What is a reverse mortgage?
Updated March 9, 2022
A reverse mortgage is a kind of loan that permits homeowners who are 62 years old and older to borrow from a portion of their home’s equity (on their primary home only). With traditional mortgages, homeowners make monthly payments to lenders which allows them to take over more equity of their home over a period of time. But just as its name suggests, with reverse mortgages, lenders pay the homeowners. The income derived from a reverse mortgage is usually tax-free, and the money borrowed from a home’s equity can be converted into cash. This is an enticing prospect because it allows homeowners to stay in their home, or have additional income to pay other expenses.
The amount a homeowner can borrow is based on the following factors: the age of the youngest borrower or eligible nonborrowing spouse, current interest rates and the value of the home. Credit: Tierra Mallorca/Unsplash
With reverse mortgages, homeowners are not required to pay monthly installments, nor do they
have to sell their home. In fact, the loan does not have to be paid back as long as the homeowner stays in the residence. However, it has to be repaid in full when the last surviving borrower dies, sells the home or moves out permanently.
Factors to consider before applying for a reverse mortgage
Since reverse mortgages can be complex, there are several things to think about before deciding that it is the best course of action for a homeowner to take:
- More will be owed over time. Interest on the loan will be charged on a monthly basis. So the amount a homeowner owes will increase as the interest on the loan accumulates. The interest rate will depend on the type of reverse mortgage chosen. (According to the Federal Trade Commission, the majority have variable rates, which means they are tied to a financial index and are affected by the market. Some reverse mortgages, mainly HECMs, offer fixed rates. But these require homeowners to take the loan as a lump sum upon closing, and the total amount a homeowner is able to borrow is less than they could get with a loan that has a variable interest rate.)
- This interest is not tax-deductible. Homeowners cannot deduct the interest from the loan on their taxes until the loan is paid off (either partially or the full amount), unlike regular mortgage interest rates.
- There will likely be fees and other costs. It is the norm for lenders to charge an origination fee as well as other servicing fees associated with the mortgage, along with closing costs.
- Home expenses must still be paid. With a reverse mortgage, homeowners still retain the titles to their homes, meaning they are still responsible for the costs associated with homeownership, such as insurance, property taxes, maintenance, utilities, et cetera. If these expenses are not paid, then the lender could demand repayment of the loan.
Types of reverse mortgages
When applying for a reverse mortgage, homeowners should consider how much they want to borrow against their home equity—the value of their home—and how they want to use the money lent to them. Based on these factors, they can determine which of these reverse mortgages best serve their needs.
- A single-purpose reverse mortgage: Considered the least expensive option, this kind is offered by various local and state government agencies as well as some nonprofits. In this case, the loan taken from the home equity can only be applied to a specific purpose, as outlined by the lender. Examples include the lender specifying that the loan can only be used toward property taxes, or improvements or repairs made to the home. Most homeowners, including those of low and moderate income, would qualify.
- Proprietary reverse mortgages: These loans are offered by private lenders, and therefore not as strictly regulated as the other two kinds, and are also not federally insured. Homeowners who opt for a proprietary reverse mortgage usually do so because they want to be able to borrow more than the federally insured reverse mortgages are able to allot. Since their homes also tend to be valued at more than the mortgage limit set by the Federal Housing Administration (in 2021, this was set at $822,375), homeowners who apply for this kind of mortgage may also be eligible for a bigger loan as well.
- Home Equity Conversion Mortgages (HECMs): As reverse mortgages insured by the U.S. Department of Housing and Urban Development, there are no regulations on what this type of loan can be used for, or a specific income requirement in order to qualify. As part of the application process, homeowners will be given a financial assessment to determine whether they will be able to repay the loan and other monetary obligations in relation to their home, such as property taxes and homeowner’s insurance.
The amount a homeowner can borrow is based on the following factors: the age of the youngest borrower or eligible nonborrowing spouse, current interest rates and the value of the home. The value is the lesser of either the appraised value, the FHA mortgage limit or the sales price.