Understanding How Reverse Mortgages Work

A reverse mortgage is a loan available to homeowners at least 62 years old. The loan amount increases instead of decreases over time. A reverse mortgage allows borrowers access to convert part of their home’s equity into a lump sum of money, line of credit or fixed monthly payment.

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Last Updated: 7/18/2022
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Many homeowners experience financial difficulties when they reach or pass retirement age. For some, the trouble is due to reduced income. Others may run out of savings. Seniors need to fill the financial gaps in their lives for themselves or their families.

One of the solutions available to seniors, especially those age 62 or older, is a reverse mortgage. It is a type of loan that enables a homeowner to tap into the equity they have built and turn that into cash they can use.

MoneyGeek breaks down what a reverse mortgage is and how it works to help you determine if it is right for you.

Key Takeaways

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A reverse mortgage is available to homeowners age 62 or older with substantial home equity. Unlike regular mortgages, lenders pay the borrowers in reverse mortgages a portion of the home’s equity up to the maximum amount. Still, the loan must be paid back.

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There are three types of reverse mortgages: home equity conversion mortgages (HECM), single-purpose reverse mortgages and proprietary or jumbo reverse mortgages. The best option for a borrower depends on their needs and circumstances.

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Repayment on a reverse mortgage is triggered in three circumstances: when the borrower dies, when the borrower moves out of their house permanently or when the borrower sells the home.

What Is a Reverse Mortgage?

A reverse mortgage is a type of home loan in which a homeowner borrows a portion of their equity. It is a particular type of loan only available to homeowners age 62 or older. Additionally, the homeowner should have considerable home equity to qualify.

Unlike a regular mortgage, where the borrower makes monthly payments to the lender, there are no monthly payments in a reverse mortgage. The homeowner is also not compelled to sell their house. Instead, the lender pays the borrower. That is why it is called a reverse mortgage; the roles of the borrower and lender are essentially switched. The borrower draws out money from the home equity, which is released and paid by the lender.

Payment of a reverse mortgage loan is made in the following circumstances:

  • When the borrower dies
  • When the borrower moves out of their house permanently
  • When the borrower sells the house

The heirs of the borrower may also sell the property to pay off the reverse mortgage.

Reverse mortgages are often issued through government-backed programs, so they have strict lending standards.

Types of Reverse Mortgages

Different types of reverse mortgages are available to interested borrowers. The most popular type is the home equity conversion mortgage (HECM). The best option may vary depending on a borrower’s needs and circumstances.

  • Home Equity Conversion Mortgage (HECM): HECMs are federally insured and backed by the Federal Housing Administration. They are also regulated by the Department of Housing and Urban Development (HUD). They are the most popular type of reverse mortgage. Borrowers can use HECM loans for any purpose. There are different ways to receive the money, like a lump sum, a line of credit, fixed monthly payments or a combination of a line of credit and fixed payments.
  • Single-Purpose Reverse Mortgage: A single-purpose reverse mortgage is the least expensive option among reverse mortgages. It is best for homeowners who have meager incomes. While local governments, housing agencies and charitable organizations offer this option, it may not be available everywhere. Additionally, this type of reverse mortgage can only be used for one purpose specified by the lender.
  • Proprietary or Jumbo Reverse Mortgage: Homeowners with high-value properties may opt for proprietary or jumbo reverse mortgages. This type of loan allows homeowners to borrow more than is allowed in HECMs. There are no standard guidelines because these are private loans.

How Does a Reverse Mortgage Work?

Home equity is the monetary value of a house less any debt owed against it. While a house is a significant investment, homeowners can only access equity by selling a property or borrowing against it. A reverse mortgage can allow the homeowner to convert some or all of the accumulated equity into cash, usually for short-term financial uses.

A homeowner needs to meet certain requirements to qualify for a reverse mortgage. One of these is considerable equity, at least 50% of the home’s value.

Reverse mortgages are not like regular mortgages in that the borrower does not make monthly payments. Because of this, many borrowers mistake a reverse mortgage for free money. However, that is far from the truth because this type of loan comes with many terms, risks and drawbacks.

Interest and fees are added to the loan balance every month, so the amount the borrower owes the lender increases over time. The loan balance increases, while the home equity decreases.

HECM Effects on Spouses of Borrower

Couples do not have to apply together for a HECM reverse mortgage. However, if you are married, you need to know your spouse's category.

There are three primary categories for spouses:

1

Co-Borrowing Spouses

This refers to the spouse of a borrower that is on the home’s title. They have to be legally obligated by the reverse mortgage. Co-borrowers have rights and protections.

If one co-borrower moves out or dies, the other co-borrower can stay in the home without paying the reverse mortgage balance. They can also continue withdrawing funds up to the maximum loan amount.

2

Eligible Non-Borrowing Spouses

Eligible non-borrowing spouses include those married to the borrower, living in the home, and identified in the loan documents. To maintain eligibility, the non-borrowing spouse must certify each year that they are still married to the borrower and treat the mortgaged home as their primary residence. An eligible non-borrowing spouse’s age is important when calculating reverse mortgage loan amounts.

If the borrower moves out of the home or dies, the eligible non-borrowing spouse cannot continue making withdrawals from the loan. They can receive a deferral period and reside in the home without paying off the reverse mortgage loan amount.

3

Ineligible Non-Borrowing Spouses

Ineligible non-borrowing spouses are not married to the borrower, not identified in the loan documents or have a primary residence different from the home financed with HECM during the closing of the loan. They are not eligible for a deferral period and cannot continue living in the home after the borrower moves out or dies.

HECM Effects on Estate Planning

Before borrowing through HECM, it is vital to understand how this loan affects your estate planning. Here are some steps to make a well-informed decision:

1

Consult experts.

While HECM counselors may cover estate planning and reverse mortgages, it may be smart to consult additional professional advisors. An estate planning lawyer, accountant or investment consultant may be able to provide advice on how a reverse mortgage can affect certain situations, especially in estate planning. You may also ask about finance alternatives available to you.

2

Discuss with your family.

Explain to family members why you need money, such as requiring it to supplement income or retirement benefits. Let them know about your plan to take out a reverse mortgage. A reverse mortgage diminishes your estate’s value because the loan must be paid when you die.

3

Understand the maximum amount.

You need to know how much you can borrow. You can use a reverse mortgage calculator to get an estimate. Generally, the loan amount cannot be more than the value of your home.

Reverse Mortgages vs. Traditional Mortgages

Another way to understand how reverse mortgages work is to compare them to traditional mortgages. The difference between the two types of mortgage loans is pretty straightforward.

The lender provides a lump sum that a borrower uses to buy a home in a traditional mortgage. This produces a sizable initial loan balance that the borrower must pay over time. As the borrower makes payments, the loan balance shrinks.

That is not the case for a reverse mortgage. Instead of a considerable loan amount, the borrower’s balance starts at zero. The borrower draws from the home’s equity, increasing their loan balance over time.

Debt decreases and equity increases over time in a traditional mortgage. Conversely, debt rises and equity falls with reverse mortgages.

  • Reverse Mortgage
    Conventional Home Loans
  • Purpose

    Borrowers typically take out reverse mortgage
    loans to access cash from their home’s equity.

    Borrowers take out a traditional home loan to
    finance the purchase of a home.

  • At the time of closing

    The borrower owes the lender either zero or small
    amount, and they have a lot of home equity. The
    lender does not release the loan amount yet.

    The borrower has little home equity, and they owe
    the lender a lot of money. The lender pays out the
    loan amount to help the borrower purchase their
    chosen home.

  • During the loan

    The borrower receives payments from the lender.
    These can be accessed as a lump sum, fixed monthly
    payment or line of credit. As the loan balance
    increases, the home’s equity decreases.

    The borrower makes monthly payments. As their loan
    balance decreases, their home equity increases.

  • At the end of the loan

    The borrower owes the lender. While it may be a
    huge amount, it cannot be more than the home’s
    value. The borrower ends up with either little
    equity or none at all.

    The borrower owes the lender nothing. They will
    have considerable home equity.

  • Closing costs

    The closing costs are based on the appraised value
    of the borrower’s home and can be financed as part
    of the loan.

    The closing cost is calculated based on the loan
    amount. The borrower can finance closing costs as
    part of the loan.

Reverse Mortgage Loan Limits

The borrowing limits for reverse mortgages vary depending on the lender and the borrower’s payment plan. Generally, borrowers cannot borrow up to 100% of their property’s value. That is because the loan balance is increasing and not decreasing.

If the lender allows a borrower to take out a loan equal to the home's entire value, the borrower’s mortgage would be underwater immediately. Lenders need an equity cushion to prevent the loan balance from growing higher than the property value.

  • HECM Loan Limits: Lenders use a table provided by HUD to determine a borrower’s loan limits. Generally, they consider two factors: the mortgage interest rate and the age of the youngest borrower or eligible non-borrowing spouse.

    You can check out MoneyGeek’s reverse mortgage calculator to find out how much you can borrow with a HECM. Keep in mind that a higher interest rate on your loan will result in being eligible to borrow less money.

  • Proprietary and Jumbo Loan Limits: Borrowers who want a maximum loan amount higher than what’s available with a HECM loan can consider proprietary or jumbo reverse mortgages. Since they are from private lenders, they are not subject to HUD rules. They also may not have the same protections from foreclosure.
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MONEYGEEK EXPERT TIP

The method of equity payout matters in a reverse mortgage. HUD discourages homeowners from taking out reverse mortgage proceeds in a single lump sum. Current HUD rules state that you can take out up to 60% of your initial principal limit in the first year of your HECM loan term. You can take out more only if your current mortgage balance exceeds 60% of your initial principal limit.

Reverse Mortgages Closing Costs

The federal government administers HECMs and regulates the closing costs. Proprietary or jumbo reverse mortgages are not regulated, and their closing costs are not regulated.

For HECMs, there are two options to pay the closing costs. You can add them to your loan balance. You may also opt to pay for the closing costs out of pocket.

Generally, closing costs paid to the government are non-negotiable, though you may negotiate certain fees with the lender.

Here are some examples of costs you need to take note of:

  • Mortgage Insurance Premium (MIP): MIP is non-negotiable, but borrowers can pay MIP in two parts.
    1. Annually for the Loan Term: For annual MIP, the rate is 1.25% of the mortgage balance.
    2. Up Front at Closing: Up-front MIP is based on the amount of home equity the borrowers tap during the first year of the loan.
  • Origination Fee: Generally, a lower interest rate leads to a higher origination fee. The government does not require origination fees, so you may be able to negotiate with the lender. HUD has set limits for HECM origination fees at $2,500–$6,000, depending on the property value. If the property value is $125,000, the maximum fee is $2,500. However, if your property’s value exceeds $400,000, the maximum origination fee is $6,000.
  • Servicing Fee: Typically, lenders charge fees for maintaining and monitoring borrowers’ HECM loans. This is not required, but lenders may add monthly servicing fees to the loan balance. The maximum fee is $30 per month if the interest rate is adjusted annually and $35 if the rate is adjusted monthly.
  • Third-party Charges: Closing costs usually include appraisal fees, title insurance premium, escrow service fees and recording fees. Costs of these third-party charges may vary per state.
  • Reverse Mortgage Counseling: Typically, the cost for a counseling service is $125. This fee can be waived for low-income borrowers.

Reverse Mortgage Application Process

There are various steps a borrower needs to complete when applying for a reverse mortgage. The process may vary per lender but typically takes 60 to 90 days. Shop around and compare lenders to find the best deal available to you.

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    Counseling and Application

    If you are interested in getting a reverse mortgage, it is wise to undergo counseling first with a HUD-approved counselor. A counselor can help you understand the costs and benefits of reverse mortgages. You will receive a certificate when you complete counseling and can apply with a lender, who will conduct a financial assessment.

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    Approval, Appraisal and Closing

    You need a satisfactory financial assessment from your lender, or they may deny the loan. The lender will appraise your home’s value if you receive loan approval. This will be the basis of the maximum loan amount. You then sign documents to close the loan, and the lender will record a mortgage lien on your property.

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    Payouts

    After closing the loan, you will receive the proceeds based on your chosen payout. It may be a lump sum, line of credit, fixed monthly payments or a combination of these options.

    Typically you will pay off the loan after vacating the property, whether through a sale, death or other causes. You or your estate will have to repay the loan. If the loan balance exceeds your property’s value, your heirs may opt to turn over your home to the lender.

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HECM REVERSE MORTGAGE REQUIREMENTS

A HECM has strict eligibility requirements. To qualify for a loan, the borrower will have to meet the following:

  • The youngest property owner should be 62 years old or older.
  • The borrower has completed HECM counseling with a HUD-approved counselor.
  • The property is the borrower’s primary residence.
  • The borrower owns sufficient equity in the property.
  • The borrower owns the property in their name or a living trust.
  • The property is in acceptable condition (the lender may require repairs before closing).
  • The property is an eligible type, including:
    1. — Single-family home (one to four units)
    2. — Manufactured home built after June 1976
    3. — Condominium
    4. — A property in a planned unit development (PUD)
    5. — Townhouse

Where Can You Use Your Reverse Mortgage Proceeds?

There are various reasons why a homeowner would want to get a reverse mortgage loan. Homeowners can use the proceeds from their reverse mortgage in several different ways.

  • Debt payment: Some homeowners remain burdened with mortgages or other debts even in seniorhood. A reverse mortgage can consolidate debt, removing high-interest debts and simplifying them into one loan payment.
  • Early bequests: Some homeowners choose to give money to their heirs while they are still alive. A reverse loan can help distribute money to heirs without vacating your home for the rest of your life.
  • Supplement Social Security benefits: For some individuals, retiring at 62 will not get them the maximum Social Security benefit. A reverse mortgage can help. You can use the loan amount to increase your monthly budget.
  • In-home care: Homeowners with disabilities or who need extra help or nursing care at home can benefit from a reverse mortgage. The loan can provide a source of funds to age in place.
  • Home purchase: A reverse mortgage can also be used to purchase a home. You can check the HECM purchase program. Doing this can help you buy a new place without using your savings.

FAQs About Reverse Mortgages

Reverse mortgages can be confusing, especially for people who have never applied for one before. MoneyGeek answers some frequently asked questions about reverse mortgages to help you understand the subject more.

About the Author


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Gina Pogol writes about mortgages and personal finance for several national publications. Pogol is a licensed Nevada mortgage lender (#963502) with more than 20 years of experience. Gina is a well-rounded business professional with experience as an estate planning and bankruptcy paralegal, a systems consultant for Experian and a tax accountant with Deloitte. She loves teaching and empowering consumers.