What Is a Reverse Mortgage?

Author  Lorien Strydom

Last updated: December 16, 2024

A reverse mortgage is a type of home loan that allows the homeowner to get a loan against the equity in their home.

Reverse mortgages allow homeowners to convert their home equity into cash income with no monthly mortgage payments.

The borrower must own their home free and clear (without any mortgage or other loans secured against it) and have sufficient income to make the loan payments.

A reverse mortgage lender will then provide the borrower with a lump sum payment or line of credit based on the value of their home.

The borrower can use this money however they choose, including paying off existing debt or supplementing their income.

How Does a Reverse Mortgage Work?

To qualify for a reverse mortgage you must either have a very low remaining balance on your mortgage or own your home outright.

You’ll need to pay off the remaining balance of your mortgage with the funds from the reverse mortgage.

You have two payout options: a lump sum payout, or a line of credit. Lump sum payouts carry higher fees as you’ll pay interest on the full loan amount.

Types of Reverse Mortgages

There are three types of reverse mortgages:

• Home Equity Conversion Mortgage (HECM)
• Proprietary reverse mortgage
• Single-purpose reverse mortgage

Home Equity Conversion Mortgage (HECM)

A Home Equity Conversion Mortgage (HECM) is a type of reverse mortgage loan available to homeowners 62 years and older.

It allows borrowers to convert their home equity into cash. This is in the form of loan proceeds without the burden of monthly payments, provided they continue to live in the home as their primary residence.

HECMs are federally insured and as such, these types of reverse mortgages must meet Federal Housing Administration (FHA) limits.

This means that if your home value is $1,500,000 the maximum loan amount you may receive will be determined using a value of $1,089,300.

With a proprietary reverse mortgage, the full value of the home will be used.

With HECMs, borrowers should also pay property taxes and insurance, maintain the home according to FHA standards, and until the last borrower passes away or moves out of the property.

The HECM loan has several one-time fees associated with it including origination fees, closing costs, and mortgage insurance premiums which are paid upfront at closing and then continue every year thereafter.

Additionally, there is an interest that accumulates on the loan balance over time as well as administrative fees if applicable.

Proprietary Reverse Mortgages

A reverse mortgage plan is a type of home loan that allows homeowners to take out a loan against the equity in their homes.

Similar to private loans, proprietary reverse mortgages are offered by private lenders and they are not backed by the government.

As they are not federally insured, these reverse mortgages don’t have to be bound by the Federal Housing Administration’s limits.

Proprietary reverse mortgages are also known as jumbo reverse mortgages.

The homeowner receives an upfront lump sum or monthly payments, depending on the type of reverse mortgage they choose.

This money can be used for any purpose, including paying off existing mortgages or bills, purchasing additional property, or providing for retirement income.

There are no monthly mortgage payments under this type of loan; however, there may be other costs associated with it such as closing fees or interest rates which may increase over time.

Borrowers must continue to pay taxes on the borrowed funds just as they would with any other income received from investments or pensions etc.

Single-Purpose Reverse Mortgage

A single-purpose reverse mortgage is a type of reverse mortgage that allows borrowers aged 62 or older to borrow against the equity in their home and receive a lump sum payout for a single, lender-approved purpose.

Single-purpose reverse mortgages are more affordable than other reverse mortgages as they are federally insured and backed by non-profits.

Examples of what the payout from these equity loans can be used for include property maintenance, or paying property taxes.

With a HECM and a proprietary reverse mortgage, you can use the funds however you like, which is not the case with a single-purpose reverse mortgage.

Who Is Eligible for a Reverse Mortgage?

HECMs have more stringent requirements than other reverse mortgages:

• You must be at least 62 years of age
• You must live in the home as a primary residence
• You must own the home outright (or have significant equity)
• You must not be delinquent on federal debt
• You must be able to keep paying taxes, insurance, and other costs

The property also must meet FHA requirements. To receive a HECM, borrowers must pay an origination fee, an up-front mortgage insurance premium (MIP), other standard closing costs such as title searches and appraisals, loan servicing fees (sometimes), and interest on the loan.

The US government has a nationwide network of participating counseling agencies to help consumers make informed decisions.

You can find a reverse mortgage counselor by searching the HECM Counselor Roster or by calling (800) 569-4287.

What Are the Benefits of a Reverse Mortgage?

Let’s look at some of the reverse mortgage pros and cons:

1. Access to Cash While Still Living in the Home

With a reverse mortgage, a person can access their home equity in the form of cash. This can be beneficial for those who are no longer able to make mortgage payments or need extra funds for modifications such as walkers or wheelchairs.

The benefit of having access to cash while still living in the home with a reverse mortgage is that it allows seniors to stay in their homes while still having access to money they may need for modifications or other expenses.

It also helps them maintain control over their finances as they age since they don’t have to make any payments until they leave their home or die.

2. Avoidance of Home Equity Taxes

A person with a reverse mortgage can avoid paying home equity taxes on their home.

This can benefit them in the long term, as it can help offset the interest costs and reduce their overall cost of borrowing.

3. No Mortgage Payment or Interest Payments

With a regular mortgage, the borrower must make monthly payments on the loan in order to repay it. With a reverse mortgage, however, the borrower does not have to make any payments on the loan until it comes due.

In contrast, with a regular mortgage interest payments are typically required each month and added onto the principal balance of the loan. With a reverse mortgage, there are no interest payments until repayment of the loan is due.

4. No Need to Prove Liquid Income to Qualify

Both a conventional mortgage and a reverse mortgage do not require proof of liquid income. Both types of loans allow you to purchase a home and make monthly payments.

However, with a conventional mortgage, your equity increases as long as you have the loan. With a reverse mortgage, your equity decreases for as long as you have the loan.

Additionally, with a conventional mortgage, you are required to make regular payments until you leave the home or die; whereas with a reverse mortgage, there are no payments until either of these two scenarios occurs.

5. Reverse Mortgage Loans with Fixed Interest Rates

Reverse mortgage loans with fixed interest rates are similar to traditional loans in that they both have an annual percentage rate (APR) and a principal balance.

The APR is the total cost of borrowing, including the interest rate and other fees associated with the loan.

The principal balance is the amount of money owed on top of any outstanding payments or previous balances.

The main difference between reverse mortgage loans with fixed interest rates and traditional loans is that traditional loans typically have variable rates that change over time, while reverse mortgage loans have fixed rates that remain constant throughout the life of the loan.

Additionally, while credit scores may affect a traditional loan’s APR or ability to qualify for some lenders, they do not affect a reverse mortgage rate or ability to qualify for any lender offering this type of loan option.

6. Ability to Convert Home Equity into Cash Payments

A reverse mortgage allows you to convert some of your home equity into cash payments in the form of a lump sum, line of credit, or regular payments over time.

The proceeds from a reverse mortgage loan are generally tax-free and do not impact Social Security or Medicare payments (although this may vary depending on individual circumstances).

You can stay in your home without making monthly mortgage payments but must continue to maintain it and pay for any necessary repairs that may arise.

Funds from the loan can also be used to pay off an existing mortgage closing costs and ongoing fees associated with it are also financed with this loan.

7. Potential to Avoid Probate

A reverse mortgage helps avoid probate because it allows the borrower to obtain access to the home’s equity without having to pay off the loan.

This allows heirs of the estate to inherit the home without going through a long and costly process of probate. It also allows them to keep all of their inheritance in one piece, rather than having to divide it up between multiple heirs or sell off portions of it in order to cover debts or expenses.

What Is the Downside Of a Reverse Mortgage?

1. Possibility of Losing Your Home

The possibility of losing your home with a reverse mortgage is relatively low.

In fact, according to the U.S. Department of Housing and Urban Development (HUD), 95% of reverse mortgages are still owned by borrowers at the end of their term.

Additionally, HUD reports that since 2004 only about 1% of borrowers have had their homes foreclosed on due to nonpayment or defaulting on their loan.

Furthermore, many lenders offer life insurance as part or all of a reverse mortgage plan which can help protect against potential loss in value or repairs that could lead to foreclosure in the future.

2. High Loan Fees

The high loan fees associated with a reverse mortgage include:

• Mortgage insurance: An initial premium of 2% of the loan amount, plus 0.5% of the annual outstanding loan balance each year.
• Closing costs: You may be stuck with these third-party charges, which vary depending on the lender you use.
• Origination fees: Lenders can charge up to $6,000 in origination fees based on your home’s value.
• Servicing fees: The FHA allows lenders to charge monthly servicing fees that can be as high as $35 if your interest rate adjusts on a monthly basis

3. Lack of Information

The lack of information about a reverse mortgage is a con because it makes it difficult for consumers to fully understand the product and its implications.

Many people are unaware that they can use their home equity to access cash without having to sell their homes or take out a traditional loan.

Additionally, there is limited guidance on the risks associated with this type of financial product, such as potential foreclosure or loss of equity in your home over time.

Finally, there is no uniformity between lenders when it comes to terms and conditions associated with these loans which means potential borrowers have difficulty comparing offers from different institutions.

4. Taxes and Insurance Dues

Taxes and insurance dues for a reverse mortgage are the payments that the borrower must make to maintain the loan.

Generally, these payments are made on an annual basis and vary depending on factors such as the value of the property, interest rates, and other expenses associated with the loan.

Additionally, some states require borrowers to pay additional taxes on top of their regular mortgage interest deduction.

Finally, homeowners should also consider getting pet insurance if they have a pet since it can help cover veterinary bills in case of injury or illness.

5. Mortgage Insurance Premiums

Mortgage insurance premiums (MIPs) are fees that borrowers of reverse mortgages must pay to cover the lender’s losses if the loan balance grows larger than the home’s value.

This change from 2017 onwards saves borrowers $750 per year for every $100,000 borrowed and helps offset the higher up-front premium.

Furthermore, lenders cannot go after borrowers or their heirs if their home turns out to be underwater when the loan is due; these mortgage insurance premiums provide a pool of funds to cover such losses in this scenario.

6. Loss of Property Value

The loss of property value can affect a reverse mortgage in several ways.

First, it could reduce the borrower’s equity in their home, making them ineligible for a reverse mortgage. Second, it could lead to higher interest costs as the loan balance grows higher than the home’s value.

Third, if the home becomes underwater when the loan is due, borrowers cannot be held liable for losses incurred by lenders nor can their heirs be held responsible for paying back the loan.

As a result of these potential scenarios, borrowers should be careful when calculating and projecting their potential costs associated with a reverse mortgage, so they can make an informed decision about whether or not it is right for them given their current financial situation.

They should also consider the potential risk of losing their home due to declining property values in their area or other factors outside of their control such as natural disasters or economic downturns that may impact values over time.

7. Loss of Heirship Rights

Loss of heirship rights refers to the loss of inheritance rights for heirs when there is a reverse mortgage against a property.

When someone with a reverse mortgage dies, their heirs will not be responsible for paying off the balance of the loan.

However, they may still have to make monthly payments for property taxes and insurance as well as cover ongoing maintenance costs.

If the estate cannot afford this expense, then heirs may be required to sell the home at its current market value in order to get enough money to pay off the loan.

They are not liable if there has been significant devaluation since they took over ownership of the property.

8. Low Reverse Mortgage Limits

A reverse mortgage is a type of home loan that allows homeowners to access the equity in their homes.

The low reverse mortgage limits for a reverse mortgage are the maximum amounts that can be borrowed using this type of loan.

Reverse mortgages come with several downsides, including high fees and interest rates, which make them difficult to qualify for and expensive to use over time.

Additionally, many lenders have strict requirements regarding income levels, credit scores, and homeowner status in order to qualify for a reverse mortgage.

Lastly, there may be restrictions on how much money can be taken out each year or during one loan term due to regulations set by the federal government.

9. Risk of Foreclosure

Reverse mortgages do not have required monthly payments for principal and interest, so it might seem as though foreclosure is impossible.

However, this is not the case as homeowners can still be at risk of foreclosure if they fail to keep up with property taxes, homeowner’s insurance, or required HOA fees.

Unlike traditional mortgages where the lender may allow you more time to make payments if needed, reverse mortgage lenders will require all outstanding balances to be paid off in full upon the borrower’s death or sale of their home.

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