How Does a Reverse Mortgage Work?

For many retirees, their home is their most valuable asset, but its value is locked away. A reverse mortgage can be the key to unlocking that wealth, offering a way to access cash without selling or taking on new monthly payments.

But how does this financial tool really work? A reverse mortgage is a complex loan with specific rules, costs, and consequences for both you and your heirs. This guide will break down the mechanics of a reverse mortgage, from eligibility and costs to the all-important question of repayment, helping you understand if it’s the right move for your financial future.

Key Takeaways

• No Monthly Payments, But a Growing Balance: Homeowners aged 62 and older can receive cash from their home’s equity without making monthly mortgage payments. However, the loan balance increases over time as compounding interest and fees are added to the amount owed.
• You Keep Your Home’s Title: The borrower retains full ownership and title of the home throughout the life of the loan. The lender places a lien on the property, which is their claim to be repaid when the loan becomes due. The lender can foreclose on the property if the loan terms are not met by the borrower, such as paying property taxes and insurance.
• The Loan Is Repaid Upon a “Maturity Event”: The loan typically becomes due and must be repaid when the last surviving borrower sells the home, passes away, or permanently moves out. Failing to pay property taxes or maintain the home can also trigger repayment.
• Built-in Protection Against Owing More Than the Home’s Value: Federally-insured reverse mortgages (HECMs) are “non-recourse” loans. This is a critical protection that guarantees you or your heirs will never owe more than the home’s value at the time of sale, even if the loan balance is higher.
• Ongoing Homeowner Responsibilities Are Not Eliminated: A reverse mortgage does not relieve you of your homeowner duties. You are still required to pay property taxes, maintain homeowner’s insurance, and keep the property in good repair to avoid defaulting on the loan.
• Costs Are Higher Than Traditional Loans: Reverse mortgages have significant costs, including origination fees, third-party closing costs, and mandatory mortgage insurance premiums for HECMs. These fees can be financed into the loan, which reduces the cash you receive and increases the balance that accrues interest.
• Mandatory Counseling Is a Key Safeguard: Before you can even apply for most reverse mortgages, you must complete a counseling session with an independent, HUD-approved agency. This is designed to ensure you fully understand the complex features, costs, and risks associated with the loan.

What Is a Reverse Mortgage?

A reverse mortgage is a loan that allows homeowners aged 62 and older to borrow against the equity in their home. The name “reverse” reflects that the payment stream is opposite to that of a traditional mortgage. Instead of the homeowner making monthly payments to a lender, the lender makes payments to the homeowner.

The loan is typically repaid when the last surviving borrower sells the home, moves out, or passes away. This structure allows seniors to access their home’s value while continuing to live in it. It is designed specifically for older homeowners as a way to supplement their retirement income.

Key Features of a Reverse Mortgage

A common misconception is that the bank takes ownership of the home, which is incorrect. The borrower keeps the title and full ownership of their home for the entire life of the loan. The lender simply secures the loan by placing a lien on the property’s title, the same process used for a traditional mortgage.

The most well-known feature of a reverse mortgage is the absence of required monthly payments from the borrower to the lender. This is a key appeal for seniors looking to improve their cash flow during retirement. However, this feature has a direct and critical consequence.

Because no monthly payments are being made to reduce the loan, the loan’s balance grows over time. Each month, interest and any ongoing fees, like mortgage insurance premiums, are added to the amount owed. This process, known as negative amortization, causes the loan balance to grow at an accelerating rate as interest compounds.

How Do You Qualify for a Reverse Mortgage?

Qualifying for a reverse mortgage involves meeting a specific set of criteria related to your age, property, and financial standing. These requirements are designed to determine who can obtain the loan and to ensure they can sustain homeownership for the long term. Federal regulations mandate a comprehensive financial review for all applicants to verify their ability to meet ongoing obligations.

Borrower Requirements

To be eligible, all borrowers on the home’s title must be at least 62 years of age for the most common type of reverse mortgage, the Home Equity Conversion Mortgage (HECM). You must own your home and have a substantial amount of equity in it, with a common benchmark being at least 50%. If an existing mortgage is still in place, it must be paid off using the proceeds from the reverse mortgage.

The property must be your principal residence, meaning you live there for the majority of the calendar year. To ensure you can handle ongoing property expenses, lenders conduct a mandatory financial assessment, which is a forward-looking review of your income, assets, and credit history. Lastly, before a lender can even process an application for a HECM, you must complete a counseling session with an independent, HUD-approved agency.

Property Requirements

A variety of property types can qualify for a reverse mortgage. These include single-family homes and properties with two to four units, as long as the owner occupies one of the units. Certain condominiums and manufactured homes can also be eligible, provided they are approved by the Federal Housing Administration (FHA) or meet HUD requirements.

The home must be in good repair and well-maintained to serve as collateral for the loan. The loan agreement gives the lender the right to inspect the property to ensure it is being properly maintained. If the home is found to be in disrepair, the lender can require the borrower to make the necessary repairs to avoid a loan default.

Types of Reverse Mortgages

There are three primary categories of reverse mortgages, each designed to serve different financial goals and situations. The vast majority of these loans are HECMs, which are the only type insured by the federal government. The right choice depends on your home’s value, your financial needs, and how you intend to use the funds.

Home Equity Conversion Mortgage (HECM)

The Home Equity Conversion Mortgage (HECM) is the most prevalent type of reverse mortgage in the U.S., insured by the FHA. This federal insurance provides critical consumer protections, most notably a non-recourse guarantee. This guarantee ensures that you or your heirs will never owe more than the home’s value when the loan is repaid.

Proprietary Reverse Mortgages

Often called “jumbo” reverse mortgages, proprietary loans are offered by private lenders and are not federally insured. These loans are designed for owners of high-value homes whose property values exceed the national HECM lending limit. Because they are not bound by FHA rules, they can offer much higher loan amounts and may have more flexible age requirements.

Most proprietary reverse mortgage lenders still require borrowers to be 62 or older, aligning with HECM standards. However, some private lenders may lower the age to 60, but this is not common and may vary by state.

Single-Purpose Reverse Mortgages

Single-purpose reverse mortgages are the least common and are typically the most affordable option. They are offered by some state and local government agencies and non-profit organizations, usually for low-to-moderate-income homeowners. As the name suggests, the loan proceeds can only be used for one specific purpose designated by the lender, such as paying for essential home repairs or delinquent property taxes.

How Much Can You Borrow?

The total amount of cash available from a reverse mortgage is not your full home equity, but a calculated figure known as the “principal limit.” This amount is a percentage of your home’s value determined by a formula that considers several interacting variables. The calculation uses the lesser of your home’s appraised value or the national HECM lending limit for that year.

Factors That Determine Your Loan Amount

The specific amount you can borrow is determined by a combination of three main factors:

• The Age of the Youngest Borrower: As a general rule, the older the borrower, the higher the principal limit, meaning more funds are available.
• The Current Expected Interest Rate: A lower expected interest rate will generally result in a higher principal limit because it affects how quickly the loan balance will grow.
• The Home’s Value: The calculation is based on the home’s appraised market value or the current HECM lending limit, whichever is less.

The Costs of a Reverse Mortgage

Reverse mortgages are complex financial products that are generally more expensive than traditional home loans. It is imperative to understand every fee to assess the loan’s long-term impact and compare offers from different lenders. These costs can be paid out-of-pocket or financed into the loan, which reduces the net proceeds available and increases the initial loan balance.

Upfront Costs

These are one-time fees associated with originating and setting up the loan, which are paid at or before closing.

• Origination Fee: This fee is paid to the lender for processing the loan and is federally regulated for HECMs, with a maximum cap of $6,000.
• Initial Mortgage Insurance Premium (MIP): For HECMs, this is a mandatory fee paid to the FHA, which is 2% of the home’s appraised value or the HECM lending limit, whichever is less.
• Third-Party Closing Costs: These are standard fees for services like the appraisal, title search and insurance, property survey, and recording fees.

Ongoing Costs

These costs are not paid out-of-pocket but are added to the loan balance each month, causing it to grow. The primary ongoing cost is the interest that accrues on the outstanding principal balance. In addition to interest, HECM borrowers are charged an ongoing annual MIP, which is equal to 0.5% of the outstanding loan balance for that year. Some lenders may also charge a monthly servicing fee, capped at $35 for HECMs, to administer the loan.

When Is a Reverse Mortgage Repaid?

Unlike a traditional mortgage with a set end date, a reverse mortgage’s term is indefinite, becoming due only when a “maturity event” occurs. These triggers are based on life events, not a calendar, making the loan’s endpoint uncertain. Understanding these triggers is essential for both the borrower and their family to prepare for the repayment process.

Maturity Events

A reverse mortgage loan becomes due and payable in full when the last surviving borrower on the loan experiences one of several key events. The loan must be repaid if the borrower sells the property, as the debt is paid off from the sale proceeds at closing. The loan also becomes due upon the death of the last surviving borrower.

Furthermore, the loan matures if the property ceases to be the borrower’s principal residence, which includes being absent for more than 12 consecutive months in a healthcare facility. Other key factors are absences due to long-term travel, moving in with relatives, or illness.

Finally, the loan can be called due if the borrower defaults on their obligations, such as failing to pay property taxes and insurance or not maintaining the home. The most common reason for default is the failure to pay these property charges.

Options for Heirs

When the loan becomes due after the borrower’s death, their heirs have several distinct options. They can choose to keep the home by paying off the reverse mortgage balance, either with their own funds or by obtaining a new mortgage. If the home’s value is less than the loan balance, the non-recourse feature allows them to satisfy the loan by paying 95% of the home’s current appraised value. However, be aware that some reverse mortgages do not have a non-recourse feature, so check the details of the loan carefully.

Alternatively, the heirs can sell the property, use the proceeds to pay off the reverse mortgage, and keep any remaining funds as their inheritance. If they do not wish to keep the home and no equity remains, they can simply turn the property over to the lender without any further financial obligation. The lender’s recourse is limited to the value of the home itself.

FAQs

Will the bank own my home?

No. You continue to retain the title and ownership of your home for the life of the loan. The lender puts a lien on the property, which gives them the right to be repaid from the home’s sale proceeds when the loan becomes due.

What happens to my spouse if I pass away?

This is dependent on your spouse’s status on the loan. If your spouse is a co-borrower, the loan continues without change. If they are not a borrower but qualify as an “Eligible Non-Borrowing Spouse,” they can remain in the home for life but cannot access more funds from the loan. If your spouse is not on the loan and does not meet these eligibility rules, the loan becomes due when you die.

What are my heirs’ options when I die?

Your heirs have several choices when the loan becomes due.

• Keep the home by paying off the reverse mortgage balance. If the home is “underwater” (worth less than the loan balance), they only have to pay 95% of the home’s current appraised value.
• Sell the home, pay off the loan with the proceeds, and inherit any remaining equity.
• Turn the home over to the lender and walk away with no further financial obligation.

Can I sell my house if I have a reverse mortgage?

Yes. You own the home and have the right to sell it at any time without penalty. When you sell, the outstanding loan balance, including all principal, interest, and fees, must be paid from the sale proceeds. Any money left over after paying off the loan is yours.

What are the biggest risks of a reverse mortgage?

The two most significant risks are depleting your home’s equity and defaulting on the loan. The loan balance grows over time, which reduces your primary asset and leaves less money for heirs or for your own future needs. You can also lose your home to foreclosure if you fail to fulfill your responsibilities, which include paying property taxes, keeping the property insured, and maintaining the home in good condition.

How much does a reverse mortgage cost?

Reverse mortgages are generally more expensive than other types of home loans. For a HECM, costs include a lender’s origination fee (which is capped at $6,000), an upfront FHA mortgage insurance premium equal to 2% of the home’s value, and various third-party closing costs. Ongoing costs, which can be added to your loan balance, include compounding interest and an annual FHA mortgage insurance premium of 0.5% of the outstanding balance.

Why is reverse mortgage counseling required?

For HECM loans, counseling from an independent, HUD-approved agency is a mandatory consumer protection. The counselor’s job is to give you unbiased, objective information about how the loan works, its costs, and its risks. This process ensures you make a fully informed decision that is in your best interest before you are allowed to submit a loan application.

Some proprietary reverse mortgages do not require HUD-approved counseling, which could expose some borrowers to higher risks.

Conclusion

A reverse mortgage can be a valuable tool for seniors looking to access their home equity in retirement. It provides a way to supplement income, cover expenses, and age in place without the burden of monthly mortgage payments. However, it is a complex financial product with significant costs and long-term implications.

The decision to take out a reverse mortgage should not be made lightly. It is essential to understand the terms, costs, and your responsibilities as a borrower. Before moving forward, speak with a HUD-approved counselor, consult with a financial advisor, and discuss your options with your family to ensure that a reverse mortgage is the right choice for your unique financial situation.

Marimark Mortgage

Marimark Mortgage is based in Tampa, Florida, and serves the mortgage needs of homebuyers, homeowners, and investors in Florida, Virginia, and Pennsylvania.

We specialize in conventional home mortgages, FHA, VA, and USDA mortgage options, refinance loans, and reverse mortgages. We’ve worked extensively with cash-out refinancing and help clients to lower their monthly mortgage payments.

To get started with a mortgage to buy your next home, please fill out our Quick Mortgage Application, or contact us direct.

Resources for Additional Research

• S. Department of Housing and Urban Development (HUD)
• Consumer Financial Protection Bureau (CFPB)
• Federal Trade Commission (FTC)
• National Council on Aging (NCOA)
• How Much Equity Do You Need for a Reverse Mortgage? The Definitive Guide (Marimark Mortgage)
• Jumbo Reverse Mortgage vs. HECM: Unlocking More of Your Home’s Equity (Marimark Mortgage)