What is a reverse mortgage?
If you’re 62 or older, you can convert the equity in your property into cash, a line of credit, or a monthly payment from a reverse mortgage lender. Note: Proprietary products are available to borrowers as young as 55 years old in some states
Why is it called a reverse mortgage? The reason is surprisingly simple: in a traditional mortgage, you make monthly payments to your lender. But in a reverse mortgage, the lender pays you.
That’s what makes this mortgage program an attractive feature for retirees — it provides a supplemental source of income once you retire.
Lenders cannot recall the loan unless the homeowner dies, sells the home, or moves. Under normal circumstances, the loan will be transferred to your heirs once you pass on, and it can be easily repaid from the sale of the house.
Reverse mortgage pros
What are some notable reverse mortgage pros and cons? Many homeowners use reverse mortgages to fund their retirement years and supplement other sources of income, such as Social Security. Here are some other reverse mortgage pros that are worth considering.
Reverse mortgage cons
Despite several major advantages, there remain some drawbacks that homeowners need to consider before entering a reverse mortgage.
Reverse mortgage eligibility
You must meet certain requirements to qualify, including:
- You must be at least 62 years of age (55yrs+ on some proprietary products in certain states)
- You must own your home outright or have decent equity available
- The home must be your principal place of residence
- The home must be in good shape and meet FHA minimum property standards
- You must be free from any federal debt defaults and not currently in bankruptcy proceedings (income taxes, federal student loans)
Finally, before you qualify, you may be asked to meet with a counselor approved by the U.S. Department of Housing and Urban Development (HUD). The purpose of this interview is to highlight the pros and cons of reverse mortgages, discuss your financial preparedness, and consider possible alternatives.
Types of reverse mortgages
Not all reverse mortgages are the same. Different types of reverse mortgages offer unique advantages, though they can also bring different fee structures, interest rates, and more.
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Home Equity Conversion Mortgage (HECM)
One of the most common types of reverse mortgages is the Home Equity Conversion Mortgage (HECM). The main advantage of HECMs is that they’re federally insured and backed by the U.S. Department of Housing and Urban Development (HUD).
HECMs can be quite flexible, with no income limitations or medical requirements.
You should also be prepared to pay mortgage insurance premiums (MIPs). These fees consist of a 2% upfront fee and a 0.5% monthly fee over the life of your loan. You can finance both fees through your loan, though doing so will reduce the amount you receive.
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Proprietary reverse mortgage
Proprietary reverse mortgages are backed by private lenders. Their primary advantage is that these lenders will often appraise your home at a comparatively high value, which can give retirees a larger amount of money to draw from.
Because the federal government doesn’t back proprietary reverse mortgages, recipients aren’t responsible for making upfront or monthly insurance premiums. That usually means you’ll be able to borrow more, which can add to the overall value of the program.
Just make sure you compare mortgage interest rates and other terms between at least three lenders. That way, you can obtain the best rates and terms and avoid hefty origination fees or hidden costs.
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Single-purpose reverse mortgage
A single-purpose reverse mortgage is the least expensive option and one that may be backed by local or state government agencies or nonprofits. But that also means that this reverse mortgage program is not available in all 50 states, so you’ll need to check with a reverse mortgage lender to determine whether this program is available to you.
As the name suggests, single-purpose reverse mortgages are designed to finance one specific need, such as covering taxes or performing a home renovation or repair.
Lenders must approve this need before issuing the reverse mortgage, which means you have much less flexibility than with the previous two options.
Payment options and disbursement
How do you claim the funds from a reverse mortgage? There are several different options. More specifically, you can receive your mortgage payments in one of three ways:
- Monthly payments for a set period (term option)
- Monthly payments for as long as you own the house (tenure option)
- A line of credit
You can also combine some of these options. For instance, you might pair monthly payments with a line of credit for maximum flexibility.
Considerations to make
As you weigh the pros and cons of reverse mortgages, you’ll also need to ask yourself questions related to your financial future.
- Is my home increasing in value? If the value of your home<6.2 home value estimator> is rising, you can take out a reverse mortgage based on your current equity and pass on the remaining value of your home through your estate.
- Do I plan on remaining in my home? Remember, a reverse mortgage is due once you sell your home. If you plan on staying in your home for a long time, a reverse mortgage can be a good way to receive income without having to worry about repayment.
- Can I cover the cost of my current home? A reverse mortgage won’t necessarily help you cover the current costs of homeownership. And if you get behind with taxes or other expenses, you risk foreclosure. That said, if you’re already reasonably secure, a reverse mortgage can help you supplement your current income.
Discuss your reverse mortgage options
Before you make any big decisions, it’s a good idea to sit down with a qualified financial advisor or discuss your financial future with your loved ones. A reverse mortgage can have a certain appeal, but the risks that can come with it shouldn’t be taken lightly.
If you’re looking for ways to tap into additional money after you retire, you might consider alternatives like:
- Personal loans
- A home equity line of credit (HELOC)
- A home equity loan
If your home’s mortgage isn’t paid off, it might also be an appropriate time to consider refinance loan options. Refinancing your home will lock in a lower interest rate, which can reduce your monthly payments during a season of life when your cash flow is limited.
