What Is A Reverse Mortgage?

A reverse mortgage is a home loan for homeowners at least 62 years old to use existing real estate as collateral, with the homeowner receiving payments based on the amount of equity you have and the property's value.

Instead of taking out a traditional loan and making payments for 15 to 30 years, the bank makes payments to the homeowner. The funds are from the equity built upon an existing home or other property. The more equity that has been built up, the easier it is to qualify for a reverse mortgage. Reverse mortgages are typically recommended for those homeowners who have completely paid off their home loan.

Homeowners with a reverse mortgage do not make monthly payments, and the loan must be paid back after the borrower dies, permanently moves out of the home, or sells the property.

What Are The 3 Types Of Reverse Mortgages?

The three types of reverse mortgages are single-purpose reverse mortgages, federally-insured reverse mortgages, and proprietary reverse mortgages.

Single-Purpose Reverse Mortgage

Local, state, and nonprofit organizations offer single purpose reverse mortgages that are used for specific home-related expenses like property taxes or needed home repairs. The cheapest option for reverse mortgage loans, single-purpose reverse mortgages can be used only for those predetermined applications.

Homeowners can typically pay less in interest and fees for a single-purpose reverse mortgage than for the other reverse mortgage options.

The loan does not have to be repaid until:

  • Ownership of the home changes.

  • The borrower changes primary residences.

  • The borrower dies.

  • There is no longer active homeowners insurance on the property.

  • The property is condemned by the city.

Federally-Insured Reverse Mortgages

Home equity conversion mortgages (HECM) are insured by the federal government and backed by the U.S. Department of Housing and Urban Development (HUD). A federally insured reverse mortgage generally comes with higher upfront costs and is more expensive than a traditional home loan. An HECM is a popular choice for many because there are no income limits or medical requirements and the funds can be used for any reason or application.

The homeowner is required by law to undergo counseling to ensure a full understanding of the costs, payments, and overall responsibilities inherent in accepting an HECM. The charge for the counseling sessions can be applied to future loan proceeds.

Payment options for federally insured-loans include:

  • Term Option: Monthly cash advances for a specified period.

  • Tenure Option: Monthly advances for as long as the property is the borrower’s primary residence.

  • Credit Line: Homeowners can draw from their HECM account at any time.

Proprietary Reverse Mortgage

Owners of higher-end homes can apply for a proprietary reverse mortgage for large advances with high-value appraisals. A counselor is sometimes required to help the homeowner compare the details of an HECM with a proprietary reverse mortgage to determine which is best for your unique circumstances.

A proprietary reverse mortgage is usually backed by private lending companies and banks and is not insured by the FHA. Because they are not federally insured or backed, proprietary reverse mortgages do not require insurance premiums or some of the other requirements typically associated with HECM regulations.

Proprietary reverse mortgage funds are available in one lump sum at closing. Interest rates are usually higher than HECMs, but closing fees and other expenses are typically lower.

What Is The Downside To A Reverse Mortgage?

A reverse mortgage can present an ideal option for many seniors, though it is not for everyone. Common drawbacks to reverse mortgages include:

Varying Costs

The expenses associated with taking out a reverse mortgage can add quickly. Between an origination fee, a mortgage insurance fee, a servicing fee, and additional third-party fees, it is important to understand all potential costs before finalizing any type of mortgage.

Variable Interest Rates

Reverse mortgages usually have variable interest rates that will change and adjust to current rates throughout the life of the loan.

Not tax-deductible

You cannot deduct paid interest on a reverse mortgage until after the loan has been completely repaid.

Acquire Less Equity

The good news is that you can apply earned equity to a reverse mortgage. The bad news is that the reverse mortgage will also siphon away equity from home and lower the future asset value.

Prequalifying Repairs

It may be necessary to pay for significant home repairs before qualifying for some reverse mortgage applications. Having to pay for substantial repairs will eat into the potential savings of getting a reverse mortgage.

Early Repayment

The primary stipulation for a reverse mortgage is that it does not have to be paid back until the borrower passes away or permanently moves out. However, there are other circumstances when the loan will need to be repaid sooner.

  • If the homeowner fails to pay applicable property taxes.

  • If homeowners insurance is not paid.

  • If the homeowner is not keeping up with maintenance and repairs on the property.

Medicaid Eligibility

While getting a reverse mortgage will not impact Social Security or Medicare benefits, it can affect Medicaid eligibility.

Is a Reverse Mortgage Right for You?

Only you can decide if a reverse mortgage fits into your current financial situation and future needs. If you are planning on moving in the near future, cannot afford the costs associated with processing the loan, or want to leave your home to heirs when you pass, a reverse mortgage might not be for you. However, many people benefit greatly from a reverse mortgage that helps manage homeowners' finances late in their lives.