As we grow older, our financial needs change. Perhaps you need a different strategy to cover your regular living expenses, or an unexpected expense crops up. If you’re a homeowner, your home’s equity might hold a key to unlocking some financial flexibility. Enter the reverse mortgage.
These special mortgages are specific loans that allow you to tap into your home’s value without selling it. On the surface, that definition bears a resemblance to a HELOC, but there are notable differences between the two. For example, reverse mortgages have a minimum age requirement of 62. HELOCs don’t have age restrictions. Reverse mortgages have fixed interest rates, whereas HELOC interest rates fluctuate based on the prime lending rate.
With a reverse mortgage, instead of you sending a mortgage payment to your lender each month, you receive a payment from the lender. You can use these funds for making home improvements, paying for medical expenses or supplementing your retirement income. You’ll eventually need to repay the loan, typically when you sell your home.
But the good news? You can stay in your home and don’t need to begin repaying a reverse mortgage until you leave your home permanently, whether you sell, move elsewhere or pass away.
Different paths to a reverse mortgage
Just like there are different retirement accounts, different home equity loans, and HELOCs, there are different types of reverse mortgages.
- The Federal Housing Administration (FHA) insures Home Equity Conversion Mortgages (HECMs), which have clear guidelines and protections. You must meet with a Department of Housing and Urban Development (HUD)-approved counselor before applying for one of these loans from an FHA-approved lender.
- Private lenders issue proprietary reverse mortgages, which aren’t FHA-insured but are often used for higher-value homes. A caution: because these loans are relatively easy to qualify for, they’re a prime target for scammers.
- State or local governments, as well as some nonprofits, can offer single-purpose reverse mortgages to address a specific need, such as paying for home repairs or property taxes.
Requirements to qualify for a reverse mortgage
To qualify for a government-backed reverse mortgage, you’ll generally need to:
- Be at least 62 years old
- Live in the home as your primary residence
- Have significant equity in your home (a low mortgage balance or you own it outright)
- Have zero outstanding debt to the federal government
If you do carry a mortgage, you’ll need to pay it off when you close on the reverse mortgage, either with your own money or funds from the reverse mortgage itself.
Proprietary mortgages don’t have a set limit—it’s up to you to decide. Government-backed loans like the HECM have limits. You can’t borrow your home’s entire value, and the amount you borrow takes your age, credit rating and current interest rate into consideration.
The pros and cons of a reverse mortgage
Many seniors experience a significant decline in their incomes during retirement. A reverse mortgage can help supplement your income without you having to dip into your savings account. The IRS doesn’t tax funds from a reverse mortgage, which are considered ‘loan proceeds,’ not income.
Typically, your loan becomes due once you permanently leave your home (although you can pay off a reverse mortgage at any time). If you pass away, your heirs can sell your property and use the proceeds to pay it off. They can keep your home and repay the loan themselves or refinance the balance if your home’s value is high enough. If the loan balance is higher than the home’s value, or your heirs don’t want the property, they can let the lender take ownership. In this scenario, the lender makes a claim to the FHA for any unpaid balance, so your heirs aren’t personally responsible for more than the home’s value.
The drawbacks to a reverse mortgage include the fees you’ll pay, including an origination fee ($6,000 max for HECMs), closing costs that may include appraisal or recording fees, a monthly servicing fee (around $35), and mortgage insurance premiums. You can roll these expenses into your loan principal, but doing so increases the overall amount you’ll repay.
Unlike a traditional mortgage, you can’t deduct interest paid on your taxes. Depending on the mortgage amount, you could surpass income restrictions for Medicaid/Supplemental Security Income and lose eligibility (unless you’ve opted to delay receiving Social Security benefits). You’re also still responsible for other home-related costs like HOA fees, homeowners’ insurance and property taxes.
Before you decide, ask questions
A reverse mortgage isn’t a one-size-fits-all solution, but it’s a genuinely helpful solution for some seniors. If you’re considering moving in the near future, may need to move into assisted living or are struggling to pay home-related costs like homeowners insurance and property taxes, a reverse mortgage isn’t a great fit.
On the other hand, if you have substantial equity in your home, want to age in place or have limited savings, it might be a good fit. It’s a big financial decision and worth taking the time to understand all the costs and consider other potential financial options.
Consult with your financial advisor or estate planner, if you have one. They can help you navigate the specifics and understand how a reverse mortgage fits into your long-term plans. If you’re considering applying for an HECM, you must meet with a HUD-approved counselor. This professional will offer insights and clarify any questions you have about the loan terms. It’s also a good idea to chat with other family members potentially impacted by your decision.
One last piece of advice: If you choose to move forward, review all the loan terms, especially how you’ll receive the funds and the specific loan’s rules for repayment.
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