What Is A Reverse Mortgage And How Does It Work?
Victoria Araj7-minute read
April 26, 2022
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Between the rising costs of health care, living expenses and limitations on Social Security, many Americans reach age 62 without enough money saved to sustain themselves through retirement. A reverse mortgage is a potential solution that can help you cover your expenses – but is tapping into your home's equity a good idea?
Follow along as we explain what a reverse mortgage is and how it works.
Rocket Mortgage® does not offer reverse mortgages.
What Is A Reverse Mortgage?
A reverse mortgage is a loan that allows you to borrow against the equity in your home, tax-free. Unlike with a traditional mortgage, where you make monthly payments to pay down your loan, with a reverse mortgage loan, you’re the one receiving payments from the lender. While you no longer have to make monthly mortgage payments, you are still responsible for paying your property taxes and homeowners insurance and must continue to maintain your home.
There are just a few main requirements for a reverse mortgage:
- You must be at least 62 years old.
- You may only get a reverse mortgage on your primary residence.
- If you are getting a home equity conversion mortgage (HECM), you must attend a reverse mortgage counseling session, as it is required by the Department of Housing and Urban Development (HUD).
Once you've applied, what you can use funds for depends on your specific loan type. In most cases, though, you'll be able to use the money for anything you want. In general, reverse mortgages are for people of retirement age who want to lower or eliminate their monthly mortgage payments to better cover their expenses.
How Does A Reverse Mortgage Work?
Getting money from your home loan might sound too good to be true. After all, if you haven't finished paying your mortgage and you aren't selling your house, where is the money coming from? It’s coming from the equity you have in your home.
It's important to remember that a reverse mortgage is still a loan and that the money you receive from it is ultimately your own money that’s tied up in your home.
To determine your loan proceeds, your reverse mortgage lender will order an appraisal of your home. They will then use that loan to pay off your existing mortgage. The remaining funds are what you receive to use however you want, whether that’s covering your living expenses, paying off debt, creating a safety net or purchasing a home. If you own your home free and clear, you can get the full value of the loan.
Accounting For Interest, Taxes, Insurance And Fees
It’s important to note: a reverse mortgage is not free money. “Reverse” refers to your loan balance. While you remain the owner of your home and receive payments, monthly interest is added to the loan balance, increasing your debt throughout the life of the loan – unless you decide to make payments.
Even if you don't make payments, you won't be able to defer all payments on your house. You will still be required to pay:
These are important obligations to remember, because you could lose your home to foreclosure if you fall behind on property taxes or insurance or let your home deteriorate.
How Do You Pay Back A Reverse Mortgage?
As mentioned before, you do have the option of making regular payments to your loan, but repayment isn't required until you sell the home, no longer live there or pass away. When you do eventually sell your home, the money from the sale will go toward paying back your existing reverse mortgage plus interest.
This means you won't make as much money on the actual sale as you might have with a traditional mortgage. A reverse mortgage simply lets you take advantage of your home's value sooner than later, which is why these loans are intended for homeowners of retirement age.
If you have a HECM, which is backed by the government, your loan is considered a non-recourse loan, meaning you’ll never owe more than your home is worth. If you sell your home for less than what you owe, you will not have to pay the difference.
If you pass away, and your heirs wish to keep the home, they can refinance to a traditional mortgage, purchase it for the amount owed on the reverse mortgage or 95% of the appraised value – whichever is lower. They can also sell the home and keep any remaining proceeds after the loan is paid off or simply sign the deed over to the lender.
The decision your heirs make will usually depend on how much equity is in the home. You shouldn’t take out this sort of loan if leaving your home to your heirs, with or without a traditional mortgage, is a high priority for you.
Types Of Reverse Mortgages
There are three main types of reverse mortgages.
Home Equity Conversion Mortgage (HECM)
A HECM reverse mortgage is the most common type, obtained via Federal Housing Administration (FHA)-approved lenders. You can spend the money you get from a HECM loan on anything. These are government-backed by the U.S. Department of Housing and Urban Development (HUD) up to $$970800for 2022. If your home is worth more than $$970800, you might want to seek out a proprietary loan, also known as a jumbo reverse mortgage.
Single-Purpose Reverse Mortgage
A single-purpose loan is the least expensive option, but it differs from basic HECM loans in that it can only be used for a single, lender-approved reason. For example, the lender might say that you can only use the loan for home repairs, property taxes or insurance premiums. These loans come from local governments and charitable organizations and are geared toward homeowners with low and moderate income, but they aren’t available everywhere.
Proprietary Reverse Mortgage
A proprietary reverse mortgage is issued by a private lender. If you have a high-value home, you may need to take this type of loan to borrow more funds. Keep in mind, a proprietary reverse mortgage is not backed by the federal government and, therefore, will not have the same protections for borrowers.
Selling Your Home With A Reverse Mortgage
You may still sell your home if you have a reverse mortgage. However, you must pay back the debt you’ve accrued after you sell your home. Before you list your home for sale, contact your lender and confirm the amount you owe. You may keep the remainder and put it toward a new home if your home sells for more than your appraised value.
If your home sells for less than what’s owed on the loan, you won’t be responsible for paying the difference. As long as your loan is a non-recourse loan, you’ll never pay more on the loan than the value of your home.
The Pros And Cons Of A Reverse Mortgage
As with any big financial decision, it’s important to weigh the pros and cons to make sure this is the right option for you. Here are a few to get you started.
Pros Of A Reverse Mortgage
- You get to remain in your home and your name stays on the title.
- You can access your home’s equity without selling your home or making monthly mortgage payments.
- Reverse mortgages are immune from declining home values because they’re nonrecourse loans.
- Your spouse may be able to remain in your home after you pass, even if they are not the borrower.
Cons Of A Reverse Mortgage
These loans aren’t for everyone. They come with several drawbacks that you might want to consider before you get one:
- Reverse mortgages decrease the amount of equity you have in your home.
- Your loan balance will increase if you don’t pay down your interest over time.
- You may outlive your loan’s benefits if you don’t choose to receive monthly payments throughout the life of the loan.
- A reverse mortgage can make it more difficult for your heirs to benefit from the equity in your home after you pass away.
You should also be aware that, as with many loans, there are many reverse mortgage scams. Make sure you verify your loan and beware of contractors who suggest loans to pay for home repairs or programs that target veterans. The Department of Veteran Affairs (VA) does not sponsor any reverse mortgage loans.
Reverse Mortgage Vs. Refinance: Which Is Better?
Reverse mortgages can be a good idea for seniors who need more retirement income but still want to live in their homes. However, this might not be the best choice for you if you want to pass your home down to your children, or if you plan on vacating the home soon.
If you're not sure a reverse mortgage is right for you, there are other refinancing options for seniors. For a homeowner in the right situation, one of these types of mortgages could provide a very viable or even better alternative as it accomplishes one of the major goals of a reverse mortgage – accessing equity – but allows more flexibility for you and your heirs.
Rocket Mortgage offers cash-out refinances. Read our guide to refinancing to see if this option makes sense for you.
The Bottom Line: Is A Reverse Mortgage A Good Idea?
When deciding whether to take out a reverse mortgage, remember that the main advantage of this loan is that it allows you to use your money now, but you won't have as much saved in the future. Consider your current financial situation and where you want to be a few years down the road. If you've already closed on a loan, remember you have up to 3 days to cancel via your right of rescission.
However, if you’re interested in a cash-out refinance instead, you can get started online with Rocket Mortgage.
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