Reverse mortgages are a way for older homeowners to create additional income using the equity they’ve built up over time, but they come with strings attached that are essential to understand before entering into an agreement with a lender. This type of financing allows homeowners that have a significant amount of home equity to pull value out of their home in either a lump sum or in monthly payments. The entire loan then becomes due when the homeowner moves, sells the home, or passes away.
Who qualifies for reverse mortgages?
Unlike other types of home financing, reverse mortgages are restricted by age: you must be at least 62 years old. Additionally, you must either own your home outright or already have a majority of your primary mortgage paid down.
|Age||Must be at least 18||Must be at least 62|
|Credit score min||600||Does not apply|
|DTI||60%||Does not apply|
|LTV||85%||Up to 50-65%|
What are the costs of a reverse mortgage?
While you won’t pay any monthly payments when you take out a reverse mortgage, fees and other closing costs of a reverse mortgage are typically higher than other financing alternatives. You’ll also need to factor in any additional ongoing fees, like servicing fees (generally below $30 a month) and Mortgage Insurance Premium costs, which become more costly if your loan grows to more than 60% of your property value.
|Closing costs||3%(min $2,000)||Up to 5% (or higher)|
|Interest rate||0%||Fixed (3.68%) or variable (3.5%)|
Is a reverse mortgage the best option for me?
If you own your property outright and are over the age of 62, a reverse mortgage may help you eliminate your monthly mortgage payments. You’ll have the option to receive the money in a lump sum (fixed interest rate) or in monthly installments (variable interest rate), and proceeds are generally tax free and don’t affect social security or medicare benefits. Your interest may also be deductible once the loan is fully paid off.
They’re also one of the few financing options that will allow you to take out a majority portion of your home equity, which means if you are looking to finance a large purchase or generate substantial, steady income, it may be an option worth considering with a financial advisor.
When might a reverse mortgage not be my best option?
The most important thing to think about when considering a reverse mortgage is your homeownership horizon. How long do you intend to stay in your home? Where will you be living at the end of your reverse mortgage financing term? If you take out a reverse mortgage but then die or move out of your home for more than 12 months, the entire loan will become due – and if you don’t have the means to pay your lender, you (or your family) may need to sell the home.
Costs are also important to take into account here; closing costs for reverse mortgages can be much higher than alternative options.
Finally, application requirements may end up pushing back your timeline if you’re not prepared for the time investment. Plan to do your research and make sure your lender is licensed to offer reverse mortgages (not all banks are). All reverse mortgages that are insured by the Federal Housing Administration will require that you to complete a financial assessment to make sure you have the means to pay your property taxes and homeowners insurance for the foreseeable future, plus you may be required to complete a counseling session to ensure that you understand the terms of your reverse mortgage.
How Does a Reverse Mortgage Compare to a Home Equity Loan?
Reverse mortgages and home equity loans are two popular options to convert your home equity to cash, but the financing terms are quite different. Let’s break down those differences so that you can decide which type of home financing is right for you.
Who qualifies for reverse mortgages?
What is a Reverse Mortgage?
Reverse mortgages are loans available to homeowners age 62 and older who have a considerable amount of home equity. Secured against the home, reverse mortgages allow the homeowner to create additional cash flow for themselves using the equity they’ve built up over time in either a lump sum or in monthly payments. One benefit of a reverse mortgage is that they typically don’t require any monthly payments. Instead, the entire loan then becomes due when the homeowner moves, sells the home, or passes away – an important distinction for you and your family to consider before signing the dotted line on this type of financing.
What are the 3 Types of Reverse Mortgages?
There are three different types of reverse mortgages you should know about when considering a lender:
Home Equity Conversion Mortgages (HECMs)
Most reverse mortgages today are HECMs, which are insured by the Federal Housing Administration (FHA), a part of the U.S. Department of Housing and Urban Development (HUD). These federally backed loans can be used for any purpose.
Single-Purpose Reverse Mortgage
Unlike HECMs, single-purpose reverse mortgages are not federally backed and can only be used for a purpose the lender specifies, such as home repairs, home improvements, or property taxes. These reverse mortgages are offered by some state and local governments as well as select non-profits, but they are not available everywhere. Of the three types of reverse mortgages, single-purpose reverse mortgages are typically the least expensive.
Proprietary Reverse Mortgage
Proprietary reverse mortgages are offered by private companies. These loans are not backed by the FHA and are typically designed for borrowers with high home values.
Getting Approved for a Reverse Mortgage
Unlike other types of home financing, reverse mortgages are restricted by age: you must be at least 62 years old to take out a reverse mortgage. Generally, the more equity you own in the home and the older you are, the more likely you will be approved for a reverse mortgage. Other factors a lender will consider when reviewing your application include an updated home appraisal and a financial assessment to evaluate your ability to keep up with property taxes, homeowners insurance, and other homeownership-related expenses.
Home equity conversion mortgages (HECMs) are one of the only financial products in the U.S. that require counseling before you sign the final agreement. Because a reverse mortgage could fully cash out what is likely your largest asset – your home – the U.S. Department of Housing and Urban Development wants to ensure that homeowners are fully informed about their options before committing to a reverse mortgage. Especially because a large majority of those considering these loans are retirees on a fixed income. During the application process, a counseling session with a HUD-approved agent will ensure you fully understand the implications of the loan as well as educate you on alternative financing options like home equity investments, home equity loans and HELOCs.
Risks of a Reverse Mortgage
The most important thing to think about when considering a reverse mortgage is your homeownership horizon. Knowing that there are multiple instances in which the entire loan would become due, it’s worth asking yourself:
How long do you intend to stay in your home? If you see yourself moving anytime soon, the upfront costs of a reverse mortgage may not be worth it – closing costs for reverse mortgages can be much higher than alternative options.
Do you have anticipate any health issues that could require you to locate to a care facility? Under reverse mortgage regulations, residency at a nursing home or assisted living facility for more than 12 consecutive months would qualify as the borrower’s primary residence. This would cause the reverse mortgage to become due.
Do you live with other family members? If you live with anyone who won’t be on the loan paperwork (or anyone who is under the age of 62), should you pass away, they would be forced to either come up with the means to pay the lender back or sell the home.
And – how quickly do you need the funds? Application requirements may end up pushing back your timeline if you’re not prepared for the time investment. Plan to do your research, make sure your lender is licensed to offer reverse mortgages (not all banks are), and budget time to complete your HECM counseling session (if applicable) and financial assessment.
As reverse mortgages gained popularity in the early 2000’s, scams in which older homeowners were targeted with fraudulent reverse mortgage products also increased. If you’re seeking out a reverse mortgage, protect yourself by not responding to unsolicited advertisements and to seek out your own lender and HUD-approved counselor before signing any agreements.
Is There an Alternative to a Reverse Mortgage?
If you’re asset-rich but cash-poor, a reverse mortgage is just one of many types of home financing that may allow you to convert your home equity into cash. Home Value Investments, home equity lines of credit, cash-out refinancing, and home equity loans are all worthwhile options to consider, depending on your personal financial goals.
What is a Home Equity Loan?
Sometimes referred to as a second mortgage, home equity loans allow borrowers to access their home equity in exchange for a lump sum cash payment with a fixed interest rate. Repayment generally happens over a 30 year time period, where the homeowner repays the loan amount in monthly installments that include accrued interest. These loans are one of the most common forms of home financing for homeowners with good credit who have paid down a significant portion of their primary mortgage.
Getting Approved for a Home Equity Loan
Because a home equity loan requires monthly payments, one of the most important things a lender will look for when they review your application is a documented ability to repay your loan. They’ll analyze your source of income, your credit history, and your debt-to-income ratio. If you are not a W2 employee and have a non-traditional income source, you may have to provide additional documentation to prove that you have the ability to make your monthly payments over the term of the loan.
While the minimum credit score requirement is lower for home equity loans than some other forms of financing, it will affect your interest rate. The higher your credit score, the more likely that you’ll qualify for the best rates.
Risks of a Home Equity Loan
While home equity loans are a good option for borrowers with a spotless financial record, it is still a secured loan. Without a solid plan for how you’ll use the money and how you’ll budget for your monthly payments, you could find yourself missing payments and putting your property at risk of foreclosure.
Before taking out a home equity loan, or any type of home financing with accrued interest, it’s also worthwhile to calculate your total interest costs over the length of the loan. Interest can add up quickly – especially when considering a 30 year loan.
Interest is how lenders generate revenue, so if you someday come into a windfall or are otherwise able to pay off your loan earlier than planned, some lenders may offset the lost interest revenue by charging you a prepayment penalty (anywhere from 0.1%-20% of the loan). If you’re considering a home equity loan, it’s worth asking your lender what prepayment penalty they charge before finalizing your financing agreement.
So Which is Better: a Home Equity Loan or a Reverse Mortgage?
Personal finance is personal – only you can make the decision about what type of home financing is the best for you and your family’s situation.
When evaluating the differences between a home equity loan and a reverse mortgage, the main aspects to focus on are how you receive the funds and the loan repayment schedule.
If you’re in need of steady income to supplement your social security or other retirement income and aren’t planning to leave your home to your children, a reverse mortgage may provide the steady check you need to cover your living expenses. But if you’re looking for a large lump sum in order to achieve a goal like completing home renovations or starting a small business, a home equity loan may be the better choice for you – provided you’re able to absorb the monthly payments. However there is another option you should consider: A Home Value Investment.
Why You Should Consider a Home Value Investment
If the lump sum payment structure of a home equity loan appeals to you, but there’s no other room in your budget for another monthly payment, a Home Value Investment may also be worth consideration.
An alternative to home loans, a home equity investment or Home Value Investment is an innovative type of home financing that doesn’t add to your debt load. Home equity investors like RealtyGO provide upfront financing that allows you to cash out of a portion of the equity in your home, while completely eliminating monthly payments and added interest. In exchange for the investment, you allow RealtyGO to share in a portion of the future value of your home. You have up to 10 years to buy out RealtyGO’s investment, whether you sell, refinance, or pay us back another way, without the worry of prepayment penalties if you’re able to repay our investment sooner than planned. Homeowners like Home Value Investments because they aren’t considered a loan or debt- and therefore doesn’t appear on their credit reports or add burdensome monthly payments.
Get a free quote for up to $350,000 in upfront funding from RealtyGO today, without any impact to your credit score. RealtyGO’s Home Advisory team will guide you through the application process every step of the way, with funds in your bank account in as little as 15 days.
Is a Reverse Mortgage Right for You?
A reverse mortgage lets you borrow from your home’s value, while you continue to live in the home. If you’re struggling for cash but have high equity, this might sound like a great solution to your trouble. But is it really?
Reverse mortgages can be a helpful financial strategy or turn into a disaster. The key is knowing your responsibilities as a borrower and determining whether you’re a good candidate for this kind of loan.
What Is a Reverse Mortgage?
A reverse mortgage is a loan for borrowers 62 years old or older. The lender gives you an advance on a portion of your home equity. You don’t make monthly payments, but interest and fees add onto the loan balance each month. Whenever you stop living in the home, whether that’s because you sell it or pass away, the loan balance is due.
There are three types of reverse mortgage available. They have their own requirements and pros and cons, so look into options carefully.
Home equity conversion mortgage
A home equity conversion mortgage (HECM) is federally insured through the U.S. Department of Housing and Urban Development (HUD). The amount you can borrow depends on your age (and possibly your spouse’s), current interest rate, and the appraised value, FHA mortgage limit, or sales price of the home.
Most reverse mortgages are HECMs. You can use the loan for anything, but the loan may be more expensive than a traditional home loan. To get started, you’ll need to complete a session with a HUD-approved financial counselor, which usually costs around $125.
Proprietary reverse mortgage
A proprietary reverse mortgage is backed by a private company. If your home is worth more than $765,600 and you have a high amount of equity, you may qualify for more money (e.g., a higher advance) out of a proprietary reverse mortgage than an HECM.
Single-purpose reverse mortgage
Single-purpose reverse mortgages are available through some non-profit organizations, as well as some state and local government agencies. Their main benefit is that they are less expensive, making them an option for more low-income borrowers. The main drawback is that you can’t use the funds for whatever you want, unlike HECMs and proprietary reverse mortgages. The lender specifies what you can use the funds for (e.g., home repairs and improvements).
Pros and Cons of a Reverse Mortgage
There are times when having cash in hand is more urgent than building higher equity in your home. Anytime you consider home financing, you should talk through pros and cons with a qualified financial advisor so you don’t end up in more serious financial difficulty later.
Reverse mortgage pros
Here are the benefits of applying for a reverse mortgage:
1. Get cash without selling your home: You’re taking a loan against the equity, but the title remains in your name and you can stay in the home.
2. No taxes: Reverse mortgage funds are loan proceeds, not taxable income, so the full amount is yours to keep.
3. Freedom over spending: In most cases, you can spend reverse mortgage funds on whatever you choose.
4. Payment cap: You never need to pay more than market value of the home, even if interest grows until your debt exceeds your home’s value.
Reverse mortgage cons
Consider these important downsides before proceeding with a reverse mortgage:
1. You could lose your home: Even if you don’t have monthly payments, you may incur monthly fees. Fail to pay, and you could face foreclosure.
2. Your family could end up homeless: If you die, the loan is due. If family members living in the house can’t pay, they could be left without a place to live.
3. Interest and fees: Reverse mortgages increase your debt over time with interest and fees.
4. Beware scams: Unscrupulous dealers run scams targeting seniors. Only consider reverse mortgage agreements insured by the Federal Housing Authority.
5. Medical trouble could equal financial trouble: If you have to move out for medical reasons, you need to pay the loan balance in full.
A reverse mortgage can be a way to come up with much-needed cash, or it can turn into a nightmare. You should think seriously about your health, your heir’s ability to pay the debt if you pass away, and how to keep up with monthly bills for interest and fees. Without strong financial planning in place, a reverse mortgage could cause far more problems than it solves.
Is a Reverse Mortgage Ever a Good Idea?
It would hardly make sense for the federal government to offer any reverse mortgage program if a reverse mortgage was always a bad idea. A reverse mortgage benefits some families, including some retirees. Here are signs you’re a good candidate for a reverse mortgage:
1. You have high equity: The more you have, the more likely it is you’d be eligible for the funding you need.
2. You’re staying in place: Moving makes the loan due, so only apply if you’re staying put for the long term.
3. Heirs don’t want the house: The loan balance is due after you die. The easiest way to pay is often to sell the house. If your loved ones plan to do that anyway, you may be in a better position than a family still living in the house (or with a strong emotional attachment to it).
4. You’re comfortable managing your own money: A reverse mortgage can provide a helpful supplemental source of cash or cover unexpected expenses. You need a solid plan to use loan funds wisely, and stay current on expenses like home insurance and property taxes.
A reverse mortgage gradually eats up your home equity, while providing you with a source of cash now. For some people, this can be part of a sensible financial plan. Jumping into a reverse mortgage to escape major financial trouble might backfire if you don’t have a clear sense of how you’ll use the proceeds and repay the loan.
How Does a Reverse Mortgage Work?
If you think a reverse mortgage could help you with your finances, here’s what you need to know to get started.
Reverse mortgage qualification requirements
In order to get a reverse mortgage, you need to meet these requirements:
# Be 62 years old or older
# The home must be your primary residence
# Own home outright or have a “considerable amount” of equity (over 50% is a good rule of thumb)
# Have no federal debt
# Be able to keep up with HOA fees, property taxes, and other home-related costs
Reverse mortgage interest rates
As with a traditional mortgage, you’ll need to pay closing costs and service fees. You don’t need to make monthly payments on a reverse mortgage, but there may be servicing fees throughout the duration of the loan. You may also pay off interest on a regular basis to keep it from accumulating too high.
Interest rates for HECM traditional loans (the most common type of reverse mortgage) typically fall between 4-5%.
How borrowers get the money
Borrowers usually have several options to choose from for how to access reverse mortgage funds:
# Lump sum
# Fixed monthly payments
# Line of credit
# Combination method (e.g., fixed monthly payments with an additional line of credit)
Talk to your prospective lender about what options are available for you. A financial advisor can also help you determine which method will be easiest for you to use wisely.
The maximum reverse mortgage value you can borrow is determined by a principal limit factor (PLF). The lender will calculate your PLF depending on age, credit, home value, and other factors. Expect that the maximum equity you could borrow through a reverse mortgage is around 80%, and most people will be approved for a lower amount.
How to pay back a reverse mortgage
A few circumstances can trigger your reverse mortgage loan to become due:
# Death of the borrower
# Sale of the house
# Borrower moves out of the house (home is no longer principal residence)
# Borrower falls behind on property taxes or other qualifying home expenses
Heirs are responsible for reverse mortgage debt to a certain extent. They have to get an appraisal within a set timeline. They are responsible for satisfying the loan balance with funds from your estate, or by selling the house (the lender may specify that the home has to sell for at least 95% of the appraisal value).
If the heirs don’t follow these steps, the lender can typically start the foreclosure process after about 6 months.
Heirs are not responsible for paying reverse mortgage debt that exceeds the appraised value of the home. Reverse mortgages are a kind of non-recourse loan, meaning the FHA has to cover the extra cost if the loan exceeds the home’s value. So a reverse mortgage won’t sink your family into debt, although they may lose the house.
Reverse Mortgage Example
The best place to start looking for reverse mortgage options is through HUD. You can find more detailed information about requirements, loan amounts, and how to start an application. You can also explore these options:
# AAG: American Advisors Group is one of the most prominent reverse mortgage providers in the country.
# AARP: The American Association of Retired Persons offers guidance on home financing and other financial subjects for seniors.
# AIG: American International Group is a global insurance company that also offers home financing services.
Home financing is a significant decision. It’s always smart to start by talking with a professional to compare the benefits and risks of different financing paths.