A reverse mortgage is a special type of loan that lets seniors access some of the equity stored in their home.
Reverse mortgages are available to homeowners aged 62 years or older who either own their home outright or have built enough equity through mortgage payments to qualify.
These loans allow seniors to borrow off this built equity in order to supplement retirement income, finance renovations, or pay off unexpected expenses.
A reverse mortgage can be a simpler, more effective alternative to selling a house or applying for home equity loans or lines of credit (HELOCs). More than a million reverse mortgages have originated in the United States to date.
However, they’re not suitable for everyone: it’s important to consult with an experienced broker or real estate agent to understand how a reverse mortgage will mesh with your personal financial situation and goals.
In the United States, the majority of reverse mortgages are called Home Equity Conversion Mortgages (HECM) and are guaranteed by the Federal Housing Administration (FHA).
That means that these loans, once approved, will be paid even if lenders default or go bankrupt. It also means that the loan can never exceed the value of the home that backs it — so it’s not possible for a borrower to go into debt over a reverse mortgage.
How Do Reverse Mortgage Work?
Only homeowners aged 62 years or more can apply for a reverse mortgage, and this rule applies to the youngest borrower on the title. The home must be a primary residence in good condition, and the borrowers must own a fair share of its equity.
If those conditions are met, a strict qualification process follows. The homeowners must undergo a financial assessment and meet with a HUD-approved counselor to discuss the loan and alternative options.
Borrowers must prove that they’re able to afford property taxes, home insurance, maintenance costs, and (if applicable) HOA fees before a loan is granted.
The value of a reverse mortgage depends on a few variables. In general, a homeowner’s borrowing power will increase alongside their age, the value of their home, and their share of equity within it. Of course, lower interest rates in the market will also increase borrowing power.
Once the loan has been approved and its value set, the homeowner has a lot of choice in how to accept the money.
Almost three-quarters of reverse mortgages are taken as a lump sum, but borrowers can also accept monthly annuities (either tenured or limited to a specific term) or even open a line of credit.
Conveniently, these payment methods can be mixed, matched, and altered to suit any homeowner’s specific needs.
The key idea of a reverse mortgage is that a borrower’s equity in their home decreases over the lifetime of the loan. This lifetime ends when the house is sold, when the homeowner passes away, when loan obligations cease to be met, or when the borrower decides to close it.
Once a reverse mortgage has been paid off, any remaining equity in a home belongs to the homeowner or their estate. And if the balance of the loan exceeds a home’s value, lenders must turn to the FHA to make up for the loss. The homeowner’s remaining assets or estate cannot be claimed to pay off a reverse mortgage.
A Simple Reverse Mortgage Example
Here’s a breakdown of a simple reverse mortgage for some qualifying individual:
- Current Home Value: $250,000
- Current Mortgage Value: $25,000
- Available Loan Amount: $150,000 (note that this value depends entirely on eligibility criteria, home, and equity value, lender, and state; this amount is merely an example)
These are up-front fees that are generally built into the loan balance.
- Origination Fee: $4,500 (2% of the first $200,000 of property value and 1% of any value above that, for a minimum of $2,500 and a maximum of $6,000)
- Third Party Fees: $1,000 (variable; this is the amount needed to cover necessary inspections, appraisals, and the like)
- Up-front Mortgage Insurance Premium (MIP): $4,000 (2% of the property value, paid to the FHA for borrower protection)
The initial cost of acquiring this reverse mortgage is, therefore, $9,500.
The net value of a reverse mortgage can be calculated as the available loan amount - current mortgage value - initial fees, which in this example brings us to a net loan amount of $115,500.
As with all loans, interest will accrue on the balance of a reverse mortgage. For HECMs, this means both interest paid to the lender (generally between 3-7% of the loan balance) and an annual MIP of 0.5% of the balance, paid to the FHA.
The exact annual cost of a reverse mortgage depends on the specific lender, current interest rates, and the terms of the loan itself. Interest is generally deducted straight from home equity.