For many people, their home is their largest asset. It builds equity over time as you pay down the mortgage and as it increases in value. Saving for retirement can be challenging, and many retirees find themselves short on funds.
One way to create more retirement income is with a reverse mortgage. However, many homeowners are unsure if a reverse mortgage is a ripoff or a good idea. In this article, we'll define what reverse mortgages are, how they work, and reverse mortgage pros and cons.
What is a reverse mortgage?
A reverse mortgage is a type of mortgage that allows homeowners age 62 and older to borrow money from their home equity. Your home equity is the value of your home less the balance of your mortgage. For example, if you have a home that’s valued at $250,000 and you have a mortgage balance of $50,000, you have $200,000 in equity.
With a reverse mortgage, the equity in a home is converted into income for the homeowner, and the homeowner no longer makes monthly mortgage payments. It’s not free money, though. It’s a loan, and the principal and interest grow over time. The loan is then repaid when the reverse mortgage borrower passes away or moves out of the home. For example, the homeowner may move out of the home when they need to live in a long-term care facility.
The most common type of reverse mortgage is a home equity conversion mortgage (HECM), which is backed by the Federal Housing Administration (FHA). With a HECM, the reverse mortgage loan amount depends on your age, current interest rates, and the lesser of the appraised value of the property or the HECM FHA mortgage limit of $822,375.
How do you receive the funds from a reverse mortgage?
There are three primary ways to receive reverse mortgage loan payments:
- Lump sum: These loans provide immediate payment of a portion of the home's equity. They offer a fixed interest rate and tend to be the most popular choice. The downside is the amount available to withdraw may be lower than other options. Plus, these loans tend to cost more in interest because you're paying interest on the full amount withdrawn, not on what you've used. Lump-sum loans also carry the risk that the homeowner may outlive the money borrowed.
- Monthly payout: The borrower receives a set monthly payout for a specific number of years or for as long as they live in the home. These loans are lower cost because you're only paying interest on the cumulative amount borrowed.
- Line of credit: A line of credit provides the most flexibility and ensures that you're paying interest only on the amount needed. It’s similar to a home equity line of credit (HELOC) in that you have a line of credit that you use when and if you need it. If you don’t use it, that’s less you or your heirs have to worry about paying back.
Some reverse mortgage lenders allow borrowers to receive a monthly payout and have access to a line of credit. Ask your lender whether that option is available if this combination is appealing to you.
If your needs change, the best mortgage lenders may allow you to change your payout option in exchange for a small fee.
Who is eligible to receive a reverse mortgage?
These loans are not available for every homeowner. Here's how to get a loan from a reverse mortgage lender:
- Must be at least 62 years of age: The amount you can borrow is based on your age and how much equity you have in your home.
- Must be your principal residence: You must live in the home the majority of the year.
- Have equity in your home: In order to qualify, you should own your home outright or have a low mortgage balance. If you have an existing mortgage, the reverse mortgage will pay off your current mortgage in addition to giving you access to your equity.
- Not delinquent on any federal debt: If you’re applying for a HECM, the most common type of reverse mortgage, you can’t be delinquent on federal debt such as student loans or income taxes.
- Have money available to pay ongoing property expenses: If you can't provide proof that you're able to cover ongoing expenses, such as property taxes and homeowners insurance, then a portion of your loan proceeds may be set aside to ensure they are paid.
- Home must be in good shape: Before the loan closes, your home will be inspected and you may be required to complete repairs before your loan can be funded.
- May be required to undergo counseling: In order to qualify for a HECM loan, you must receive counseling from a HUD-approved counseling agency to discuss eligibility, consequences of the loan, and potential alternatives.
How do reverse mortgages work?
A reverse mortgage is a fairly simple loan product. You'll receive a portion of your home's equity today — lump sum, monthly payments, or access to a line of credit — and the interest accrues until the loan is paid off. You can remain in your home until you die or move out of the home.
Although there are no monthly principal or interest payments required, you are still responsible for property taxes, insurance, and ongoing maintenance. The interest continues to accrue and is added to your balance.
When you pass away, move out, or sell the property, the outstanding loan balance becomes due. For borrowers who die, the beneficiaries generally sell the property or take out a loan to pay off the reverse mortgage.
Example of a reverse mortgage
A 75-year-old homeowner has a paid-off home that is worth $400,000. They need money to retrofit the home so they can continue to live there as they age. The homeowner doesn't have enough retirement income to qualify for a traditional loan, so they take out a reverse mortgage instead.
They are unsure of the final project costs, so they take out a reverse mortgage line of credit. This provides the option for them to cover all of the necessary expenses, while paying interest only on the amount they actually borrow. The line of credit also allows them to access money in the future in case other expenses occur.
Reverse mortgage pros and cons
A reverse mortgage can be the best way to access your home's equity in the right situation. Before starting the application process, it helps to understand the pros and cons of this type of mortgage.
Reverse mortgage pros
These reverse mortgage facts show that not all of these loans are bad. Many seniors use reverse mortgages to supplement their income and provide access to home equity, even when they don't qualify for a traditional mortgage.
Here are the advantages of a reverse mortgage:
- Access home equity without selling. With a reverse mortgage, you can receive regular monthly income, a lump sum of cash, or access to a line of credit.
- The money you receive is not taxable. Because a reverse mortgage is a loan, the money that you receive is not considered taxable income by the IRS.
- It should not affect Social Security or Medicare. Money received from a reverse mortgage generally does not affect Social Security or Medicare benefits.
- You won’t have mortgage payments. You do not have to make any payments toward your balance or interest during the life of your loan.
- It’s a non-recourse loan. The repayment of your loan is limited to 95% of the home's fair market value. If you owe more than what your home is worth, the lender cannot sue you for the remaining balance.
- There are no minimum credit score or income requirements. Your ability to get a reverse mortgage is based on your age and the equity in your home. Although you do still have to show that you can handle property taxes, insurance, and maintenance expenses, the underwriting requirements are much less stringent than a traditional mortgage.
- It might stop a foreclosure. Repaying your existing mortgage with a reverse mortgage is a strategy some seniors take to save their home from foreclosure. The new loan proceeds are used to pay off the existing mortgage with the potential to access additional cash for the homeowner.
Reverse mortgage cons
Although reverse mortgages do offer some benefits, it's not all positive.
Here are the downsides to a reverse mortgage:
- Reverse mortgages cost more than a traditional mortgage. Upfront costs such as mortgage counseling, appraisal costs, and closing costs, which include origination fees of up to $6,000, an initial mortgage premium, and a .5% annual mortgage insurance premium, are normal for a reverse mortgage. You’ll also be charged an initial mortgage insurance premium (MIP) of 2% of your loan at closing.
- You'll owe more over time. Unlike a traditional mortgage, which balance decreases each month, a reverse mortgage balance increases over time. This is because interest and fees accumulate and are added to the mortgage balance throughout the mortgage term.
- The interest rate may not be fixed. Most reverse mortgages have variable interest rates, which means that you are not able to lock in a low interest rate. Some reverse mortgages offer fixed rates if you take out a lump sum at closing.
- You lose the mortgage interest deduction. You can’t deduct interest on a reverse mortgage on your tax returns until the loan is repaid.
- Does not eliminate all housing expenses. Homeowners must still pay for property taxes, insurance, and ongoing maintenance of the home.
- The loan must be repaid at death or if you move out. These loans are meant for your primary residence. If you are away from the home for more than 12 consecutive months (unless a co-borrower lives there), the loan must be repaid. An exception may be made for an eligible non-borrowing spouse.
- It may affect Medicaid or SSI qualification. Needs-based benefit programs may be affected by a reverse mortgage because they are tied to your assets and monthly income. Research your state's rules and keep your income from a reverse mortgage below those thresholds to ensure you can qualify for those programs.
8 signs a reverse mortgage is a scam
Is a reverse mortgage a ripoff? Sadly, for some people, the answer is yes. Criminals often target seniors with financial schemes. If you encounter any of these situations, you may be the target of reverse mortgage scams:
- Aggressive sales tactics: Be wary of pushy salespeople who try to rush you into a decision.
- The salesperson suggests investing money from the loan: Some salespeople will try to get you to invest the money into scam products to steal money from you.
- Questions aren’t answered: When a salesperson won't answer your questions or provide opaque answers, that's a sign they may be hiding something.
- Uses terms that you don't understand: Salespeople often "speak over the heads" of borrowers by using acronyms or industry jargon to seem like experts and use this tactic to confuse borrowers and hide unfriendly terms, conditions, and costs.
- Seems too good to be true: If the deal that your salesperson is proposing sounds too good to be true, it probably is. Trust your gut and get a third party involved to review the documents if you don't understand them or think something is fishy.
- What they say versus what's in writing doesn't match: No matter what your salesperson says, the words on the contract are what matters. Some salespeople will change terms, fees, or interest rates at the last minute expecting you not to catch it.
- Charges excessive fees: Although it is expected that a reverse mortgage charges higher fees than a traditional mortgage, it shouldn't be excessive. Push back on the costs and remember that everything is negotiable until you sign the contract.
- Tells you not to speak with anyone: If someone is discouraging you from seeking outside counsel, such as your current lender, attorney, or financial advisor, they're probably hiding something.
4 signs a reverse mortgage is safe
When evaluating potential options, look for these qualities to ensure that you're working with a safe lender:
- Working with a reputable lender: Start your search with names you know and trust. These lenders generally have an established track record and are less likely to scam you. If they don't offer reverse mortgages, they may be able to refer you to someone that does.
- You reached out to them for information: Avoid lenders that reach out to you. These are often scammers that purchase your name from a list. By being proactive and picking the lender yourself, you stand a better chance of finding a safe lender.
- No high-pressure sales tactics: A reputable lender will take the time to answer your questions and won't make you sign documents before you've had a chance to review them with a third party. If they feel another option would be a better fit, such as refinancing or a home equity loan or HELOC, the lender will make that recommendation.
- You've received mortgage counseling: Before cashing out your home equity, HECMs require borrowers to receive mortgage counseling. Counselors discuss your options and help you decide whether this product is a good fit.
Can you lose your house with a reverse mortgage?
You may lose your home if you're dealing with a scam artist. However, when you use a legitimate reverse mortgage lender, you will not lose your home. You can stay in the home for the rest of your life without making a mortgage payment. When you die or move out of the home, the amount you borrowed plus interest must be repaid.
How do you get a reverse mortgage?
Because of the way a reverse mortgage loan is structured, you have to be at least 62 years old. You are able to tap into your home equity by applying for a reverse mortgage through a lender or mortgage broker that offers this type of loan. The title remains in your name and the loan is due when the borrower no longer lives in the home.
What happens at the end of a reverse mortgage?
A reverse mortgage is designed to stay with the home until you die or the home is sold. There are four primary ways that a reverse mortgage can end: you pay it back, sell the home, move out, or die. If you die, your heirs will likely sell the home and repay the home. Even if the loan balance is more than the value of your home, your heirs won’t be stuck — they won’t have to pay more than 95% of the appraised value of the home. In each of these situations, the lender gets paid by you or takes possession of the home.
So is a reverse mortgage a good idea? The answer is "it depends." Reverse mortgages can be a good source of retirement income or access to capital in the right situation. However, seniors should be cautious of scams and make sure they understand how they work before borrowing. For more information about these loans, read our in-depth guide to reverse mortgages.