If you’re 62 years old (or older) and have owned your home for long enough to have built up some equity, there’s a way to turn your equity into cash to finance home improvements, medical costs or even supplemental income: a reverse mortgage. Unlike a traditional “forward” mortgage -- the kind you use to buy a home -- there are no recurring loan payments to make with a reverse mortgage.
The catch? You, your spouse or your estate will eventually have to pay back the loan amount -- once you no longer occupy the property. Read on to learn more about reverse mortgages and whether it’s a good option for you.
What is a reverse mortgage?
A reverse mortgage is a type of loan offered to seniors who are at least 62 and who have a sufficient amount of home equity -- which is the difference between what is owed and what the home is currently worth. A reverse mortgage transforms that equity into payments. This money is not taxable, because it’s considered a loan proceed and not income.
As long as you’re living in the home, you don’t have to pay back the money and you retain the title to the house. But someone will have to pay it back when you move out, sell the property or die. Sometimes, that can mean having to sell the house to repay the loan.
With a traditional mortgage, you pay the lender. With a reverse mortgage, however, the lender pays you. The amount of money you can borrow against your home’s equity depends on variables including your age, the home’s value, interest rates and loan limits set by the government.
Reverse mortgage requirements
Not everyone is eligible for a reverse mortgage. To qualify, you must:
- Be 62 or older
- Keep up with your property taxes
- Maintain your home and keep it in good condition
- Pay your home insurance
- Live at the home
- Have a sufficient amount of equity -- usually 50% or higher
Types of reverse mortgages
There are three types of reverse mortgages, with different terms, requirements, benefits and disadvantages. Here’s how they stack up.
Single-purpose reverse mortgages
This type of reverse mortgage isn’t offered everywhere -- but it’s generally the least expensive option. Single-purpose reverse mortgages are granted by local and state governments and nonprofit agencies, generally for homeowners with low to moderate incomes. These types of loans can be used only for certain purposes, as defined by the lender. For example, you may qualify for a single-purpose reverse mortgage on the condition that it’s used to make repairs to your house.
Home equity conversion mortgages
These reverse mortgages, backed by the US Department of Housing and Urban Development, are among the most common. While home equity conversion mortgages have higher upfront costs, they’re popular because there are no constraints on how borrowers use the proceeds -- and no medical restrictions or income requirements. Borrowers are required to meet with a counselor to review the costs, requirements and responsibilities of HECMs, however. In 2020, the borrowing limit for HECMs was raised to $822,375 from $765,600.
Proprietary reverse mortgages
Unlike single-purpose and HECM loans, these types of loans are private and not funded by the government. Proprietary reverse mortgages are beneficial if your home is valued higher than the HECM cap of $822,375.
Pros and cons of a reverse mortgage
Pros
No monthly mortgage payments: You can avoid paying monthly mortgage payments as long as you have at least 50% equity. However, you’ll still have to pay property taxes and homeowner’s insurance and keep the home in good condition.
Spared from foreclosure: Obtaining a reverse mortgage lets you access funds needed to avoid foreclosure.
Lump sum: Depending upon the type of reverse mortgage you get, you can spend the money any way you wish.
Housing security for spouse: If a spouse was not involved in taking out a reverse mortgage, in most cases they can stay in the home even after the borrower dies. They’ll have to pay taxes and insurance.
Cons
Scams: Just as there are plenty of legitimate reverse mortgage offers, there also many illegal scams out there. If you believe you’ve come across a reverse mortgage scam, alert your lender and file a complaint with the Federal Trade Commission and your state Attorney General’s office. Follow these tips from the FBI to avoid reverse mortgage scams.
Borrowing against equity: When you take out a reverse mortgage, you’re borrowing against the equity you’ve likely worked hard to obtain. This may impact not only your retirement funds, but your ability to obtain other loans. It also leaves fewer assets for your heirs.
You’ll owe more over time: That’s because the interest on your loan adds up over time. And interest rates may change. Most reverse mortgages have variable interest rates.
Other payments: Just because you won’t have to make mortgage payments doesn’t mean you can live in your home for free. As part of your loan requirement, you’ll need to continue paying property taxes and home insurance.
Fees and closing costs: Like other refinance options, reverse mortgages have closing costs and fees you’ll have to pay. Ask your lender to estimate how much those will be.
Alternatives to a reverse mortgage
Refinance your home
While you would essentially be starting over on your mortgage, you may be able to find a better interest rate on your new home loan than your original. You can go with traditional refinancing, in which you borrow the same amount of money as the original mortgage, or you can obtain a cash-out refinance, where you can borrow up to 80% of your home’s value through a loan larger than your original. You’ll receive the difference in a lump sum amount.
Home equity loan
While you’ll have to put your home down as collateral for a home equity loan, you’ll be able to borrow a lump sum of money at a fixed interest rate. But these types of loans come with higher interest rates. If you use the funds to make improvements or repairs on your home, you may be eligible for a mortgage interest tax deduction.
Sell your home
While you may not walk away from selling your home having pocketed the full value, you could downsize and pay for a new home with cash. Just keep in mind you may have to pay income tax on the sale of your home should the value have increased from when you bought it.