Home > Blog > What is Reverse Mortgage and How Does It Work

What is Reverse Mortgage and How Does It Work

Within financial tools tailored for older people, a distinct choice manifests itself, offering a channel to tap into the wealth tied up in residences without adhering to customary mortgage reimbursement structures. The incremental surge in property values over time has propelled the overall value of domiciles owned by seniors to unprecedented levels. The reverse mortages serve as a conduit through which this amassed prosperity becomes attainable, presenting an unconventional avenue to fortify post-retirement funds. 

Crafted for individuals aged 62 and beyond, this financial mechanism transforms home equity into fluid assets. The funds can materialize as a lump sum, periodic allowance, or adaptable line of credit. This mortgage only demands doesn’t reimbursement once the homeowner departs, sells their dwelling, or embarks on an extended sojourn away from their residence.

The allure of reverse mortgages is gaining momentum among seniors. Recent National Reverse Mortgage Lenders Association data reveals nearly 660,000 active reverse mortgage loans as of 2019. Elderly homeowners can discern whether the reverse mortgage aligns with their unique financial needs and aspirations. What exactly is a reverse mortgage?

What Exactly is a Reverse Mortgage

A reverse mortgage is a home loan for homeowners aged 62 and older. Here are the key features:

  • Allows homeowners to access home equity without selling the property
  • Requires no monthly mortgage payments – borrowers retain ownership
  • Proceeds can be taken as a lump sum, monthly payouts, or a line of credit
  • Loan repayment is not due until the homeowner moves, sells, or dies
  • Borrowers must continue paying property taxes and homeowner’s insurance
  • Homeowners retain title and can leave property to heirs after repayment
  • The loan amount depends on age, home value, and interest rates
  • Insured by the Federal Housing Administration to ensure lenders are paid

The unique structure of reverse mortgages allows seniors to tap home equity while living in the home long-term. This can provide funds to cover retirement costs without taking on monthly housing payments. How does reverse mortgages work?

How Does Reverse Mortgages Work

A reverse mortgage is a complex financial product that allows homeowners to access their home equity. Here is an overview of how these unique loans operate:

  • Homeowner meets with lender and applies for a reverse mortgage
  • The lender assessed home value, borrower’s age, and loan options
  • Borrower selects payout option – lump sum, monthly, or line of credit
  • FHA insures the loan, protecting lenders if the balance exceeds the home value
  • Borrower retains title and ownership of the home
  • No repayment is due until the homeowner moves, sells, or passes away
  • Interest accrues over time and is added to the loan balance
  • Heirs can choose to repay their loan and keep their home or sell their property

Key factors determining the amount of funds available include the borrower’s age, home appraisal value, interest rates, and fees. Older borrowers and more valuable properties qualify for more equity. So, how does reverse mortgages work? Now you know it!

Reverse mortgage example

Ponder a situation designed to elucidate the inner workings of reverse mortages. Envision Clover, a septuagenarian widow, opting for this financial maneuver on her abode, appraised at $350,000. Considering her age and the property’s value, she attains eligibility for a solitary disbursement of $150,000, funneled directly into her bank account for unbridled utilization. Clover retains unmitigated ownership and control over her dwelling. During her occupancy, there exists no imperative for her to disburse periodic mortgage contributions. Interest accumulates on the $150,000 at prevailing rates over time.

The loan must be settled upon Clover’s relocation, sale of the property, or demise. If the home fetches a price surpassing the loan balance, the surplus returns to Clover or her heirs. This showcases how a reverse mortgage empowers seniors like Clover to tap into home equity sans the burden of monthly housing payments or surrendering their hold on property ownership.

Things To Consider Before Getting a Reverse Mortgage

While reverse mortgages offer benefits, they are complex products with long-term implications. Those exploring reverse mortgages should consider the following:

  • How long do you plan to stay in the home – these loans can be expensive to pay off early
  • Your financial needs in retirement – will the funds be used wisely?
  • Non-borrowing spouse’s age – they must be 62 or older to remain in the home
  • Potential costs – origination fees, closing costs, servicing fees
  • Impact on government benefits – loan proceeds may affect Medicaid/SSI
  • Future home equity growth – less equity will pass to heirs
  • Alternatives like downsizing or home equity lines of credit
  • Seeking input from financial advisors and family members
  • Reading paperwork carefully and evaluating lender reputation

The funds provided by the basics of reverse mortgage can give retirees greater financial security. However, borrowers should think critically about whether benefits outweigh total costs over time. Thoroughly evaluating options will lead to the most informed decision. Meeting with a reputable reverse mortgage counselor is highly recommended.

Comparing reverse vs. regular mortgage

We want to present you with a comparative table illustrating the differences between two distinct types of mortgages and what you should focus on when considering these variances. This is a convenient way for you to examine two different transactions that appear similar visually.

FeatureReverse MortgageRegular Mortgage
PurposeA reverse mortgage essentially serves as a means to furnish retirees with a consistent flow of income, catering to those in need of supplementary funds while steering clear of levies on their Social Security benefits.At the core, the mundane mortgage’s raison d’être spins around bankrolling either the homestead’s inception or a melodious encore through refinancing.
Loan AmountThe cash you can get from a reverse mortgage hinges on how old you are and how long you’re likely to live. It typically turns out to be a hefty chunk of change, playing out like this flexible credit line linked to your home’s value. You’re free to tap into it whenever, whether you live until forever or decide to part ways with your abode.In the dance of conventional mortgages, the loan digits twirl in tandem with the property’s appraisal and the buyer’s initial contribution.
Interest RateInterest rates on reverse mortgages are usually less than what you’d find on typical mortgages, and this is because these loans are backed by the homeowner’s life insurance policy.These run-of-the-mill mortgages often flirt with loftier interest realms, tracing a trajectory skyward due to the inherent venture in lending money for real estate exploits.
Borrower AgeReverse mortgages are available to people over the age of 62.Eligibility for these mundane mortgages extends a welcome mat solely to those who have weathered 18 years or more on life’s calendar.
Fees and Closing CostsEngaging in reverse mortgages usually entails various expenses during the closing process, encompassing charges like the “Good Faith Estimate.” This upfront fee encapsulates an array of costs such as title insurance, origination fees, and sundry additional expenditures.The closing chapter brings forth its own entourage of costs – an ensemble featuring title insurance, origination fees, and the enigmatic specter of private mortgage insurance, stepping into the limelight when the loan-to-value ratio eclipses the 80% frontier.
Repayment TermThe reverse mortages doesn’t come with a predefined payback period; it lingers on until the homeowner either departs this mortal coil or decides to pack up and move.The lifespan of reimbursement wears different hats, influenced by the mortgage breed chosen – be it the stoicism of a fixed rate or the ever-shifting cadence of an adjustable rate. The intricate dance also sways to the tunes negotiated during the labyrinthine loan application minuet.
EligibilityOnly eligible homeowners aged 62 or older can apply for a reverse mortgage.In the quest for mortgage normality, the portal beckons to any candidate gallant enough to satisfy the twin gatekeepers of credit credentials and fiscal stability.

As you can see, despite the similarities in name and purpose between these two types of mortgages, the methods of achieving their goals are still distinct. Pay close attention to these nuances as thoroughly as possible.

Reverse mortgage requirements

To access a reverse mortgage loan, individuals must satisfy specific conditions established by the Federal Housing Administration. The criteria encompass the age of applicants, the nature of the property, and engagement in mortgage counseling. But how to do a reverse mortgage?

Prospective borrowers on a reverse mortgage must clock in at least 62 years. In instances involving married pairs, any spouse not directly borrowing must also surpass the 62-year threshold to continue residing in the home should their partner precede them in departure. The age of the youngest borrower acts as the yardstick for determining the available fund pool, with older borrowers qualifying for more financial inflow.

The residence anchoring the basics of reverse mortgage must serve as the primary domicile for all borrowers, rendering secondary residences or investment holdings ineligible. It stipulates that the home be either a single-family dwelling or a unit within an FHA-approved condominium or planned unit development. Manufactured homes aligning with FHA foundation criteria also gain eligibility. Lenders commission an appraisal to validate that the accessed equity aligns with the property’s value.

All potential reverse mortgage borrowers must undergo counseling approved by the Department of Housing and Urban Development. This counseling ensures a grasp of the loan’s terms, costs, and fiscal repercussions. Counselors present impartial information to aid seniors in gauging the compatibility of these products with their retirement requisites and strategies. Including trusted family members in the counseling process can contribute valuable perspectives.

By satisfying fundamental age, residency, and counseling prerequisites, elderly homeowners can leverage their amassed home equity for heightened fiscal adaptability during retirement. The counseling procedure functions as a catalyst for informed decision-making.

Types of reverse mortgages

Several varieties of reverse mortgages are available to older homeowners looking to tap equity. The most common types include single-purpose loans, Home Equity Conversion Mortgages, and proprietary products.

Single-Purpose Reverse Mortgages

Single-purpose reverse mortgages are government loans issued directly by state or local agencies to fund specific needs. These are low-cost loans with favorable terms tailored to particular borrowers. Examples include specialized options for veterans and programs helping low-income seniors with medical expenses or home repairs. Loan uses are restricted to the designated purpose.

Home Equity Conversion Mortgages

Home Equity Conversion Mortgages (HECMs) are the most popular reverse mortgages insured by the FHA. Borrowers can receive funds as a lump sum, term payments, credit line, or a combination. HECM requirements include being 62+, undergoing counseling, and owning an eligible property. You can explain reverse mortgages by: Initial costs are capped, and cross-default provisions protect non-borrowing spouses.

Proprietary Reverse Mortgages

Private lenders or banks provide proprietary reverse mortgages. These loans may offer higher loan amounts and lower rates than HECMs but lack standard consumer protections. Loan terms can vary widely between proprietary products. Borrowers should research lenders’ financial strength and understand all costs. Counseling is still required.

Benefits of reverse mortgages

Reverse mortgages can provide significant financial benefits to older homeowners seeking their built-up home equity. When used strategically, these loans offer advantages including:

  • Covering emergency costs – Health care needs, home repairs, or other unforeseen expenses can be covered using proceeds from a reverse mortgage. This offers a financial safety net.
  • Passing on residual assets – Any remaining equity after loan repayment can be part of a borrower’s estate and be passed on to heirs.
  • Avoiding the need to downsize – Reverse mortgages allow borrowers to age in place rather than selling the family home to access equity. This provides housing stability.
  • Funding home modifications – The loan can pay for accessibility upgrades like grab bars, ramps, and stair lifts that support independent living.
  • Supplementing retirement income – The funds received from reverse mortages can be used to pay for living expenses, medical bills, or other costs that may exceed regular retirement plan disbursements. This additional income stream can help maintain quality of life.
  • Providing peace of mind – The reassurance that a reserve of home equity is available if needed can give seniors and families greater security.
  • Customizing payout options – Borrowers can receive funds as needed through a line of credit or term payout option.
  • Offering consumer protections – HECM reverse mortgages require counseling and limit upfront costs, providing safeguards for borrowers.
  • Paying off an existing mortgage – For borrowers still paying a traditional mortgage, a reverse mortgage can eliminate the remaining principal and free up monthly cash flow.

When used prudently, reverse mortgages can be an effective tool for older homeowners to achieve financial objectives and age comfortably. It is how a reverse mortgage works with such benefits.

Risks of reverse mortgages

Despite their benefits, explain reverse mortgages also come with some cautions that borrowers should consider:

  • Reduced home equity – Loan balances and accrued interest lower the equity remaining for heirs. Home values often appreciate slower than interest rates.
  • Upfront costs – Origination fees, mortgage insurance premiums, appraisal, and closing costs must be paid at the time of the loan. This reduces net proceeds.
  • Rising loan balances – Interest compounds over time as unused funds remain in the available credit line. Balances proliferate.
  • Prepayment penalties – Repaying a loan early results in stiff penalties. Borrowers are locked in for the long term.
  • Tax implications – Loan proceeds may impact income taxes or reduce Social Security benefits if not used carefully.
  • Probate avoidance – Non-borrowing spouses may need to repay the loan faster if not on the title after the partner dies.
  • Financial shock if needed to move – An unexpected relocation to assisted living may require urgent loan repayment.
  • Credit line closure risk – Lenders can freeze available funds if the home value drops too low relative to the balance.
  • Scams and sales pressure – Unethical lenders may push reverse mortgages on those who don’t understand risks.
  • Future health costs – Loan funds spent too fast may leave insufficient assets later in retirement.
  • Impact on estate plans – Heirs may be left with lower value property or forced sale.

Reverse mortgages allow borrowers to access home equity and deplete it over time. Seniors should carefully weigh benefits against total costs. Involving trusted advisors prevents misunderstandings.

Conclusion: Does Reverse Mortgages Worth it?

Reverse mortgages undoubtedly allow older homeowners to access sizable lump sums or supplemental income streams from their accrued home equity. However, these complex financial products also come with substantial costs and risks that deplete equity over time. Does getting a reverse mortgage make sense?

The answer depends significantly on seniors’ unique financial situation and retirement goals. For cash-strapped borrowers with limited income options, reverse mortages can provide funds to cover essential living expenses or medical needs. When used conservatively, they offer a valuable source of financial flexibility.

However, the long-term costs may outweigh the benefits for retirees with sufficient assets elsewhere. Savvy planning of withdrawals from investment accounts may be a wiser strategy. Downsizing or relocating to tap equity is preferable.

Now you know what’s reverse mortgage. The key is carefully evaluating all alternatives to determine if a reverse mortgage aligns with your needs and plans. Be realistic about your future health costs and housing options. Seek input from an experienced financial advisor and housing counselor. Read the paperwork thoroughly, and avoid resorting to aggressive sales tactics. With prudent decision-making, reverse mortgages can play a constructive role in retirement funding.

Subscribe to Our Newsletters and Get Your Free Guide to Smart Property Buying

    Stay informed, make informed decisions, and discover the secrets to successful real estate investments.

    Connect with us

    Whether you’re buying a home or are ready to refinance, our professionals can help