Reverse Mortgage: Your Guide To What It Is And How It Works
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*Rocket Mortgage® does not offer reverse mortgage loans.
Whether you’re already retired or are approaching retirement, you’ve likely prepared for this stage in your life ahead of time. But with rising costs of living and longer life expectancy, more and more people find themselves coming up short on funds.
What’s the solution? For some, a reverse mortgage might be just the ticket to securing a comfortable retirement.
What Is A Reverse Mortgage?
A reverse mortgage is a loan that allows homeowners age 62 or older to convert a portion of their home equity into cash. This type of loan is especially appealing to people who want, or need, to supplement their retirement funds.
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What Can A Reverse Mortgage Be Used For?
Whether you need financial assistance or just want access to more funds throughout your retirement to reach other financial goals, there are several reasons why you may want to consider a reverse mortgage:
- Eliminate or lower monthly mortgage payments, while still paying property taxes, homeowners insurance, and home maintenance costs.
- Consolidate debts
- Pay for in-home care
- Make home improvements or modifications
- Purchase a new home with a home equity conversion mortgage for purchase
- Supplement income to allow other assets to grow in value
- Create an emergency fund or increase savings
- Protect home equity from declining home markets
- Have access to the equity tied up in your home
How Does A Reverse Mortgage Work?
A reverse mortgage works by using a portion of your home equity to first pay off your existing mortgage on the home – that is, if you still have a mortgage balance.
You are not required to make monthly payments on the reverse mortgage because the loan balance doesn’t come due until the final borrower moves out of the home, passes away, fails to pay taxes or insurance, or neglects to maintain the home. You will still be responsible for paying your property taxes and homeowners insurance.
While you’re not required to make monthly payments, doing so could reduce your monthly interest or prevent it from accruing altogether. If you choose not to make a monthly payment on the loan, interest for that month will get added to the total loan balance.
After paying off your existing mortgage, your reverse mortgage lender will pay you any remaining proceeds from your new loan. If you own your home free and clear, you’ll receive all of the proceeds from the loan since you don’t have a mortgage balance to pay off first.
As the homeowner, you can choose to receive your funds as a lump sum payment, monthly payments, a line of credit or any combination of the three.
Who Is Eligible For A Reverse Mortgage Loan?
To be eligible for a reverse mortgage, you must meet the following criteria, at a minimum:
- You must be 62 years or older.
- You must have enough equity in your home – usually about 50%, but the required amount varies by lender.
- Depending on the type of reverse mortgage you get, you may need to attend a counseling session from a Department of Housing and Urban Development-approved counselor to learn more about the loan and your options.
- You must go through a financial assessment to ensure you’re in the best position to be successful with your loan. This will also depend on the type of loan you receive.
Along with these requirements, your home also needs to qualify for the loan. Here are a few basic requirements:
- The home must be your primary residence.
- The home must be in good condition and meet FHA standards (if the loan is government insured).
- The home cannot be a mobile or, in most cases, a manufactured home.
- If the home is a condo, it must be on the HUD/FHA approved condo list. You may still be eligible for a proprietary reverse mortgage if it is not.
What Are the Different Types Of Reverse Mortgages?
It's essential for homeowners to understand the different types of reverse mortgages when considering whether it’s a suitable option for them. Let’s discuss the available options:
- Single-purpose reverse mortgage: This loan allows you to borrow money against your home equity to pay for a specific lender-approved goal and purpose, such as paying property taxes or making improvements/additions to your house. Only nonprofit and government organizations insure this type of reverse mortgage and it is only offered in some states.
- Proprietary reverse mortgages: Private lenders offer borrowers this loan, which allows you to convert some of your home's equity into cash. These loans are available in amounts that are over the federal loan limit, but they are not backed by the government.
- Home Equity Conversion Mortgages (HECMs): This loan is insured by the Federal Housing Administration (FHA) and lets you withdraw some of your home's equity. The HECM offers various payment options, including a single lump sum, tenure or a line of credit. This loan comes with certain qualification requirements set by the government and have a loan limit.
What Responsibilities Come With A Reverse Mortgage?
It’s important to remember that a reverse mortgage is still a loan and, as the homeowner, you still have responsibilities tied to the loan and the home. You’ll need to:
- Continue to pay property taxes and homeowners insurance.
- Keep the home in good condition – complete repairs and maintenance.
- Live in the home for more than half the year as the primary residence.
If you do not stay current on your taxes and homeowners insurance, fail to maintain the house or live in the home for less than 6 months of the year, your loan may come due.
However, if you uphold the loan obligations listed above, your reverse mortgage will not come due until the last borrower moves out of the home or passes away. When this happens, the home is sold, and the proceeds of the sale are used to pay the loan balance in full. If heirs wish to keep the home, they can refinance the reverse mortgage into a traditional loan. They will need to pay either the loan balance or 95% of the appraised value, whichever is lower.
A reverse mortgage is a nonrecourse loan. That means if the home sells for less than what is due on the loan, this insurance covers the difference so you won’t end up underwater or with negative equity on your loan – and the lender doesn’t lose money on their investment. Depending on the type of reverse mortgage you get, the FHA or the lender will cover the difference and absorb the cost.
On the other hand, if the home sells for more than what is owed on the loan, the remaining money is given to you or your heirs.
How Much Does A Reverse Mortgage Cost?
Just like a traditional mortgage, there are costs associated with getting a reverse mortgage, specifically the HECM. These costs are typically higher than those associated with a traditional mortgage and will depend on the type of loan you get. Let’s look at a few fees you can expect:
Upfront MIP: The upfront mortgage insurance premium (MIP) is paid to the FHA when you close your loan. The MIP protects you and the lender by making the loan a nonrecourse loan. If the home sells for less than what is due on the loan, this insurance covers the difference so you won’t end up underwater or with negative equity on your loan. This way, too, the lender doesn’t lose money on their investment.
It also protects you from losing your loan if your lender goes out of business or can no longer meet its obligations. In that case, the FHA takes over so you can still access your loan proceeds.
The cost of the upfront MIP is 2% of the appraised value of the home or $970,800 (the FHA’s lending limit) – whichever is less. For example, if you own a home worth $250,000, your upfront MIP will cost around $5,000.
Along with an upfront MIP, there’s also an annual MIP that accrues annually and is paid when the loan comes due. This charge is usually around .5% of the loan balance.
Origination fee: The mortgage origination fee is the amount of money a lender charges to originate and process your loan. This cost is 2% of the first $200,000 of the home’s value plus 1% of the remaining value.
The FHA has set a minimum and maximum cost of the origination fee, so no matter what your home is valued, you will not pay less than $2,500 or more than $6,000.
With the same $250,000 home mentioned above, the origination fee would cost around $4,500 (2% of $200,000 and 1% of $50,000).
Servicing fee: The servicing fee is a monthly charge by the lender to service and administer the loan, and can cost up to $35 each month.
Appraisal fee: Appraisals are required by HUD and determine the market value of your home. While the true cost of your appraisal will depend on factors like location and size of the home, they generally cost between $300 and $800.
Third-party charges: These are the smaller charges from businesses other than your lender. These costs may include:
- Credit report fees: $30 – $50
- Document preparation fees: $50 – $100
- Courier fees: $50
- Escrow, or closing fee: $150 – $800
- Title insurance: Depends on your loan and location
Interest rates: Many factors influence the interest rate for a reverse mortgage, including the lender you work with, the type of loan you get and whether you get a fixed- or adjustable-rate mortgage.
Most of these costs can be rolled into your loan, but you can pay any of them out of pocket if you want to forgo financing them. Talk to your lender to get the most up-to-date costs, as fees may change over time.
How To Determine The Amount Of Money You Can Get From A Reverse Mortgage
A reverse mortgage calculator can be a great way to get a solid estimate of how much money you can get from a reverse mortgage. Depending on the type of reverse mortgage you choose, you may be able to access up to 60% of your home’s equity.
The actual amount of money you’ll receive from a reverse mortgage is based on the age of the youngest borrower, the amount of equity you have in the home and the current interest rate. If you have a HECM, you may also be restricted by loan limits, depending on the appraised value of the home. If you have an existing mortgage, you may want to subtract that amount from your total, since the lender will use that money to pay your mortgage off first.
You may also want to factor in closing costs if you’d like to use some of your proceeds to pay those off, though they can be rolled into the loan balance.
To get a more accurate estimate that takes your specific lifestyle and financial goals into consideration, call a reverse mortgage specialist.
Can You Refinance A Reverse Mortgage?
Yes, you can refinance a reverse mortgage. A homeowner can refinance their existing mortgage, but will need to meet their lender’s eligibility requirements and qualifications before moving forward. These requirements hinge on various factors, such as the amount of equity on the home, your credit score and your ability to make payments.
Should You Refinance A Reverse Mortgage?
Refinancing a mortgage is not for everyone. It’s essential to assess your situation before doing anything. A borrower can choose from different refinancing options but should only refinance their reverse mortgage if it helps financially. Here are some reasons why you might want to refinance:
- There’s been an increase in your home’s value
- The HECM loan limits have risen
- A lower interest rate is available
- You want to add your spouse to the loan
What Are The Pros And Cons Of Reverse Mortgages?
As with any major financial decision, you should weigh the pros and cons of getting a reverse mortgage and decide if it’s right for you. We also recommend speaking to a financial advisor.
Depending on your needs and financial goals, a reverse mortgage may benefit you in the following ways:
- You remain the homeowner, and your name stays on the title.
- You can access your equity without selling the home or making a monthly mortgage payment.
- There are no credit score requirements, though your credit history will be reviewed during a financial assessment.
- You’re protected from declining home values since it’s a nonrecourse loan.
- There are no restrictions on how proceeds are spent. In other words, you can use the funds on whatever you want or need.
- Even after the borrower dies, non-borrowing spouses who aren’t listed on the mortgage may still live in the home.
- If the loan comes due because you pass away and your heirs wish to keep the home, they can purchase the home for 95% of its appraised value or the balance of the loan – whichever is lower. They can also refinance that cost into a traditional mortgage.
Although there are a number of benefits that come with a reverse mortgage, the loan can also have some points that you will want to consider.
- Since you’ll be borrowing against the equity in your home, you’ll decrease your equity and increase your amount of debt.
- If you choose not to make payments, the loan balance will increase over time as interest accumulates.
- Depending on the type of loan you choose and how you handle your money, you may outlive your proceeds.
- While heirs will have a few options for keeping your home after you pass away, you may not be able to pass the home on to your heirs without a cost to them.
- The loan may come due for several reasons. For example, the loan must be for your primary residence. If you do not live in the home for more than 6 months out of the year, the loan could come due. On the same note, a reverse mortgage will come due if you move out of the home or pass away. It could also come due if you fail to uphold your loan responsibilities, including maintaining the house and paying your property taxes and homeowners insurance.
- As stated above, you must continue to pay property taxes and homeowners insurance. If you do not stay current on these expenses, your loan may come due.
- There may be high closing costs and fees associated with the loan.
The Bottom Line
A reverse mortgage allows you as the homeowner to supplement your income for your retirement or other expenses. It’s also essential for you to know the eligibility and qualification requirements before settling on this option, as not everybody can use this loan. Before applying for this type of mortgage, we recommend speaking with a professional.
Contact us today and speak with an expert to find out if a reverse mortgage is the right option for you.