A reverse mortgage is a loan that allows homeowners 62 and older to convert a portion of their home equity into cash and defer repayment until they pass away, sell the home, or move out of the home.
Today, most, but not all, reverse mortgages are Home Equity Conversion Mortgage (HECM) loans—the only reverse mortgages insured by the Federal Housing Administration (FHA).
How does a reverse mortgage work?
With a reverse mortgage, you borrow against the equity in your home. Home equity is simply the current value of your home minus any mortgage balance(s)—if any—you owe on your home. Unlike a traditional mortgage for which you pay the lender each month, with a reverse mortgage the lender pays you (think of it as an advance on your home equity).
Reverse mortgage loan proceeds
The amount of funds you may qualify to receive depends on your age, the appraised value of your home, and the current interest rates.
There are a variety of ways you can choose to receive your proceeds, including a single, lump-sum disbursement; a line of credit; or a monthly cash flow payment (for a set period of months or over the life of the loan).
The most popular option is the line of credit. You only pay interest on the money you borrow, and the unused portion of the available credit grows over time (at the same rate as the loan balance)—giving you access to even more available funds over time.
You can use the reverse mortgage loan proceeds however you want. Common uses are to:
- Supplement retirement income
- Pay off (refinance) a current mortgage
- Consolidate debt
- Pay for in-home care or home renovations
- Live a legacy with family
Like any other type of borrowed money, reverse mortgage loan proceeds are usually not subject to income tax.* Your Social Security and basic Medicare are generally not impacted.
The loan balance and repayment
With a reverse mortgage, the unpaid loan balance grows over time. As a borrower, you can pay as much or as little toward the loan balance each month as you would like, or you can make no monthly mortgage payments at all. Of course, you still have to maintain the home and pay property taxes and homeowners insurance.
As long as you meet all of the terms of the loan, the loan balance only becomes due when the home is no longer your primary residence (e.g., you permanently move out or pass away).
The loan is typically satisfied through the sale of the home. If your heirs want to purchase the home, they can by paying 95% of the appraised value or paying off the loan balance, whichever is less. They can also choose to refinance the home into their name or simply walk away (in which case the home is usually sold on the open market).
You, or your heirs, keep the remaining proceeds (if any) after the loan is paid off. If the loan balance owed on your reverse mortgage exceeds the home value, neither you, your estate nor your heirs are responsible for paying back the deficit—thanks to the loan’s non-recourse feature.**
Reverse mortgage loan costs
While the reverse mortgage loan costs may be more expensive than a traditional mortgage, it may also provide you with greater financial flexibility in retirement, as it can increase your cash flow and repayment can be deferred to a later date.
Almost all of the upfront costs—appraisal fee, third-party closing costs, initial mortgage insurance premium (MIP, which is calculated at 2.0% of your loan’s maximum claim amount), and a loan origination fee (has a regulated cap based on the home’s appraised value)—can be rolled into the reverse mortgage loan. One exception is the HECM counseling fee, which is around $125 and must be paid upfront and out of pocket.
There are also ongoing costs, which include annual MIP (0.5% of the outstanding loan balance) and loan servicing fees (Fairway doesn’t charge those), that are tacked on to the loan balance and will accrue interest.
Basic Reverse Mortgage Qualifications
In order to be eligible for a reverse mortgage, you must meet the following qualifications:
- You (or at least one borrower) must be 62 or older. In Texas, both spouses need to be at least 62.
- Your property must be a single-family home, 2- to a 4-unit dwelling or FHA-approved condo
- You must meet minimal credit requirements
- You must receive reverse mortgage counseling from a HUD-approved counseling agency
- You must not be delinquent on any federal debt
- You must be a homeowner and either own home outright or have significant equity
- You must live in the house as the primary residence (meaning you must live there 6+ months per year)
Types of Reverse Mortgages
In addition to the HECM reverse mortgage, Fairway offers other types of reverse mortgages to give you options when seeking to find the best complement to your retirement plan.
- For example, if you own a high-value property, a jumbo reverse mortgage offers a much higher equity limit that you can borrow against versus a traditional HECM reverse mortgage (for which the current limit you would face is $1,089,300).
- And, if you are looking to buy a new home, there’s a reverse mortgage loan specifically for that—it is called HECM for Purchase.
Ways to Use A Reverse Mortgage
There are several instances in which a reverse mortgage may be the right options for you. Below are several different usages and benefits to reverse mortgages.
1. Use for lengthening or increasing retirement cash flow
Create memories that you will be glad to have at the sunset of life. It is sad when folks sit at home on top of thousands of dollars in equity and miss vacations, grandchildren’s college graduations, or even a dinner out because the budget is too tight. No well-meaning child would ever ask you to pinch pennies so they could have a more substantial home equity inheritance when you pass away. They would rather have you enjoy retirement with them.
2. Use to satisfy immediate cash needs
In any rough economic times, there are many things that you can take advantage of if you have cash. For example, you could help a grandchild save their home from foreclosure or help them with college as costs soar over $20,000 per year at public universities. Think about it—if you had an extra $100,000 in your hand today, whom could you give it to, or what else could you do with it? With your wisdom and experience, we know you can think of lots of options.
3. Use to enhance legacy for charity or the next generation*
If you work with a professional financial advisor in the life insurance industry, you may find there are many products designed for those with excess cash, including some that may accomplish more than a paid-off house could by itself. Talk to your financial advisor about products that may be available to you and your specific situation.
4. Use to avoid draining other investments*
Using the loan proceeds from a reverse mortgage loan can potentially help all of your investments last longer. Many people use reverse mortgages as part of a strategic financial retirement plan. Talk to your financial advisor about how to incorporate this loan into your overall financial plan.
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*This is not tax or financial advice. Please consult your tax and/or financial advisor for your specific situation
** There are some circumstances will cause the loan to mature and the balance to become due and payable. The borrower is still responsible for paying property taxes and insurance and maintaining the home: credit subject to age, property, and some limited debt qualifications. Program rates, fees, terms, and conditions are not available in all states and subject to change.