For many people, the biggest asset they own is their home. But the only time that asset’s value is actually usable is when they sell their home or borrow against their equity. One example of the latter is a reverse mortgage. Despite its name, a reverse mortgage is actually a loan, which allows homeowners aged 62 and up to turn their home’s equity into cash payments.
How a reverse mortgage works
A reverse mortgage essentially lets you tap into your home’s equity without needing to sell your home. Instead of making payments to your lender, your lender sends you money. Your house serves as the collateral to secure the loan, but you retain the title to your home, just like with a regular mortgage.
The amount you can borrow (known as the principal limit) depends on your age, the interest rate on your loan and how much your house is worth. Typically, your limit will be higher if you are older, have a higher-priced home and your mortgage interest rate is lower.
Of course, this isn’t free money. You will no longer have to make mortgage payments, but you have to stay current on your property taxes, homeowners insurance and upkeep of your home. Plus, you’ll be charged interest and fees based on the loan amount, which means the balance of the loan will keep growing. If you still owe money on your traditional mortgage, you’ll have to pay that off first. You can pay it off with other funds or use the money from the reverse mortgage to pay it off, but that will lower the amount you have to spend on anything else.
The full balance of the loan becomes due if you sell your home, die or permanently move. By law, the loan can’t be larger than the value of your home, which means that even if your home winds up selling for less than the balance of your loan, you or your heirs only need to repay the amount you borrowed.
Types of payments
If you’re approved for a reverse mortgage, you can choose from one of three main types of payment:
Line of credit (adjustable interest rate). The borrower gets access to a line of credit that can be drawn upon. The upside is that the homeowner only pays interest on the amount they withdraw from the line, not the total amount available.
Monthly payout (adjustable interest rate). You receive a set amount of money each month either as a term (a fixed number of monthly payments over a set number of years) or tenure (fixed monthly payments that last as long as you keep the reverse mortgage).
Lump sum (fixed interest rate). You receive the money upfront when the loan closes. You’ll also have to pay interest and fees based on the total amount, not just how much you’ve borrowed so far.
In some cases, you can also combine more than one type of method. The money can be used for almost anything, including supplementing your income, making repairs to your home, or paying off other debts or bills.
Who is eligible for a reverse mortgage?
Although there are a few types of reverse mortgages, the most common are Home Equity Conversion Mortgages (HECM), which are insured by the Federal Housing Authority. To be eligible, you must be:
- Age 62 or older
- Own the property outright or have a small mortgage balance (in most cases, you’ll need at least 50% equity in your home)
- Live in the property as your principal residence
- Not be delinquent on any federal debt
- Participate in a consumer information session led by an approved HECM counselor
Unlike a home equity loan or a home equity line of credit (HELOC), you don’t need good credit or strong income to qualify for a reverse mortgage.
Does a reverse mortgage make sense?
In most cases, a reverse mortgage is best for people who no longer owe money on their home or don’t owe much (since you’ll be responsible for paying off that amount first). If you only plan on living in your home for a few more years, you might also want to consider other options like a home equity loan because of the expense of a reverse mortgage. For example, you have to pay the closing costs on a reverse mortgage upfront and that can be as much as 5% of the loan.
Conversely, if you think you’ll live in your home for a very long time, a reverse mortgage may not be a good idea because of how large your loan balance will grow. You also could wind up outliving the proceeds the reverse mortgage provides.
“For people who want to stay in their houses, there’s a dignity to that. But for a reverse mortgage to make sense, the math has to shake out,” says Michael Bovee, co-founder of Resolve and debt relief expert. “Life expectancy comes into play and whether you want to leave your house to your heirs.”
Having a reverse mortgage could make it tough for your heirs to keep your home unless they can afford to pay off the reverse mortgage without selling the house.
If you’re an older homeowner, a reverse mortgage can be a useful way to boost your income or take care of a project, but for it to make sense, you have to think about how long you want to stay in your house, whether you want to keep your house in your family, and whether other types of loans would work better for you.