For homeowners 62 and older, a reverse mortgage can unlock home equity without monthly loan payments—freeing up extra cash for retirement. You won't have to repay it until you move, sell the home or pass away. It can be a good option for seniors who need financial flexibility and plan on staying in their home for years. Sounds great, right?
But there's more to the story, as these loans aren't always a good fit for everyone and some alternatives may be more affordable. Before deciding, it's important to understand how reverse mortgages work and whether they're the best choice for your financial future. Here's what you need to know.
What Is a Reverse Mortgage?
As the name suggests, reverse mortgages are secured by your home but work differently than other types of mortgages. Instead of making payments to pay down a loan, you receive money—either as a lump sum, monthly payments or as-needed withdrawals. Over time, your loan balance increases as interest and fees are added to the amount you've borrowed.
The money you receive from a reverse mortgage isn't considered taxable income because it's a loan you need to repay. However, it might affect your eligibility for need-based government assistance, such as Supplemental Security Income (SSI) or Medicaid.
You—or your heirs— will need to repay the loan, plus interest and fees, when you sell, move or no longer qualify for the reverse mortgage. Or, your heirs may need to pay off the reverse mortgage if they want to keep the home.
Types of reverse mortgages
There are three main types of reverse mortgages:
- Home equity conversion mortgage (HECM): The most common type, HECM is the only option insured by a government agency—the Federal Housing Administration (FHA).
- Proprietary reverse mortgages: These private loans are offered by lenders and aren't insured by the government. Proprietary reverse mortgages don't have the same requirements and restrictions as HECMs, which might make them a good fit if you're under 62 years old or your home is worth more than the current FHA limit for HECMs. Proprietary reverse mortgages are sometimes called jumbo reverse mortgages.
- Single-purpose reverse mortgages: Some nonprofits and local or state government agencies offer reverse mortgages you can take out to pay for specific expenses. For example, you might qualify for a reverse mortgage to cover your property taxes, repair your home or make your home more accessible.
In this article, we'll focus on HECM because it's the most common type of reverse mortgage. However, proprietary and single-purpose reverse mortgages may be a better fit depending on your situation.
How Does a Reverse Mortgage Work?
The specifics of a reverse mortgage can depend on the type of reverse mortgage and the terms of your loan. Here's an overview of how HECMs tend to work.
Qualifying for a reverse mortgage
You must be at least 62 years old to qualify for a HECM. Additionally, eligibility can depend on your finances, outstanding debt and the home.
- Your finances: You need to have enough savings or income to cover home-related expenses, such as property taxes, home insurance, repairs and maintenance. If you don't, you might be able to get a reverse mortgage if you agree to set aside some of the proceeds for these expenses.
- Outstanding debt: You must own the home and can't have outstanding federal debts, such as federal income taxes or student loans. If you have a mortgage or federal debts, you might qualify if you use the reverse mortgage proceeds to pay them off.
- The home: The home must be a one-to-four-unit property, and you must live in it as your primary residence. The home must be in good condition or you may need to complete required repairs before getting approved by the lender.
Unlike with a traditional loan or credit card, your income and credit score aren't factors when you apply for a reverse mortgage. However, the lender may consider your history of paying bills and keeping up with home-related expenses to ensure you can meet ongoing financial obligations.
The loan process
You can apply for a HECM with an FHA-approved lender. You will then receive a pre-counseling information package and will have to attend a reverse mortgage counseling session with a U.S. Department of Housing and Urban Development (HUD)-approved counselor.
If you decide to move forward, the next step is to complete the lender's application. The lender will start underwriting the loan, appraise your home and review your finances.
If you're approved, you may be able to compare different options, choose how much you want to borrow and decide how you'll receive the money.
Your loan offers will have a total annual loan cost (TALC) disclosure, which can help you understand the annual average cost of the loan. The longer you keep the loan, the lower the annual cost, since up-front fees are spread out over time.
Receiving your loan proceeds
The amount you can borrow depends on the age of the youngest borrower or eligible non-borrowing spouse, current interest rates, your home's appraised value and the FHA mortgage limits.
If you get an adjustable-rate reverse mortgage, you can receive the money as equal monthly payments, a lump sum or a combination of the two. The monthly payments can continue for a specific period or indefinitely as long as you or your co-borrower or spouse qualify. You may also be able to get a line of credit with your reverse mortgage that allows you to borrow more money as needed.
A fixed-rate reverse mortgage generally requires taking the loan as a lump sum at closing.
Repaying the loan
You may have to repay the reverse mortgage when the last borrower or eligible non-borrowing spouse:
- Dies
- Sells the home
- Doesn't live in the home for most of the year
- Spends more than 12 consecutive months in a healthcare facility, such as a hospital, nursing home or assisted living facility.
You could also risk foreclosure and default on the loan and have to repay it if you fall behind on required payments, such as property taxes or homeowner's insurance, or if you don't keep up with home maintenance and repairs.
If the loan balance is higher than the home's value at the time of sale, HECM mortgage insurance covers the difference, ensuring that neither you nor your heirs owe more than the home is worth. Note that this may not apply to some proprietary or single-purpose reverse mortgages.
Benefits of Reverse Mortgages
Reverse mortgages can be a good option for some homeowners because:
- You can access the equity in your home without making monthly payments.
- It's easier to qualify for a HECM than a home equity line of credit or loan.
- You can use the money to pay for anything, including living expenses, medical bills and home-related expenses.
- There's no set repayment date—the loan is repaid when you sell the home, move out permanently or pass away.
- You won't be forced to sell the home or move if you keep the home in good condition and stay current on property taxes, insurance and other required home expenses.
- The maximum repayment amount depends on the home's value.
Considerations and Risks
Consider some of the risks and impacts of taking out a reverse mortgage:
- Higher costs: Reverse mortgages typically have higher fees and interest rates than home equity loans or lines of credit.
- Limited flexibility if you move: You won't have as much money to cover living expenses if you want or need to move.
- Ongoing home-related costs: You must continue paying property taxes, homeowner's insurance and maintenance to avoid default.
- Impact on heirs: Your heirs may need to sell the home to repay the reverse mortgage unless they can cover the balance another way.
- Effect on government benefits: The income could impact your eligibility for need-based government assistance programs.
- Risk for non-borrowing spouses or partners: A non-borrowing spouse or partner might not be able to live in the home after you move or die, depending on the loan terms.
Alternatives to Reverse Mortgages
Consider some of these alternatives if you're looking for a way to make your budget work during retirement.
- Downsizing: Selling your home and moving to a smaller, more affordable property could free up cash, reduce maintenance costs and even bring you closer to family or an area with a lower cost of living.
- Home equity loan: If you need a lump sum for a major expense and can afford to make monthly payments, a home equity loan may be a cheaper alternative to a reverse mortgage.
- Home equity line of credit (HELOC): A HELOC provides a flexible credit line with interest charged only on the amount you borrow—making it a potentially more affordable and versatile option.
- Finding ways to lower your bills: You might be able to cut back on some monthly expenses to make ends meet. You could also use BenefitsCheckUp® to see if you qualify for programs that can help with regular expenses such as utilities, food and medicine.
These may also be good alternatives if you can't qualify or aren't approved for a large enough loan with a reverse mortgage.
Shop Around When Looking for a Reverse Mortgage
The closing costs, other fees, interest rates and terms for a HECM can depend on the lender. Get offers from multiple lenders so you can compare the options and figure out which will work best.
You can also meet with a HUD-approved reverse mortgage counselor, even if you haven't applied or found a lender yet. Ask lots of questions, including how a HECM could work for someone in your situation. And consider how a reverse mortgage, or the alternatives, fits into your retirement plan.
