As a homeowner, you already know how a traditional mortgage works.
When you bought your home, you made a down payment toward the total sales price. At the same time, you took out a loan to pay for the rest. You then started making payments every month toward both the principal (the amount you owe) and the interest (what your lender charges you). As you paid down your balance, you steadily built equity in your home.
A reverse mortgage flips that entire process on its head.
HOW DOES A REVERSE MORTGAGE WORK?
Available only to older homeowners, this type of loan uses your home as collateral, converting some of the equity locked up in the home into cash. Instead of paying a lender, your lender pays you. You keep the title and get to stay in the home while using the cash as you wish.
Unlike a traditional mortgage, a reverse mortgage doesn’t typically require you to make any payments as long as you (the borrower) live in the home. The loan is due when you leave the home or die. At that point, you (or your heirs) can pay off the loan with cash or by selling the home.
While reverse mortgages come in a number of varieties, the most common is the Home Equity Conversion Mortgage (HECM). This type of reverse mortgage allows you to choose whether to get your money as a lump sum, in fixed monthly payments, as a line of credit or as a combination of these options.
DO YOU QUALIFY FOR A REVERSE MORTGAGE?
In order to apply for a reverse mortgage, at least one applicant must be 62 or older. You’ll need to own significant equity in your home — typically at least 50 percent — and it must be your primary residence.
Additionally, a lender will require you to keep up with the financial obligations of home ownership like proper maintenance and payment of property taxes, homeowner’s insurance and HOA fees. And, as part of the application process, you may need to participate in a mandatory counseling session through an approved agency.
WHAT TO KNOW BEFORE YOU APPLY
Under limited circumstances, a reverse mortgage can work as a part of your financial plan during retirement. But it’s important to keep these risks and factors in mind:
The amount you can borrow will be less than your current equity. Don’t assume that you’ll be able to borrow against the full equity of your home. The loan’s size depends on a number of factors like your home’s market value, your age, your spouse’s age and current interest rates.
Reverse mortgages typically cost more than traditional mortgages. You’ll almost always see higher interest rates with a reverse mortgage. Plus, you’ll face closing costs and fees that may be around 4 percent of your home’s value. Some lenders allow you to roll these fees into the loan so you don’t pay them out of pocket at closing, though this is more costly.
Not all reverse mortgages are the same. Even if you’re applying for a HECM, each lender has its own loan terms and qualification criteria. Shop around to ensure you find the loan that works best for your life. There also may be other options like selling and downsizing, renting or a home equity line of credit that may work better in some situations.
Your reverse mortgage may disqualify you from some government benefits. Your loan won’t impact your Social Security or Medicare. But receiving cash from a reverse mortgage could mean forfeiting your Supplemental Security Income (SSI) or Medicaid benefits. So make sure you understand your options before choosing a loan.
Your loan may come due sooner than you’d like. If you and any co-borrower on your loan move out for a period of 12 months, your lender will ask for payment at that time. So, if you find yourself in a nursing home for at least a year, you may need to sell the home to pay off the reverse mortgage.
You’ll never owe more than the home’s market value. If your home’s value drops below the loan amount, in most cases you won’t have to find extra funds to cover the difference. HECM loans, for instance, are non-recourse loans, so you won’t pay more than the home is worth. Often insurance that will cover this cost is included in the cost of the loan.
WHO SHOULD USE A REVERSE MORTGAGE?
The time to start thinking about a reverse mortgage isn’t when you’re up late because you don’t know how you’re going to make ends meet. Reverse mortgages typically make the most sense when they’re part of a broader financial plan for how you’ll generate income in retirement.
Make sure you fully understand what you’re getting into, how a reverse mortgage will work with your overall financial plan and the costs associated with it. Because the process can involve complicated documents, it’s also advisable to work with a legal professional to understand the risks and the impact on your heirs and estate plan.