as collateral for a loan. If you are at least 62, this is a viable option. If you have a large equity stake or your home is paid off, you can receive a large amount of cash to help pay bills or to enjoy for retirement. The money you receive does not need to be repaid until 6 months after death. The remaining balance on a reverse mortgage is paid off when your estate sells the home.

The good news is that you will never owe more than the appraised value of the home. The worst-case scenario is the balance of the loan is the same amount or less than the home’s appraised value. In this case, the loan will be considered paid, assuming it sells for the appraised value. If the home is appraised and sells for more than the remaining reverse loan balance, the borrower’s estate or heirs’ would be entitled to the difference.

As an example: Let’s say your current home’s value is $250,000. You have a mortgage on the home with a remaining balance of $50,000. You qualify for a reverse mortgage loan for $200,000 minus $50,000 to pay off your existing loan, leaving you with $150,000 to use how you wish. Your loan balance is $200,000.

Speak to a lender to discuss your options

Some of the highlights of a reverse mortgage

  • Available to homeowners who are at least 62 years old
  • The loan does not need to be repaid until you sell or after death.
  • Receive funds from a reverse mortgage in monthly payments or a lump sum
  • Funds received can be used for anything.
  • Can borrow up to 80% of your home’s equity
  • Maximum loan amount of $625,500
  • Should have at least 50% equity in your home to qualify

Which types of homes qualify for a reverse mortgage

  • Single-family home and 2-4-unit properties as long as you own at least one unit
  • An FHA-approved condo or townhouse
  • FHA-approved manufactured homewhat is a reverse mortgage

Reverse Mortgage Pros and Cons

Pros

  • The loan does not need to be repaid until you sell, or 6 months after death.
  • Reverse mortgage loans are tax-free.
  • If the funds are not withdrawn, the amount available will increase every year.
  • You do not have to own your home to qualify.
  • Funds received can be used for anything.
  • Receive funds from a reverse mortgage in monthly payments or a lump sum
  • Can borrow up to 80% of your home’s equity
  • No credit score requirements

Cons

  • If you move to a nursing home and are out of the home for 12 months, the loan could become due immediately.
  • Higher interest rate than other options
  • Mortgage insurance costs
  • High closing costs and lender fees
  • Could cause you to be no longer eligible for Medicaid

 

Reverse mortgage costs and interest rates

Reverse mortgage interest rate

The interest rate for a reverse mortgage will be approximately the same as an FHA loan. FHA loans have rates that are slightly lower than most conventional loans. Having a low mortgage interest rate is one of the benefits of a reverse mortgage.

Mortgage insurance premium

All reverse mortgages will require PMI or private mortgage insurance. They’re required to protect you in the event the lender declares bankruptcy. An upfront PMI payment will be 0.50% if you take out less than 60% of the loan amount. If you take out more than 60% of the loan amount in the first year, the upfront fee jumps to 2.5%.

You will also pay mortgage insurance every year until it is paid by 1.25%. The upfront and annual PMI fees will be added to your loan amount.

Lender origination fees

You will be charged a fee from the lender, known as a loan origination fee. If the home value is at or below $125,000, the maximum amount the lender can charge is $2,500.

If the home value is over $125,000, the lender can charge up to 2% of the loan amount up to $200,000. Any amount over $200,000 can not be charged at a rate of more than 1% of the home value. the maximum origination fee the lender can charge is 1%

Alternative options for reverse mortgages

Reverse mortgages aren’t for everyone. A home equity loan or home equity line of credit is another option for those that need cash and have a lot of equity built up or need a lower monthly payment.

Cash-Out Refinance

A cash-out refinance is a new loan that replaces your current loan plus provides up to 80% of your home's value in cash.


Home Equity Loan
A home equity loan is a second mortgage that uses the equity in your home as collateral for a new loan.
HELOC

Works like a home equity loan except instead of the funds being dispersed in a lumpsum a HELOC provides a line of credit you can borrower from as needed similar to a credit card. 

Benefits of Home equity loans and HELOC loans

  • No minimum age requirement
  • No services fees and low closing costs
  • Lower interest rates than reverse mortgages
  • No mortgage insurance is required.
  • Cheaper to borrow money than a reverse mortgage

The Bottom Line

A reverse mortgage can be a terrific option for some homeowners who are struggling to get by.

You can get a large lump sum or monthly payments to supplement your income during retirement and not have to repay the loan until you sell the home or death.

However, there are also reverse mortgage disadvantages to consider, as well. Reverse mortgages can be expensive and you may lose equity in your home.

Speak to a reverse mortgage lender to go over all of your options.

Speak to a lender to discuss your options