If you’re 62 years or older, you may be looking for ways to supplement your retirement income. You’ve probably heard a lot about the benefits of a reverse mortgage.
What is a reverse mortgage? It’s time to cut through the rumors and get to the facts about how these loan programs work.
How Exactly Does a Reverse Mortgage Work?
A reverse mortgage is a loan based on the equity you have in your home. But unlike a traditional loan, you don’t have to make payments to the lender but can if you so choose to. In some cases, like opting for the term or tenure programs, the lender makes payments to you. Most often, payments come in monthly installments, though some loan programs offer lump sums or even lines of credit.
Loan Repayment
If you decide not to make payments, the loan balance increases, which also means that your home equity decreases. Providing the borrowers adhere to their minimal standard responsibilities throughout the loan term, it is only paid back if you sell your home or when all borrowers pass away. Your inheritors obtain the property, just as they would with any other loan or scenario, and then can repay the mortgage by selling the home or refinancing the balance owed.
Protection of Inheritors
Once again, this is just like any other conventional mortgage lien that may exist on the property at the time of the borrower(s) passing. Even if your loan amount exceeds the sale price of the home, you’ll never have to pay more than the home’s value. Actually, the inheritors always have a 5% buffer in equity obtained, based on the current value when inherited.
Mitigating Risks and Industry Changes
Industry changes within the last decade have made it very much less likely the balance due will supersede the value of the property and in the cases that it does, this is a non-recourse loan, meaning that only the borrowers are ultimately responsible for the repayment of the loan. Heirs have the option to have the lender handle the sale for repayment. Once again, this scenario has been mitigated substantially with Principal Limit Factor or PLF calculations within the last decade.
Mitigating Risks and Industry Changes
Mortgage pre-approval lets you find out what loans and interest rates you qualify for, so you can make stronger offers and find the right home for you.
Who Would Benefit From a Reverse Mortgage?
Is a reverse mortgage right for you? The answer depends on your exact needs and financial situation. First, you must meet the criteria outlined above to even qualify for a reverse mortgage. But assuming you qualify, you’ll find that a reverse mortgage can be a particular advantage if you:
- Pass a financial assessment (a monthly residual income calculation to determine that the borrowers can sustain paying property taxes, homeowners insurance, HOAs (if applicable), and standard living expenses while living in place)
- Have significant home equity (Based on age to determine PLF)
- Planning to live in place as this is only available in your primary residence
- Would like to access tax-free funds from the equity of your home to use as you wish
Ideally, your home should be paid in full to get the maximum benefit from a reverse mortgage credit line or the monthly payment option, but you’ll still reap the rewards if you have substantial equity in your home which may enable you to pay off your current mortgage and no longer have monthly payments. On the flip side, a reverse mortgage may not be the best choice if you have low home equity or if you plan to leave your home in the near future.
3 Types of Reverse Mortgages
Reverse mortgages work differently depending on the type of loan program you choose. Make sure to examine each type of reverse mortgage to see which option may be right for you.
1. Home Equity Conversion Mortgage (HECM)
A home equity conversion mortgage is not only the most common type of reverse mortgage but also the only one insured by the federal government.
Backed by the Federal Housing Administration (FHA), this loan allows you to borrow up to $1,149,825 (as of 2024). You can choose equal monthly installments for a lifetime or for a specified loan term, obtain a credit line that grows monthly at a percentage, or you can receive the funds in a single lump sum.
2. Single-Purpose Reverse Mortgage
In a single-purpose reverse mortgage, your lender can stipulate what the funds can be used for. For example, you might use this loan to cover home repairs, property taxes, insurance premiums, or other defined expenses.
These loan programs are not as common as others and are typically offered by nonprofits or local government agencies as a way to help seniors struggling with household expenses.
3. Proprietary Reverse Mortgage
Proprietary reverse mortgages are mortgage programs that are not insured by the federal government. These loan programs are offered by private lenders and may come with higher interest rates.
The advantage of a proprietary reverse mortgage is that you can typically receive a loan amount higher than the standard set by the U.S. government. You’ll likely receive your loan in the form of a single lump sum rather than installments.
What Is the Benefit of a Reverse Mortgage?
For some seniors, a reverse mortgage can truly be a valuable financial vehicle. A reverse mortgage will provide benefits that include:
- Supplemental retirement income to augment savings and Social Security benefits
- The ability to stay in your home while using the equity you’ve accrued
- Elimination of your existing mortgage, meaning no more monthly payments
- For some loans, the loan is insured against housing market declines
- For HECM loans, you have total flexibility in how you use the funds
Given today’s rates of inflation, seniors can tap into their home equity through a reverse mortgage to fund their retirement years while living in place.
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