A reverse mortgage is a sort of loan for homeowners who are at least 62 years old and have a significant amount of equity in their homes. Seniors can access funds to pay for cost-of-living expenses late in life by borrowing against their equity, typically after they’ve exhausted all other resources or sources of income. Homeowners can acquire the cash they need with a reverse mortgage at rates as low as 3.5 percent per year.
Consider a reverse mortgage to be a traditional mortgage with the roles reversed. A conventional mortgage is when a person takes out a loan to purchase a home and then repays the lender over time. In a reverse mortgage, the borrower already owns the house and uses it as collateral to obtain a loan from a lender that they may or may not be able to repay.
The borrower does not repay the majority of reverse mortgage loans in the end. Instead, the borrower’s heirs sell the property to pay off the loan when the borrower moves or dies. Any extra revenues from the sale go to the borrower (or their estate).
The majority of reverse mortgages are given through government-backed schemes with stringent lending criteria. Private reverse mortgages, or proprietary reverse mortgages, are issued by private non-bank lenders and are less regulated, with a higher risk of being scams.
Taking out a reverse mortgage is straightforward: The process begins with a borrower who already has a home. The borrower has either a significant amount of equity in their house (typically at least 50% of the property’s value) or has entirely paid it off. The borrower determines that they require the liquidity that comes with reducing equity from their house and works with a reverse mortgage counselor to choose a lender and program.
The borrower next applies for the loan after selecting a specific lending package. The lender conducts a credit check and examines the borrower’s property, title, and appraised value. If the loan is granted, the lender funds it. The proceeds are structured as a lump amount, a line of credit, or periodic annuity payments (for example, monthly, quarterly, or annually), depending on the borrower’s preference.
Borrowers use the money as specified in their loan agreement once a lender funds a reverse mortgage. Some loans are restricted in how they can be used (for example, for enhancements or renovations), while others are not. These loans are valid until the borrower dies or moves, at which point they (or their successors) can repay the loan or sell the property to repay the lender. Any money left over after the loan is repaid to the borrower.
The youngest owner of a home being mortgaged must be at least 62 years old to qualify for a government-sponsored reverse mortgage. Borrowers can only use their primary residence as collateral. They must either own their home entirely or have at least 50% equity with just one primary lien—in other words; borrowers cannot have a second lien from a HELOC or a second mortgage. If the borrower does not own their home outright, the funds earned from a reverse mortgage must generally be used to pay off their existing mortgage.
Only certain types of homes are often eligible for government-backed reverse mortgages. The following are examples of properties that are eligible:
- Single-family dwellings
- Up to four-unit multi-unit properties
- Manufactured homes constructed after June 1976 are not eligible.
- Condominiums or townhouses
Borrowers who take out a government-sponsored reverse mortgage must also attend an information session with an accredited reverse mortgage counselor. They must also pay their property taxes and homeowner’s insurance on time and keep their home in good repair.
Reverse mortgages are subject to their qualifications, which vary depending on the lender and loan program.
When employing a reverse mortgage program backed by the government, however, homeowners are only allowed to borrow up to the appraised value of their house or the FHA maximum claim amount ($765,600). Instead, borrowers can only borrow a part of the value of their home. Lenders often require a buffer if property prices decrease, and part of the property’s worth is utilized to collateralize loan expenses. Borrowing restrictions are also adjusted based on the borrower’s age and credit history, and the interest rate on the loan.
Reverse mortgages backed by the government have two primary costs:
Interest rates: If you take a lump amount, interest rates can be fixed (beginning at less than 3.5 percent, equivalent to traditional mortgages and far lower than other home equity loan products). Otherwise, they’ll be changeable based on the London Interbank Offered Rate (LIBOR), with a margin applied for the lender.
Premiums for mortgage insurance: Reverse mortgages backed by the federal government carry a 2% upfront mortgage insurance cost and 0.5 percent annual premiums.
The purpose of mortgage insurance is to safeguard lenders in the event of a borrower failure. While reverse mortgages rarely default in the same manner that traditional mortgages do—when borrowers fail to make payments—they can nevertheless default if owners fail to pay property taxes or insurance or if their properties are not adequately maintained.
Lenders will also impose their origination fees, which vary by lender but typically range from 1% to 2% of the loan amount. Other expenses, such as property appraisals, servicing/administering loans, and additional closing costs, such as credit check fees, are commonly charged by lenders.
On the other hand, all costs are usually incorporated into the mortgage debt, so lenders don’t have to pay them out of pocket.