What is a reverse mortgage?
It's likely that you've heard of a reverse mortgage, but do you know how it works?
Reverse mortgages are one of those things that you've probably heard about a number of times—but maybe you're not exactly sure what all it entails. You may have seen a late night infomercial, or heard a radio ad from some C-list celebrity urging senior citizens who are financially struggling to consider a reverse mortgage as an option. But what is a reverse mortgage?
Reverse Mortgages Explained
A reverse mortgage permits qualified applicants to receive payments – not make them – using equity they’ve earned while paying off their home.
- Reverse mortgages can be complicated and should be well researched and reviewed when obtaining one.
- Reverse mortgages are sometimes referred to as Home Equity Conversion Mortgages (HECM).
- Reverse mortgage borrowers must be 62 years or older.
- Reverse mortgages must be paid off when the borrower(s) no longer live in the home.
- Reverse mortgages are specialty loan products and not all lenders offer reverse mortgages.
A traditional mortgage, including FHA, VA, USDA, and loans backed by Fannie Mae and Freddie Mac, is a loan secured by a home that the homeowner repays over time, usually by making monthly payments. It stands to reason a reverse mortgage would be the opposite. However, that’s not entirely correct.
Reverse mortgages are more like home equity loans, which are mortgage loans where the homeowner receives a cash payment equal to some percentage of a home’s equity that must be repaid. The differences between a traditional home equity loan and a reverse mortgage include how the cash payments are received by the homeowner and how the loan is repaid.
Who can get a reverse mortgage?
Unlike regular mortgages, where anyone who meets the lender’s financial and underwriting standards can qualify, reverse mortgage borrowers must be 62 years or older.
In addition to the age requirement, given that a reverse mortgage is still a loan, reverse mortgage borrowers must still meet lender underwriting guidelines. Typical reverse mortgage requirements include:
- 62 years or older
- Living in the home as a primary residence.
- Have substantial equity. Some lenders may require the home to be owned outright.
- Financial assessment that meets lender thresholds.
Why do reverse mortgages exist?
If you’ve been paying down your mortgage for years, or even decades, there is likely significant value in the asset you’ve spent much of your life paying off. Typically, the only way to realize any benefit from that value is to sell the house or borrow against it.
If selling is off the table, borrowing from the home’s equity with a traditional home equity loan or cash-out refinance will require a monthly payment. Although 62 might seem arbitrary, many Americans retire around this age. Retirees may have fixed or reduced incomes that results in making payments difficult, if not impossible. Reverse mortgages solve that problem.
Reverse Mortgage Repayment
The most important distinction between any traditional mortgage or home equity loan and a reverse mortgage is how they are repaid. Reverse mortgages typically do not have to be repaid until the homeowner leaves the home.
If a homeowner decides to sell their home and move, the cash advances they’ve taken plus interest must be paid with the sale proceeds before ownership of the home can be transferred.
When reverse mortgage borrowers pass away, the loan must also be repaid.
Reverse Mortgage Proceeds
When you take on a reverse mortgage, the funds distributed to you can be dispersed in multiple ways. Homeowners may:
- Receive the full proceeds of the loan upfront.
- Receive the proceeds incrementally, usually monthly, for either a fixed term or in perpetuity as long as one borrower remains in the home.
- Establish a line of credit and access the funds only when needed.
- A combination of equal or term payments plus a line of credit.
The idea of reverse mortgages is to provide cash flow to seniors who have paid down their home. Many seniors rely on monthly reverse mortgage payments as their sole source of retirement income. Others use the money when needed to fund vacations, graduations, weddings, or any assortment of thinkable reasons. They are essentially deferring paying the money back until they no longer need their home.
Obtaining a Reverse Mortgage
Because of their complexity, not all traditional mortgage lenders provide reverse mortgage services. No doubt you have seen television commercials from some of the larger reverse mortgage providers. It is important to research lenders and to work with reputable firms. The complex nature of reverse mortgages makes them a tool for scammers. Speaking with friends and family who have used reverse mortgage themselves can be a great way to get pointed in the right direction.
Reverse mortgages can be a great way to supplement retirement income or provide a safety net for unforeseen expenses. Be diligent when choosing a lender and take the time to understand your loan documents. Once in place, a reverse mortgage can provide senior homeowners with the peace of mind that comes with a reliable source of available funds.