Reverse Mortgages: What You Should Know

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reverse-mortgage

After retirement, without regular income, seniors may struggle with their finances. That’s not necessarily reason to find another job. One way you can solve this problem is with a reverse mortgage.

What is a reverse mortgage?

A reverse mortgage is a special type of home loan that allows homeowners 62 and older to withdraw some of a home’s equity and convert it into cash. You can do so without paying a monthly mortgage payment or taxes on the proceeds.

You can use reverse mortgage proceeds however you like; they’re often used for expenses such as debt consolidation, living expenses, home improvements, helping adult children with college or living expenses and buying another home that might better meet your needs as you age.

Nearly all reverse mortgages are issued as home equity conversion mortgages, which are insured by the Federal Housing Administration. HECMs come with stringent borrowing guidelines and a $636,150 loan limit. Since the program began in 1990, more than 1 million HECMs have been completed, according to the National Reverse Mortgage Lenders Association.

How do reverse mortgages work?

A reverse mortgage is the opposite of a traditional home loan; instead of paying a lender a monthly payment each month, the lender pays you. You still have to be able to pay property taxes, homeowners insurance and other related costs, or you could risk foreclosure.

Before issuing a reverse mortgage, a lender will check your credit history, verify your monthly income versus your monthly financial obligations and order an appraisal on your home.

The amount of money you receive in a reverse mortgage is based on a sliding scale of life expectancy; the older you are, the more you can pull out. The Consumer Financial Protection Bureau recommends waiting until you’re older to obtain a reverse mortgage so you don’t run out of money too early into retirement.

To receive your reverse mortgage proceeds, the FHA offers two loan types: an adjustable-rate mortgage and a fixed-rate mortgage. With an ARM, you can choose from these payment options:

  • Tenure: Set monthly payments so long as you or your eligible spouse remain in the home.
  • Term: Set monthly payments for a fixed period of time.
  • Line of credit: Unspecified payments when you need them, until you’ve exhausted your funds.
  • Modified tenure: A line of credit and set monthly payments for as long as you or your eligible spouse live in the home.
  • Modified term: A line of credit and set monthly payments for a fixed period of time of your choosing.

For fixed-rate mortgages, you’ll get a one-time lump sum after you close on your loan. You’ll want to have a solid plan in place for how to use the proceeds, whether it’s for paying off debt, living expenses, medical bills or helping to pay your child’s college tuition.

Am I eligible for a reverse mortgage?

To apply for a reverse mortgage, you have to meet the following FHA requirements:

  • You’re 62 or older.
  • You and/or an eligible spouse — who must be named as such on the loan even if he or she is not a co-borrower — live in the home as your primary residence.
  • You have no delinquent federal debts.
  • You own your home outright or have a considerable amount of equity in it.
  • You attend the mandatory counseling session with an HECM counselor approved by the Department of Housing and Urban Development.
  • Your home meets all FHA property standards and flood requirements.
  • You continue paying all property taxes, homeowners insurance and other household maintenance fees as long as you live in the home.

Advantages of a reverse mortgage

No payment penalty for heirs: Heirs will not be responsible for repaying a reverse mortgage loan. Proceeds from the sale of the home can be applied to the loan amount, and heirs will get any equity that’s left over.

Secure income stream: If your retirement income is limited and you need cash, tapping your home’s equity can alleviate financial pressure and give you some wiggle room — as long as you understand the parameters.

Surviving spouses can stay: Even if one borrower dies, an eligible surviving spouse can remain living in the home so long as he or she continues to pay property taxes, homeowner’s insurance premiums and other household fees.

Disadvantages of a reverse mortgage

Higher costs: Borrowers can expect to pay a hefty price for a reverse mortgage. Fees will include mortgage insurance premiums, both initial and annual; third-party fees for closing costs; a loan origination fee, capped at $6,000; and a loan servicing fee. These fees can be rolled into the new loan, but that will limit the amount of money you can take out.

Loss of equity: A reverse mortgage is borrowing against your home’s equity — and the accruing interest will add to your loan balance over time. That reduces your home’s equity, which is important to consider if you plan to make your property part of your estate.

You could lose your home: Reverse mortgages can be risky, and they aren’t for everyone. If you fail to pay your property taxes, homeowner’s and hazard insurance premiums, and other mandatory housing costs, you could lose your home to foreclosure.

If you think a reverse mortgage might be right for you, contact an HECM counselor or call 800-569-4287 toll-free to learn more about this financing option. If you decide to apply for a reverse mortgage, you can contact an FHA-approved lender.

Deborah Kearns is a staff writer at NerdWallet, a personal finance website. Email: dkearns@nerdwallet.com. Twitter: @debbie_kearns.