If you are 62 or older and own your home you have access to a special type of financing that can help you turn your greatest asset – your home – into supplemental income, enabling you to meet your other financial obligations and reach important life goals. A reverse mortgage is a financial tool that offers seniors a way to tap into the equity they’ve built up in their home and free up perhaps much-needed cash for needs such as home repairs, tax payments, medical bills, insurance, trips, etc. One of the most attractive features of a reverse mortgage is that, unlike other types of loans, it does not need to be repaid on a monthly basis. In fact you will not need to repay the loan until you, the homeowner, move out of the home permanently or until you pass away.
Types of Reverse Mortgages
There are three types of reverse mortgages:
- Single-purpose reverse mortgage – these are reverse mortgage loans offered by some state and local government agencies and nonprofit organizations. These are the least expensive reverse mortgages (they charge the lowest interest rates and fees), but they are extended to homeowners for a specific purpose – i.e. to make a home repair or pay back property taxes. These loans are limited to homeowners with low to moderate incomes.
- Federally-insured reverse mortgage – these types of loans are called a Home Equity Conversion Mortgage (HECM). HECMs are backed and guaranteed by the U.S. Department of Housing and Urban Development (HUD). These are the most common types of reverse mortgages and have no income or credit requirements. HECMs allow homeowners to borrow more than with a single-purpose reverse mortgage and loan proceeds can be used for any purpose. They charge somewhat higher interest rates and fees than single-purpose reverse mortgages.
- Proprietary reverse mortgage - these are private loans backed, or guaranteed by, the lending companies that originate them. They typically have the same loan features as HECMs, with competitive interest rates and fees and a higher loan limit than single-purpose reverse mortgages.
To be eligible for a HECM (offered by an FHA lender and backed by the federal government) or a proprietary reverse mortgages (offered and backed by an individual lender) you must meet the following criteria:
- be 62 years or older
- occupy the home against which you’re borrowing the money
- own the home outright against which you’re borrowing money or have a small remaining balance on the mortgage
- not have any outstanding delinquent federal debts (i.e. unpaid back taxes)
- receive counseling from an approved counselor to ensure you understand, and are able to meet, the loan terms
In addition there are limits on the types of homes that lenders will make reverse mortgage loans on. Single-family homes are eligible and lenders may also make reverse mortgage loans on 2-4 unit owner-occupied homes including some condominiums, co-ops, planned unit developments and manufactured homes.
How Much You Can Borrow – and Costs You Will Pay – with a Reverse Mortgage
The amount of money that you can borrow through a reverse mortgage is based on several factors including:
- the type of loan you select,
- the current interest rate,
- the appraised value of your house as compared to the FHA mortgage loan limit (for HECMs),
- the existing unpaid balance (UPB) on any existing mortgage,
- loan fees and charges, and
- the age of the youngest borrower on the reverse mortgage application.
A general rule of thumb is that the older you are, the higher your home’s value, and the lower the interest rate on the reverse mortgage, the more you can borrow. To get an idea of how much money you may be able to borrow through a HECM useAARP’s online reverse mortgage calculator.
As with any loan you will have to pay certain fees to obtain a reverse mortgage including:
- an origination fee
- closing costs – such as an appraisal, title search, inspection, survey, recording fees, etc.
- mortgage insurance premium
- servicing fee
Depending on the lenders’ reverse mortgage terms you may need to pay for the loan costs out-of-pocket or you may be able to finance those fees by rolling them into the amount of the loan and paying them only when the loan is due (which is when you either move out of the home permanently or die).
How You Will Receive Funds
Once you apply and are approved for a reverse mortgage you can select how you’d like to receive the funds. You will generally be presented with up to five options:
- a one-time lump sum
- a fixed monthly stream of income for a certain period of time (i.e. 5, 10 or 15 years) – this is known as the “term” option
- a fixed monthly stream of income for as long as you live in your home - this is known as the “tenure” option
- a line of credit
- a combination of monthly payments and a line of credit
Ask your lender if you are allowed to change the payment option you have selected during the life of the loan, and if there is a charge for doing so. For example, HECM loans allow you to change your payment selection at any time for a small fee of approximately $20.
Repaying a Reverse Mortgage
Eventually the money that you borrow (and the interest you’re charged) with a reverse mortgage will need to be repaid. However, instead of making monthly repayments (as with a standard mortgage or home equity loan), you will not need to make any payments on the reverse mortgage until you either permanently move out of the home or if you pass away, at which point the loan balance will be repaid out of your estate.
With a HECM a homeowner can live in a nursing home or other medical facility (i.e. rehabilitation treatment place) for up to 12 consecutive months before the loan must be repaid.
It’s important for you and your loved ones to understand that because you’re not repaying the loan while you remain in the home the amount that you (or your estate) will eventually owe grows over time. That’s because the interest you owe on the principal amount you borrow will be added to the outstanding balance.
If you are concerned about how much you’ll eventually owe on the loan, you should know that the repayment amount will be limited to the home’s value at the time the loan is due. If you have a HECM and, when the time comes to repay the loan the proceeds of the home sale don’t meet your obligation, the FHA will pay the lender the difference. A portion of all HECM holders’ insurance premiums are collected for this purpose. Most proprietary reverse mortgages have a “nonrecourse” clause which means that your home’s value is the only asset that can be tapped to repay the reverse mortgage debt balance. You and/or your estate cannot be required to repay more on the loan than your home is worth at the time the loan is due.
Because you still own the home you’ll be responsible for maintaining the home as well as paying the property taxes, homeowners’ insurance, utilities and other home-related expenses.
How a Reverse Mortgage Could Affect Your Eligibility for Federal, State or Local Benefits
The money you receive with a reverse mortgage is not considered taxable income, meaning that you will not need to pay income tax on the funds you receive. In addition your Social Security and Medicare benefits are not affected by funds you may receive by using a reverse mortgage
However the income you receive through your reverse mortgage could affect your continued eligibility for federal and state benefits such as Supplemental Security Income (SSI), Medicaid and others which have income and asset limitations. In order to avoid losing any of your existing or potential benefits you must use the reverse mortgage funds within the month you receive them. Reverse mortgage funds are considered a “loan advance” which is not counted toward your financial resources. However if you do not use all of your reverse mortgage funds in the month you receive them, the remaining amount is counted as part of your resources/assets in addition to any other funds you have in your checking/saving accounts. If that amount exceeds the resource limit for benefit eligibility you could lose your benefit.
For example, let’s say that you qualify to receive state-subsidized health benefits and that the income/resource limit to receive this benefit is $2,000. Now, if on the 1st of the month you have $750 in your checking account and receive $1,500 in reverse mortgage funds that would put you over the $2,000 limit. However as long as you spend the amount you’ve received so that you have $2,000 or less in your account by the 1st of the following month you’ll be fine and can retain your health benefits. However if you don’t spend all of the $1,500, the balance is rolled over to the next month and on the 1st of the following month you have more than $2,000 you could lose your health benefits. Know your benefit eligibility limits and have a plan for managing your financial resources, including your potential reverse mortgage funds, before applying for a loan.
Considerations before Applying for a Reverse Mortgage
If you, or a loved one, are considering a reverse mortgage you should carefully examine the loan terms and evaluate if it’s a financial product appropriate for your needs and your life goals. Reverse mortgages aren’t for everyone.
For example, if you want to preserve as much equity as possible in your home to leave to your dependents or loved one through your will you may not want to convert it into cash. Likewise, if you are considering selling a home soon you might not want to pay the upfront costs associated with a reverse mortgage.
There may be other financial alternatives to consider before applying for a HECM or proprietary reverse mortgage, such as:
- a subsidized government loan: if you need a fixed amount of funds for a specific purpose (i.e. making home repairs, renovating the property for increased accessibility, paying back taxes, etc.) and have limited income and assets, contact your local Area Agency on Aging (AAA) through their website (Eldercare.gov) or by phone 1-800-677-1116 about loans or grants for home repairs, property tax deferral programs or property tax abatement programs.
- a home equity loan or second mortgage: depending on your current financial situation and what you need the reverse mortgage funds for, you may want to consider a traditional home equity loan or second mortgage instead. Both of these loans also allow you to convert a portion of your home’s equity into cash; however they require that you begin repaying them on a monthly basis, unlike a reverse mortgage. If you are unable to make those monthly loan payments you could potentially lose your home to foreclosure – something that is not a possibility with a reverse mortgage.
Most reverse mortgages include a three-day cancellation clause meaning that you can cancel the loan within three business days for any reason, without penalty. If you change your mind, simply notify the lender in writing, keep a copy for your files, and send by certified mail so that you have documentation if there is a discrepancy. Once the lender receives your notification they have 20 days to return any unused funds after they have retained a portion for the financing you received within the three-day window.
Unfortunately senior homeowners can be an attractive target for less than reputable lenders including financial institutions making reverse mortgages. Be wary if a lender:
- tries to sell you additional goods or services on top of originating a reverse mortgage. If a salesman tries to steer you to a contractor that could make home repairs or improvements using the funds you will receive through a reverse mortgage, think twice. A reputable lender will be focused only on providing you with the best, most appropriate loan for your financial circumstances and not strongly suggest how you could use the funds or whom could help you “spend” the money you’ll receive through the loan.
- pressures you to purchase additional financial products. You do not need to purchase or invest in any other financial products to qualify for a reverse mortgage. For example, a lender may strongly suggest that you use all, or a portion of, your reverse mortgage funds to purchase a long-term care insurance policy or an annuity. You are not required to purchase anything else in order to apply for a reverse mortgage. Moreover, if you do consider purchase of a financial product such as an annuity, your eligibility for federal, state and local benefits could be affected. For example an annuity advance could make you ineligible for Medicaid and reduce your SSI benefits dollar-for-dollar. Know how your benefits could be affected by making another financial investment decision. Separate your financial loan product decisions and ensure that you are working with the most capable and reputable lender for each type of financing you may want to select.
- does not disclose loan terms or fees. You need to know exactly what you or your estate will be required to pay for obtaining a reverse mortgage, and how much you will be expected to repay at the end of the loan. If a lender fails to make those important terms clear walk away and find another bank to do business with.
- pressures you to sign loan documents immediately. As with any financial product you should never feel rushed or pressured to take on a loan. You should carefully review all loan-related documents and take material home to discuss with a trusted advisor or loved one before making the commitment.
If you suspect that you or a loved one is dealing with a fraudulent lender file a complaint with the Federal Trade Commission (FTC) online at FTC.gov or by calling 1-877-FTC-HELP (1-877-382-4357) and your state Attorney General’s office.