A reverse mortgage is a financial product that returns equity from your home. The cash can be used for living expenses or anything you want. We invite you to join us as we examine the details of how a reverse mortgage works.

A reverse mortgage is also known as a Home Equity Conversion Mortgage (HECM). It’s a Federal Housing Administration (FHA) program guaranteed by the federal government. That means you never have to worry about a lender defaulting or your heirs getting stuck with a bill.

Reverse Mortgage Eligibility Requirements

It’s easier to qualify for a reverse mortgage than many other types of loans such as refinancing your mortgage or getting a home equity loan. You are eligible for a reverse mortgage if all of the following are true:

• You are 62 years of age or older.
• Your home is your primary residence.
• You have significant equity in your home.
• You own a single-family home, multi-family home (maximum of 4 units), condominium, or manufactured home.
• Your home is in good condition.

Older applicants with a higher percentage of equity are preferred. The home must remain your primary residence and you must maintain it and continue to pay insurance, taxes, and homeowners association fees for the life of the loan.

Who Owns the Home?

When you get a reverse mortgage, does the bank own the home? No, that is a common misconception. With a reverse mortgage, you maintain ownership of the home. 

Unlike a conventional mortgage where the loan balance begins at 100% and ends at zero, the loan balance on a reverse mortgage begins at zero and ends at 100%. The balance increases each month as the bank makes payments to you and interest is accrued.

A reverse mortgage can be paid off at any time, but it is typically paid off when the home is sold or the last borrower is deceased. The heirs can sell the home and use the proceeds to pay off the reverse mortgage.

The terms of a reverse mortgage are designed to prevent the loan balance from exceeding the home value. However, due to market fluctuations sometimes that happens. If the loan balance exceeds the home’s value, the borrower is not responsible. The FHA picks up the tab for the difference. 

Reverse Mortgage Example

Let’s look at an example. Suppose a home with a reverse mortgage is sold or the homeowner dies. The loan balance is $400,000 but the appraised value is only $380,000. The maximum amount the borrower or their heirs would be required to pay back is 95% of the appraised value, or $361,000. On the other hand, if the appraised value exceeds the loan balance, the borrower or their heirs get to keep the difference.

Payment Options

With a reverse mortgage, you are in control of how and when you receive payments. One option is to receive a monthly payment for as long as you live, which is known as a tenure annuity. You can receive a monthly payment for a set period of time, known as a term annuity. You can set it up as a line of credit to be withdrawn whenever you need, or you can go with the most popular option: get all of your money upfront in a lump sum.

Upfront Fees

Just like when you get a mortgage to purchase a home, there are upfront fees associated with a reverse mortgage. Here is a summary of reverse mortgage upfront fees:

• Origination fee, calculated at 2% of the first $200,000 of the loan value then another 1% for any amount over $200,000.
• Mortgage insurance premium, calculated at 2% of the appraised value.
• Other fees including the appraisal, inspection, and title.

The fees can be rolled into the loan so you don’t have any out-of-pocket expenses.

Is a Reverse Mortgage Right for Me?

You are required to meet with a counselor approved by Housing and Urban Development (HUD) before you can obtain a reverse mortgage. The counselor will sit down with you and make sure you understand everything about the loan. 

A reverse mortgage might be right for you if the following applies to your situation:

• You need to supplement your Social Security retirement benefits in order to meet your living expenses.
• You plan to live in the home for a long time.
• You do not qualify for a home equity loan.

A reverse mortgage is not for everyone. In the 30 years since the program’s inception, only about 1 million loans have been originated. To put that in perspective, there are 40 million retirees in the U.S. and another 3.5 million retire each year. 

Finally, it’s important to consider adult children and others in line to receive an inheritance. They are stakeholders and may have expectations, such as inheriting a mortgage-free home. You might want to discuss the matter with them before making any final decisions.

Photo credit: Pixabay The Eggstack Blog will never post an article influenced by an outside company or advertiser. Our mission is to help you overcome uncertainty about retirement planning and inspire confidence in your financial future.