If you are looking for a way to finance a fulfilling retirement in the home you love, a reverse mortgage is a lending mechanism that can help you achieve your goals without having to sell your home or decrease your spending. As you increase in age, reverse mortgages allow you to channel the value of what could be your greatest asset––your property––into retirement or long-term care financial support so you can spend your later years in your own home.
Though homeowner equity in the U.S. is currently estimated at over $20 trillion, the process of tapping into your home’s net worth can be difficult to navigate. This post breaks down the basics of reverse mortgages, including what they do, how they work, and the importance of doing your research before committing to this major financial decision.
What Is a Reverse Mortgage?
Simply put, reverse mortgages are a type of home equity loan given to homeowners who are at least 62 years old and have considerable home equity, so they can borrow against the value of their property. Unlike traditional loans and mortgages, reverse mortgages do not require borrowers to follow a payment plan with monthly installments (although they do have the option to do so). More typically, when the loan reaches maturity, homeowners pay everything back at the same time. It’s for this reason that reverse mortgages tend to have higher fees and interest rates than bank loans or mortgages.
Though reverse mortgages and mortgages both use your home as collateral, the two differ in one crucial way. With a mortgage, the homeowner pays the lender, whereas in a reverse mortgage, the lender pays the homeowner. Homeowners can receive this payment in the form of a lump sum, monthly income, or line of credit. No matter which form the borrower chooses, because it is a loan, the money they receive is tax-free.
Wondering, “How does a reverse mortgage work?” Over the life of the reverse mortgage, the amount borrowed accumulates interest. If the homeowner dies, sells their home, or changes their primary residence, they will have to repay the outstanding balance in full, including all of the interest which has accrued on the loan. Due to the age requirement on reverse mortgages, homeowners often trigger loan maturity when they move to receive long-term care.
The 3 Types of Reverse Mortgages
If you are just beginning to explore reverse mortgages, you may be unsure of the difference between the three types available to homeowners: home equity conversion mortgages, single-purpose reverse mortgages, and proprietary reverse mortgages. In this section, each type of reverse mortgage is explained, along with each one’s advantages and the distinctions among the three.
Home equity conversion mortgage (HECM)
The most common and, arguably, most secure type of reverse mortgage is the home equity conversion mortgage or HECM. This is a federally-backed home equity loan— it is insured by the U.S. Federal Housing Administration, known as the FHA, and HECM homeowners can only borrow from FHA-approved lenders. Under a HECM loan, homeowners can borrow up to a fixed amount called the principal limit which is capped at $970,800 as of 2022 and calculated using the borrower or non-borrowing spouse’s age, current interest rates, and the home’s value. For example, an older borrower with a higher property value and is quoted a lower interest rate could expect to receive a larger principal limit and reverse mortgage loan amount.
Before choosing this option, be sure you understand all of the fees and payments associated with an HECM. If you choose this type of reverse mortgage, you will have to pay mortgage insurance premiums, an origination fee, servicing fees, and third-party fees for services like home inspections and credit checks. This loan also gives you the option of a fixed or variable interest rate. A fixed interest rate limits the borrower to lump sum payments, while a variable interest rate allows you to receive a monthly payment, line of credit, or some combination of the two.
Single-purpose reverse mortgage
Considered the most economic type of reverse mortgage, single-purpose reverse mortgages are backed by government agencies and nonprofits. These loans are often best for those who need help funding medical or disability-related home accommodations. The homeowner won’t have to make monthly payments, but they will have to continue to pay homeowners’ insurance fees and property taxes. These loans do not have to be repaid until the homeowner’s death, a change in homeownership, or a change in the homeowner’s primary residence. Unlike the HECM, borrowers do not have to pay mortgage insurance premiums when they choose this type of reverse mortgage.
Proprietary reverse mortgage
Proprietary reverse mortgages are a strong option for homeowners with high-value properties. Because this type of reverse mortgage is the only one of the three not backed by the federal or local governments, its private lenders are not bound by lending limits and can offer larger principal balance loans based on the home’s value. In addition, this lending mechanism does not require borrowers to pay mortgage insurance premiums.
Though each of the above reverse mortgages offers its own advantages and drawbacks, it is important to note that, regardless of which one you choose, your loan amount will not equal the full value of your property. A portion of the loan will be used to pay for reverse mortgages’ various fees and any loans, tax liens, judgements, or other mortgages attached to the home.
Who Qualifies for a Reverse Mortgage?
Reverse mortgages are typically used by seniors to help supplement retirement incomes, pay for health and home care, or fund home improvements. For seniors, the main requirement for a reverse mortgage is that the primary property owner be at least 62 years old. If you are interested in the most common type of reverse mortgage, the HECM, you will have to meet additional requirements which include:
- The home used as collateral must be your primary residence
- You may not have any outstanding federal debt
- You must have sufficient funds to cover the cost of maintaining your home
- You must own your house outright or have paid off most of your mortgage
- You must participate in an information session with an approved HECM counselor
Given the above qualifications, a large segment of seniors tend to qualify for an HECM. However, if you do not qualify or meet the age requirement for a reverse mortgage, you can still find ways to extract money from your home and other investments. Home equity loans, home equity lines of credit, and life settlements—which allow you to sell your life insurance policy for cash—all provide qualifying candidates with a way to supplement their retirement funds.
Reverse Mortgage Pros and Cons
As with any major financial decision, you will want to weigh the potential benefits of reverse mortgages against their drawbacks before making any commitment. Below is a list of the key reverse mortgage pros and cons that candidates should consider.
- Tax-free. Since funds from reverse mortgages are a loan and not considered income, the money you receive is not subject to taxes.
- Positive payout. If your home’s value exceeds the outstanding loan balance, you will receive the positive balance when the reverse mortgage matures.
- Proceeds options. The funds from the loan can come in several different forms: a lump sum, monthly income, or a line of credit that you can draw on as needed.
- Maturity payment options. You can choose not to make monthly loan payments for the life of the loan, but if you choose to, you can reduce the loan interest and the amount you owe at maturity.
- Usage flexibility. You have complete flexibility when it comes to how you use the funds, though some popular options include using them to fund living or healthcare costs and to pay outstanding loans, debts, liens, and judgements.
- Home value. If your HECM loan balance increases beyond the appraised value of your home at the time the loan needs to be repaid, you will not have to pay more than 95% of the property’s appraised value. Any remaining balance will be paid by the mortgage insurance that comes with all FHA-approved lenders in HECMs.
- Ongoing expenses. You must continue paying property taxes and homeowners insurance and keep the home in good condition for the life of the loan.
- Safety net eligibility. Reverse mortgages can jeopardize your eligibility for Medicaid or Supplemental Security Income (SSI).
- Foreclosure. If you get a private, non-HECM reverse mortgage from an FHA-approved lender, you will not receive mortgage insurance protection. This means you could be responsible for paying back your entire loan balance, even if it exceeds the value of your property, and potentially face foreclosure if you do not.
- Higher interest rate. The loan will continue to collect interest at a higher rate than conventional bank loans for as long as the reverse mortgage remains outstanding, adding to your debt.
- Limited tax advantages. There are no tax deductions for paying off a reverse mortgage.
- Legal ramifications. Changes to your residency or marital status or a sudden death can have complex legal ramifications if you have a reverse mortgage.
- Residency requirements. If you need to leave your home for longer than 12 consecutive months, you must pay the reverse mortgage back in full.
- Fees. Reverse mortgages come with fees and closing costs which will be deducted from the amount you receive.
Are Reverse Mortgages Bad?
What is the bottom line? Are reverse mortgages good or bad? The truth is that reverse mortgages are nuanced mechanisms and whether they are the right or wrong choice for you will depend on the particulars of your situation and financial circumstances.
Here are a few factors that could indicate that a reverse mortgage is right for you:
If you would like to remain in your home for a long time. Not only does a reverse mortgage accommodate those who want to stay in their home, it is a requirement of the loan. It is important that you are confident you will not want to relocate in a few years. If the homeowner expresses a desire to leave the home or move into a long-term care facility, then a reverse mortgage would not be the right decision.
If you do not intend to keep your home in the family for future generations. Because the payoff you will receive from the reverse mortgage comes from the sale of your home at the time of loan maturity, reverse mortgages are not advised for those who want to keep a home within their family. Consider whether this is an acceptable consequence for you or if letting go of your family home is a prospect you do not want to consider.
If you want access to additional funds and can afford to maintain your home. Reverse mortgages give you access to a lump sum of money, monthly income, or a line of credit to be drawn on as needed—provided the homeowner covers the cost of their home’s upkeep. This means maintaining payments for homeowner insurance, home maintenance, homeowner association fees, and property taxes. You will want to be sure that you can cover all these expenses before you commit to a reverse mortgage, or you may have to forfeit the loan.
Though it may take some time to understand the inner workings of reverse mortgages, carefully considering how this form of equity loan would affect your personal finances and life in retirement is an integral part of retirement planning. Not only should you ask yourself, “what is a reverse mortgage?” and “how does a reverse mortgage work?” but you should also make sure to ask “how would a reverse mortgage affect me?”
Alternatives to Reverse Mortgages
If you do not meet the requirements for a reverse mortgage but still need a way to supplement your retirement income, there are other methods you can use to extract liquidity from your existing assets. In this section, we go through the various alternatives to reverse mortgages for those who cannot or choose not to pursue this type of equity loan.
If you don’t want to risk your home in a reverse mortgage, life settlements allow you to keep your home safe from foreclosure and monetize a high-value asset: your life insurance policy. In a life settlement, you can sell your life insurance policy to a third party for cash. Sellers can receive between 10% and 50% of the face value of their policy, a sum significantly larger than what they would receive by letting their policy lapse or cancelling the policy in a cash surrender.
Life settlements offer policyowners the dual benefits of an increased retirement income through a large cash influx and decreased monthly expenses by ending costly insurance premiums. Long-Term Care Life Settlements can be a tax advantaged way to pay for expensive care needs or you can even elect to sell a portion of your existing policy in exchange for cash and a new policy with no future premium obligations. This Retained Death Benefit type of settlement payout is a great option for those who need cash but would also like to retain coverage for their beneficiaries.
You can learn more about life settlements and find out if you qualify right here on Retirement Genius.
Home equity loans and lines of credit
For those who do not qualify for a reverse mortgage, taking out a home equity loan (a second mortgage) or home equity line of credit (HELOC) can be a smart way to take advantage of your home equity. Unlike reverse mortgages, these loans do not come with any age restrictions or requirements that the homeowner maintain the property as their primary residence as with a reverse mortgage. In addition, the closing costs and interest rates on these conventional loans tend to be significantly lower than those of a reverse mortgage.
Keep in mind, however, that home equity loans and HELOCs only allow you to borrow up to around 80% of your home’s value and come with required monthly payments.
Refinancing an existing mortgage is another option for homeowners who want to increase their retirement income without going through a reverse mortgage. When you refinance your mortgage, you can change certain terms in your mortgage contract in order to lower monthly loan payments or interest rates. Instead of providing you with extra cash to spend on long-term care or medical expenses, a refinanced mortgage will decrease your monthly expenses, leaving you with more cash on hand to spend on your retirement expenses each month.
Senior Living Bridge Loans
There are two types of Senior Living Bridge Loans, secured and unsecured.
A secured bridge loan using a home as collateral for a loan with the intention that the home will be sold to fund a move into a long-term care facility. The funds from the bridge loan are made immediately available while the home is for sale. The lender makes payments to the senior care facility for whatever amount is needed on a monthly or as needed basis. The funds can be used to pay entry fees and then ongoing monthly fees. The terms of the loan are that the borrower will make interest only payments to the lender for the first 60 months. If the loan needs to continue beyond that point the payments would require principal and interest until the loan is re-paid (typically through the sale of the home).
An unsecured bridge loan specifically designed to help seniors move into retirement communities can be borrowed for amounts between $5,000 and $500,000 based on co-signers from the borrower’s immediate family. Current variable interest rates range and origination fees for the amount borrowed are charged.
With the line of credit, interest-only payments of around $12 per month per $1,000 drawn are charged. The borrower will have between 15 and 18 months to pay it off the loan and term loans have up to 36 months before they are due, with payments on both the loan’s interest and principal required.
The prospect of reaching your long-awaited retirement years only to lack the funds to remain in your forever home can be heartbreaking. Reverse mortgages offer a flexible method of adding to your income, paying for medical care, or funding home improvements with the added bonus of allowing you to remain in a home you care about. For those eligible, reverse mortgage payments are left completely within their control, though these funds are best employed when borrowers avoid the temptation to put this money towards impractical expenses.
If you’re not eligible for a reverse mortgage or don’t wish to pursue this option, alternatives like a life settlement can provide you with the funds you need to spend your retirement in your own home, without putting your property at risk. Though you may not think of your life insurance policy as an investment in the traditional sense, it carries immediate and significant value. Selling your life insurance enables you to extract the most out of your policy while eliminating additional retirement expenses.
As always, we strongly advise you to continue researching this complex topic and sit down with a trusted financial professional to discuss reverse mortgage pros and cons and whether a reverse mortgage is the right choice for you. If you’re ready to learn more about how a reverse mortgage could help you plan for retirement, the experts at Retirement Genius can help. Contact us today.