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Reverse mortgages allow homeowners who are 62 or older to convert part of their home equity into cash. In exchange for upfront money, borrowers forfeit some of the future profit that will be gained from selling their house. The money drawn from a reverse mortgage can be used to pay for medical costs, living expenses or existing mortgage payments.
Reverse Mortgages Explained
A reverse mortgage is a loan that allows older homeowners to get cash now by giving up future equity in their home. Cash payouts can be received in a lump sum, as a line of credit, or in installments for as long as the borrower lives in the house. Even the most qualified homeowners can borrow only as much money as their house is worth, as proceeds from the eventual sale of the home are used to pay off the reverse mortgage debt.
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Most importantly, reverse mortgage loans don't have to be paid off until the home is sold or until the borrower no longer lives in it. However, it's important to consider the full financial implications of this before using home equity. Because of the deferred payment plan, a reverse mortgage is helpful for an older homeowner in need of immediate cash. However, the many added fees can also drastically reduce the eventual profit that a borrower or their family will receive for selling a house. As such, a reverse mortgage should be borrowed only if it's a financial necessity, or if the borrower doesn't mind getting less money for selling their home.
Reverse Mortgage Options: HECM, Single-Purpose or Proprietary
The most popular type of reverse mortgage is a Home Equity Conversion Mortgage, or HECM. These loans are sponsored by the government's Federal Housing Administration (FHA) and distributed by FHA-approved private lenders. HECMs are commonly used by retirees to supplement their income and meet living expenses. As a general purpose loan, a HECM can be used to pay for renovations, property taxes or any other expense. Cash received from a reverse mortgage is usually tax-free and won't impact Medicare or Social Security benefits.
- Home Equity Conversion Mortgages (HECMs): General purpose loans
- Single-purpose reverse mortgages: For smaller loan amounts
- Proprietary reverse mortgages: For large loan amounts
The two other types of reverse mortgages are single-purpose, which are provided by local governments and nonprofits for one time expenses like taxes or home repairs, and proprietary, which allow for larger loan amounts. Single-purpose reverse mortgages are the most affordable option and are preferred by low or moderate income homeowners. Proprietary reverse mortgages, also known as jumbo reverse mortgages, are for borrowers who want a large loan and own a more expensive property.
Eligibility Requirements for Reverse Mortgages
The primary requirements for reverse mortgage eligibility are for homeowners to be over 62, and for them to own their home outright—although most lenders approve applicants who are close to paying off their mortgage. Lenders also require potential borrowers to have the money necessary to continue paying property taxes, homeowners insurance and other housing costs. Additionally, the FHA requires that homeowners are not delinquent on any federal debt. A borrower's maximum cash payout is determined by these same factors—age, home equity and outstanding debt—with the largest payouts for older borrowers and those with large home values.
- Must be over 62
- Must own home fully or have low mortgage balance
- For HECM, must meet with government-approved counselor
Before taking out a HECM, potential borrowers are required to meet with a government-approved housing counselor. The counselor's job is to explain how HECMs work, and to help the borrower compare them to single-purpose and proprietary reverse mortgages. Like all loans, reverse mortgages come with a variety of costs and fees, so the counseling session can help determine whether a reverse mortgage is the right loan product. You can search the housing counseling roster here to find an approved counselor in your area.
For a home to be eligible for a HECM reverse mortgage, the borrower must live in it as their primary residence. This means that a vacation home or secondary residence can't be used for a reverse mortgage. The FHA also mandates that homes meet minimum property standards as prescribed by local, state, and federal guidelines. In general, all single family units, 2 to 4 unit homes, and certain approved condos are eligible for reverse mortgages. Manufactured homes are also eligible if they meet certain criteria outlined by the Department of Housing and Urban Development.
Fees and Costs of a Reverse Mortgage
The total cost for a reverse mortgage includes interest payments, origination fees, mortgage insurance and closing costs. Origination fees are charged on most loans and cover the lender's cost of processing paperwork and creating each unique loan. For HECM loans, the maximum origination fee is 2% of the first $200,000 in home value and 1% on the remainder. This means that a $300,000 home would have a charge of $5,000. For more expensive homes, origination fees are capped at $6,000.
With all fees considered, the borrowing cost of a reverse mortgage can total thousands of dollars. Annual interest alone is around 5% for fixed-rate mortgages and 4.5% for adjustable-rate versions. Mortgage insurance usually totals 1.25% of the loan amount. Closing costs charged by private lenders can total a few thousand dollars and include credit report fees, document preparation fees and inspection fees.
Common Borrowing Charges
- Interest payments
- Mortgage insurance premiums
- Closing costs
Interest payments and other fees can add up and over the life of a reverse mortgage. Because of this, most reverse mortgage agreements have a "non-recourse" clause, which guarantees that the total cost of debt doesn't exceed the value of the home. This means that a borrower, their estate or their heirs won't be left underwater once the loan is due.