What Is a Reverse Mortgage?

If you’re like me, you’ve probably seen TV commercials touting the advantages of a reverse mortgage. If those ads have left you with more questions than answers, I bet you’re not alone. So, I’ll shed some light on reverse mortgages by telling you what they are, who’s eligible for one, and who should never consider getting one. 

What is a Reverse Mortgage?

A reverse mortgage is a loan for homeowners age 62 or older who have equity in their home. Equity is the difference between your home’s appraised market value and how much you owe on it. For instance, if your home is worth $250,000 and your mortgage balance is $100,000, then you have $150,000 ($250,000 – $100,000) in equity. It’s called a reverse mortgage because a lender pays you instead of you paying a lender (as with a regular mortgage). You don’t need to show a minimum amount of income or even have good credit to qualify for a reverse mortgage—you just need equity in your home. But just as with a regular mortgage, you eventually have to pay back the lender for the money you borrow.

Why Would You Want a Reverse Mortgage?

A reverse mortgage can be a quick way to get money you need—for example, to make home improvements or to pay medical bills—because it gives you access to a portion of your equity without you having to sell the property, give up ownership, or make monthly payments. You can get the money as a lump sum, as a series of payments, as a line of credit, or as a combination of these options, and spend it any way you like.

The cash you take from a reverse mortgage is tax-free and you don’t have to pay it back for as long as you live in the home. That means that you never have to worry about being forced out of your house because you forgot to make a monthly payment. However, once the last living borrower moves out, sells the house, or dies, you or your heirs have to pay back the loan plus interest and fees.

How Does a Reverse Mortgage Work?

One question you may have about reverse mortgages is how they differ from regular mortgages. With a fixed-rate mortgage, each monthly payment you make is made up of a principal and an interest portion. The principal part gets subtracted from your outstanding loan balance each month, which means that your debt gets a little smaller every time you make a payment. If home prices are stable then each month your equity also gets a little bit bigger.

With a reverse mortgage, this whole equity scenario is flip-flopped because you intentionally increase your debt and decrease your equity. You convert the equity that you’ve built up into cash while you remain the owner of your home. Your expenses don’t change; you still have to pay for maintenance, property taxes, and insurance, otherwise your lender could require you to pay back the loan in full.

How Much Money Does a Reverse Mortgage Pay?

In general, the older you are and the more home equity you have, the more money you’ll be eligible to receive from a reverse mortgage. But the amount you can get also depends on the specific loan program you choose, the allowable lending limits, the going interest rate, and whether you already have a mortgage on your property. Reverse mortgages typically must be the only debt on your home. So if you already have a mortgage it’ll need to be paid off at closing using proceeds from the new reverse mortgage.

Be aware that getting a reverse mortgage can cancel your eligibility for federal or state assistance programs (such as Medicaid) that are based on assets. But it doesn’t affect regular benefits like Social Security or Medicare in any way. 

How Much Does a Reverse Mortgage Cost?

You can get a reverse mortgage from a private lender or it can be federally-insured. The most well-known product is the Home Equity Conversion Mortgage (HECM) which is backed by the Federal Housing Administration (FHA). It’s generally less expensive than a reverse mortgage from the private sector, but you’ll still pay a host of fees like a mortgage insurance premium (MIP), home appraisal, title insurance, recording fees, and all the other standard loan closing costs for your area.

Who Should Never Get a Reverse Mortgage?

Because of the many upfront expenses that are charged for a reverse mortgage, the longer you have it the less it costs you over the long run. If you just need money for a short period of time or end up selling your home after just a few years, you’d probably come out ahead getting a home equity loan or a line of credit instead. However, those types of regular loans require you to have sufficient income, credit, and to make monthly payments. As I previously mentioned, none of those requirements come into play for a reverse mortgage.

Also, if you want to leave your home to your heirs, a reverse mortgage is probably a bad idea because in many cases the home has to be sold to pay back the loan. However, you could use the money from a reverse mortgage to purchase life insurance for your heirs, which would give them a cash inheritance after you die.

A reverse mortgage isn’t for everyone, but used wisely it can be a solution for cash-strapped retirees who have sufficient home equity. It could help you avoid foreclosure, pay for expensive long-term medical care, or make home improvements you desperately need. It can also be a valuable planning tool for savvy homeowners who want to add to their investment and Social Security income during retirement.

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