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What Is a Reverse Mortgage?

What Is a Reverse Mortgage?

9 Minute Read

Chances are, you’ve seen commercials boasting the benefits of a reverse mortgage: “Let your home pay you a monthly dream retirement income!” Sounds fantastic, right?

These claims make a reverse mortgage sound almost too good to be true for senior homeowners. But are they? Let’s take a closer look.

What Is a Reverse Mortgage?

A reverse mortgage is a type of loan that uses your home equity to provide the funds for the loan itself. It’s only available to homeowners who are 62 or older and is aimed at folks who have paid off their mortgage (or most of it anyway).

It’s basically a chance for retirees to tap into the equity they’ve built up over many years of paying their mortgage and turn it into a loan for themselves.

How Does a Reverse Mortgage Work?

A reverse mortgage works like a regular mortgage in that you have to apply and get approved for it by a lender. They’ll use a bunch of details about you and your home—from your age to the value of your property—to figure out how much they can lend you.

But with a reverse mortgage, you don’t make payments on your home’s principal like you would with a regular mortgage—you take payments from the equity you’ve built.

You see, the bank is lending you back the money you’ve already paid on your home but charging you interest at the same time.

For some folks, the appealing part of a reverse mortgage is that you don’t make any monthly payments to the lender or pay the interest until you sell your home. Seems easy enough, right?

But here comes the cringeworthy truth: If you die before you’ve sold your home, those you leave behind are stuck with two options. They can either pay off the full reverse mortgage and all the interest that’s piled up over the years, or surrender your house to the bank.

So, it might seem like a reverse mortgage is a helpful cash-flow option for people in their retirement, but these mortgages put seniors and their heirs at financial risk.

Types of Reverse Mortgages

Like other types of mortgages, there are different types of reverse mortgages. While they all basically work the same way, there are three main ones to know about:

1. The Federal Housing Administration’s HECM Reverse Mortgage

The most common reverse mortgage is the Home Equity Conversion Mortgage (HECM). HECMs were created in 1988 to help older Americans make ends meet by allowing them to tap into the equity of their homes without having to move out.

If you’re 62 or older, you can qualify for an HECM loan and use it for any purpose. Some folks will use it to pay for bills, vacations, home renovations or even to pay off the remaining amount on their regular mortgage—which is nuts! And the consequences can be huge.

HECM loans are kept on a tight leash by the Federal Housing Administration (FHA.)

They don’t want you to default on your mortgage, so because of that, you won’t qualify for a reverse mortgage if your home is worth more than a certain amount.1 

And if you do qualify for an HECM, you’ll pay a hefty mortgage insurance premium that protects the lender (not you) against any losses.

2. Proprietary Reverse Mortgage

Proprietary reverse mortgages aren’t federally regulated like the HECM ones. They’re offered up from privately owned or operated companies.

And because they’re not regulated or insured by the government, they can draw homeowners in with promises of higher loan amounts—but with the catch of much higher interest rates than those federally insured reverse mortgages.

They’ll even offer reverse mortgages that allow homeowners to borrow more of their equity or include homes that exceed the federal maximum amount.

This might sound good, but what it really means is a higher amount of debt against your name.

3. Single-Purpose Reverse Mortgage

A single-purpose reverse mortgage is offered by government agencies at the state and local level, and by nonprofit groups too.

It’s a type of reverse mortgage that puts rules and restrictions on how you can use the money from the loan. (So you can’t spend it on a fancy vacation!)

Usually, single-purpose reverse mortgages can only be used to make property tax payments or pay for home repairs.

The main point of these loans is to help keep you in your home if you fall behind on costs like home insurance or property taxes, or if you need to make urgent home repairs. The thing to remember is that the lender has to approve how the money will be used before the loan is given the OK.

These loans aren’t federally insured either, so lenders don’t have to charge mortgage insurance premiums. But since the money from a single-purpose reverse mortgage has to be used in a specific way, they’re usually much smaller in their amount than HECM loans or proprietary reverse mortgages.

Reverse Mortgage Requirements:

To qualify for a reverse mortgage, you must:

  • Be at least 62 years old.

  • Own a paid-off (or at least significantly paid-down) home.

  • Have this home as your primary residence.

  • Owe zero federal debts.

  • Have the cash flow to continue paying property taxes, HOA fees, insurance, maintenance and other home expenses.

And it’s not just you that has to qualify—your home also has to meet certain requirements. Single-family dwellings and multi-family units up to fourplexes (as long as you live in one of the units) are eligible for a reverse mortgage. The HECM program also allows reverse mortgages on condominiums approved by the Department of Housing and Urban Development.

Reverse Mortgage Disadvantages:

Before you go and sign the papers on a reverse mortgage, check out these four major disadvantages:  

1. It’s not really a lifeline.

You might be thinking about taking out a reverse mortgage because you feel confident borrowing against your home. Plus, you’re not planning on doing anything crazy with the money, right?

Even though it might seem like a lifeline, it isn’t really. Let’s break it down like this: Imagine having $100 in the bank, but when you go to withdraw that $100 in cash, the bank only gives you $60—and they charge you interest on that $60 from the $40 they keep.

If you wouldn’t take that “deal” from the bank, why on earth would you want to do it with your house you’ve spent decades paying a mortgage on?

But that’s exactly what a reverse mortgage does. You’re only allowed to tap into a certain percentage of your home’s value—based on several factors like your home value, the amount of equity you’ve built up, and your age.2

But even then, you’re not going to receive the full percentage you qualify for. Why? Because there are fees to pay, which leads us to our next point . . .

2. You’ll owe fees. Lots of fees.

Reverse mortgages are loaded with extra costs. And most borrowers opt to pay these fees with  the loan they’re about to get—instead of paying them out of pocket. The thing is, this costs you more in the long run!

Lenders can charge up to 2% of a home’s value in an origination fee paid up front. That’s as much as $4,000 for a $200,000 home.3 

  • You’ll also be charged an initial mortgage insurance premium of 2%, followed by an annual 0.5% mortgage insurance premium. So on a $200,000 home, that’s a $1,000 annual cost after you’ve paid $4,000 upfront of course!4

  • Closing costs on a reverse mortgage are like those for a regular mortgage and include things like home appraisals, credit checks and processing fees.

So before you know it, you’ve sucked out thousands from your reverse mortgage before you even see the first dime!

And since a reverse mortgage is only letting you tap into a percentage the value of your home anyway, what happens once you reach that limit? The money stops.

Worse still, the interest rate starts going up as soon as you’ve signed the reverse mortgage agreement. So the amount of money you owe goes up every year, every month and every day until the loan is paid off.

3. You’ll likely owe more than your home is worth.

The advertisers promoting reverse mortgages love to spin the old line: “You will never owe more than your home is worth!”

But that’s not exactly true because of those high interest rates. And here’s the math to prove it:

Home Value

$200,000

Reverse Mortgage Amount

$100,000 (lump sum)

Reverse Mortgage Interest Rate

5%

Age at Time of Loan

62

Term Length of Loan

25 years

Total Interest Accumulated

$238,635

Total Owed at End of Term or Death

$338,6355

In this example, you receive $100,000 from your reverse mortgage on your $200,000 home. Let’s say you live until you’re 87. When you die, your estate owes $338,635 on your $200,000 home.

So instead of having a paid-for home to pass on to your loved ones after you’re gone, they’ll be stuck with a $238,635 bill. Chances are they’ll have to sell the home in order to settle the loan’s balance with the bank if they can’t afford to pay it.

One option to consider is downsizing from your current home. If you’re spending more than 25% of your income on taxes, HOA fees, and household bills, that means you’re house poor. Reach out to one of our Endorsed Local Providers and they'll help you navigate your options.

4. You could lose your home.

If a reverse mortgage lender tells you, “You won’t lose your home,” they’re not being straight with you. You absolutely can lose your home if you have a reverse mortgage.

Think about the reasons you were considering getting a reverse mortgage in the first place: Your budget is too tight, you can’t afford your day-to-day bills, and you don’t have anywhere else to turn for some extra cash.

All of a sudden, you’ve drawn that last reverse mortgage payment, and then the next tax bill comes around. A few days later, the utility bills start piling up.

If you don’t pay your taxes or your other bills, how long will it be before someone comes knocking with a property seizure notice to take away the most valuable thing you own?

Not very long at all. And that’s perhaps the single biggest reason you should avoid these predatory financial products.

Is a Reverse Mortgage a Good Idea?

Before you make any decisions on a reverse mortgage, you should speak with an expert who knows the ins and outs of everything to do with mortgages. Our trusted friends at Churchill Mortgage will equip you with the information you need to make the right decision.