A reverse mortgage is one of many vehicles that individuals 62 years of age or older can use to turn the equity in their home into cash. It is very important, though, for an individual to fully understand reverse mortgages, their ramifications, and the alternatives. This article will provide an overview of reverse mortgages, as well as discuss alternatives.
What is a Reverse Mortgage?
With a “normal” home loan you pay a monthly amount (principal and interest). With each month, the amount that you owe goes down and the equity in your home goes up. As one might expect from its name, a reverse mortgage works in an opposite fashion. With a reverse mortgage you can turn the equity in your home into cash. You do not have to make monthly payments. The cash may be paid to you in one or more of the following ways:
- As a single lump sum payment
- As a regular monthly amount (a cash advance)
- As a credit line account that you draw upon as needed
With a reverse mortgage, the homeowner continues to own their home and receives cash in whatever way is preferable to them. As they receive cash, their loan amount goes up, and the equity in their home declines. A reverse mortgage cannot grow to more than the amount of the equity of the house. In addition, a lender cannot seek payment of the loan from anything other than the value of the house. Your other assets and the assets of your heirs are protected by what is called a “non-recourse limit.”
A reverse mortgage, plus accrued interest, does eventually have to get paid back. Repayment of a reverse mortgage happens when the last owner of the property named on the loan either dies, sells the home, or permanently moves out of the home. Before then, nothing needs to be paid on the loan.
There are other circumstances in which reverse mortgage lenders can also require repayment of a loan prior to the above conditions. These include:
- The borrower fails to pay their property taxes
- The borrower fails to maintain and repair their home
- The borrower fails to keep their home insured
There are also other default conditions that can cause repayment of the loan. Most of these are similar to default conditions for traditional mortgages (for example, declaration of bankruptcy, donation or abandonment of the home, perpetration of fraud or misrepresentation, and more).
A reverse mortgage should not be confused with a home equity loan or home equity line, both of which are other means of obtaining money for the equity in your home. With either of these loan vehicles, an individual must pay at least monthly interest on the loan amount received, or amount that they have drawn on their equity line.
Reverse Mortgage Eligibility
All owners of a home must apply for the reverse mortgage and sign the appropriate loan papers. To qualify for a reverse mortgage the borrower(s) must:
- Own their own home
- Be at least 62 years of age or older
A reverse mortgage is most typically a “first” mortgage, meaning that there cannot be any other mortgages or loans against the property, such as an equity line. An individual typically owns their home “free and clear” prior to seeking a reverse mortgage.
Reverse Mortgage Loan Amounts
The amount of money that an individual may receive from a reverse mortgage is a function of many different factors, including:
- The specific reverse mortgage program that the individual selects
- The type of cash advances received (e.g., lump sum vs. monthly payment)
- The individual’s age (the older an individual is, the more cash they get)
- The value of the individual’s home (the more valuable the home, the more cash they get)
Types of Reverse Mortgages
There are several different types of reverse mortgages. Some are more expensive than others. Types of reverse mortgages include:
- Reverse mortgages offered by state and local governments (often called “single purpose reverse mortgages”). These are typically the least expensive reverse mortgages. These may be the most restrictive on how the money received can be used.
- Federally insured Home Equity Conversion Mortgages (HECM). These are almost always less expensive than other private sector reverse mortgages, but more expensive than reverse mortgages obtained from state and local governments.
- Other private sector (proprietary) reverse mortgages.
Alternatives to Reverse Mortgages
While usually an option that causes a negative emotional reaction, selling a home is an alternative to a reverse mortgage. The proceeds of the sale can be used to either rent, or purchase a smaller, more “age-friendly” home, while money leftover can be invested to provide additional income. This option should at least be considered and compared to a reverse mortgage so that an individual is making an informed decision.
Reverse Mortgage Counseling
Counseling is required in order to obtain certain types of reverse mortgages. Counseling is required before an individual can obtain a Federally-insured Home Equity Conversion Mortgages (HECMs). Even if counseling is not required for a particular reverse mortgage, individuals considering a reverse mortgage should seek either counseling or the advice of a qualified financial adviser.