What a reverse mortgage?

Here’s how reverse mortgages work, and what homeowners considering one need to know.

A reverse mortgage is a type of loan that allows homeowners ages 62 and older, typically who’ve paid off their mortgage, to borrow part of their home’s equity as tax-free income. Unlike a regular mortgage in which the homeowner makes payments to the lender, with a reverse mortgage, the lender pays the homeowner.

Homeowners who opt for this kind of mortgage don’t have a monthly payment and don’t have to sell their home (in other words, they can continue to live in it), but the loan must be repaid when the borrower dies, permanently moves out or sells the home.

One of the most popular types of reverse mortgages is the Home Equity Conversion Mortgage (HECM), which is backed by the federal government.

Despite the reverse mortgage concept in practice, qualified homeowners may not be able to borrow the entire value of their home even if the mortgage is paid off.

The amount a homeowner can borrow, known as the principal limit, varies based on the age of the youngest borrower or eligible non-borrowing spouse, current interest rates, the HECM mortgage limit ($970,800 in 2022) and the home’s value.

Homeowners are likely to receive a higher principal limit the older they are, the more the property is worth and the lower the interest rate. The amount might increase if the borrower has a variable-rate HECM. With a variable rate, options include:

If you choose a HECM with a fixed interest rate, on the other hand, you’ll receive a single-disbursement, lump-sum payment.

The interest on a reverse mortgage accrues every month, and you’ll still need to have adequate income to continue to pay for property taxes, homeowners insurance and upkeep of the home.

Supplementing retirement income, covering the cost of needed home repairs or paying out-of-pocket medical expenses are common and acceptable uses of reverse mortgage proceeds, according to Bruce McClary, spokesperson for the National Foundation for Credit Counseling.

“In each situation where regular income or available savings are insufficient to cover expenses, a reverse mortgage can keep seniors from turning to high-interest lines of credit or other more costly loans,” McClary says.

To be eligible for a reverse mortgage, the primary homeowner must be age 62 or older. The additional eligibility requirements include:

“Seniors should be careful to make the most of the loan by budgeting carefully in order to avoid running out of funds too soon and to be sure that taxes and insurance are paid as agreed,” cautions McClary.

There are different types of reverse mortgages, and each one fits a different financial need.

While borrowing against your home equity can free up cash for living expenses, the mortgage insurance premium and origination and servicing fees can add up. Here are the advantages and disadvantages of a reverse mortgage.

The closing costs for a reverse mortgage aren’t cheap, but the majority of HECM mortgages allow homeowners to roll the costs into the loan so you don’t have to shell out the money upfront. Doing this, however, reduces the amount of funds available to you through the loan.

Here’s a breakdown of HECM fees and charges, according to HUD:

Keep in mind that the interest rate for reverse mortgages tends to be higher, which can also add to your costs. Rates can vary depending on the lender, your credit score and other factors.

A reverse mortgage can be a help to homeowners looking for additional income during their retirement years, and many use the funds to supplement Social Security or other income, meet medical expenses, pay for in-home care and make home improvements, Boies says.

There are also flexible ways to receive the money from the reverse mortgage: a lump sum, a monthly payment, a line of credit or a combination.

Plus, if the value of the home appreciates and becomes worth more than the reverse mortgage loan balance, you or your heirs may receive the difference, Boies explains.

The opposite, however, can pose a problem: If the balance exceeds the home’s value, your heirs may need to hand ownership of the home back to the lender.

There are also potential complications involving others who live in the home with the borrower, and what might happen to them if the borrower dies. Family members who inherit the property will want to pay close attention to the details of what is necessary to manage the loan balance when the borrower dies.

“There are provisions that allow family to take possession of the home in those situations, but they must pay off the loan with their own money or qualify for a mortgage that will cover what is owed,” McClary says.

Additionally, while not all reverse mortgage lenders use high-pressure sales tactics, some do use them to attract borrowers.

“It is always best to receive guidance from a nonprofit agency that offers reverse mortgage counseling before signing a loan agreement,” McClary recommends. “Taking advice from a celebrity spokesperson or a sales agent without getting the facts from a trusted, independent resource can leave you with a major financial commitment that may not be best for your circumstances.”

If you’re not sold on taking out a reverse mortgage, you have options. In fact, if you’re not yet 62 (and ideally not turning 62 soon), a home equity loan or HELOC is likely a better option.

Both of these loans allow you to borrow against the equity in your home, although lenders limit the amount to 80 percent to 85 percent of your home’s value, and with a home equity loan, you’ll have to make monthly payments. With a HELOC, payments are required once the draw period on the line of credit expires.

The closing costs and interest rates for home equity loans and HELOCs also tend to be significantly lower than what you’ll find with a reverse mortgage.

Aside from a home equity loan, you could also consider:

If a reverse mortgage sounds like a good idea for you, take time to research you options. Here are the top 10 reverse mortgage lenders as of 2022, according to Home Mortgage Disclosure Act data:

As you shop for a reverse mortgage and consider your options, be on the lookout for two of the most common reverse mortgage scams:

The best way to avoid a reverse mortgage scam is to be aware and vigilant. If an individual or company is pressuring you to sign a contract, for example, it’s likely a red flag.

A reverse mortgage presents a way for older homeowners to supplement their income in retirement or pay for home renovations or other expenses such as healthcare costs. There are many alternatives that should be considered, including a HELOC or a refinance depending on the equity you have in your home.

A Home Equity Conversion Mortgage (HECM), the most common type of reverse mortgage, is a special type of home loan only for homeowners who are 62 and older. A reverse mortgage loan, like a traditional mortgage, allows homeowners to borrow money using their home as security for the loan.