— A Reverse Mortgage Guide For Seniors —
How Reverse Mortgages Work
by Chris Brown, President, CB Investments
20 March 2017
Reverse mortgages can help seniors convert their home equity into cash and eliminate their monthly mortgage payments.
What is a reverse mortgage?
A reverse mortgage is a special type of home loan for seniors age 62 and older. It allows homeowners to convert their home equity into cash with no monthly mortgage payments, and defer payment of the loan until they die, sell, or move out of the home.
The Home Equity Conversion Mortgage (HECM) is FHA’s reverse mortgage program. HECM reverse mortgage loans are insured by the Federal Housing Administration (FHA), and they are a safe plan that can give older Americans greater financial security.
Many seniors use HECM reverse mortgage loans to supplement Social Security, meet unexpected medical expenses, make home improvements, and more. Proceeds can be received as a line of credit, lump sum, or monthly payments. Homeowners who have an existing mortgage often use the reverse mortgage loan to pay off their existing mortgage and eliminate monthly mortgage payments. Borrowers are required to continue paying property taxes and insurance and maintain the home.
Typically the loan does not become due as long as you live in the home as your primary residence and continue to meet all of the loan obligations. The loan does not generally have to be repaid until six months after the last surviving homeowner moves out of the property or passes away. At that time, the estate typically sells the home to repay the balance of the reverse mortgage and the heirs receive any remaining equity.
Reverse mortgage vs. traditional loan
A reverse mortgage is different than a traditional or forward loan in that it operates exactly in reverse. The traditional loan is a falling debt, rising equity loan while the reverse mortgage falling equity, rising debt loan. In other words, as you make payments on a traditional loan, the debt or amount you owe is reduced and therefore the equity you have in the property increases over time. With the reverse mortgage, you make no payments so as you draw out funds and as interest accrues on the loan, the balance grows and your equity position in the property becomes smaller.
Reverse mortgage vs. home equity loan
A reverse mortgage is a special type of home loan that lets you convert a portion of the equity in your home into cash. The equity that you built up over years of making mortgage payments can be paid to you. However, unlike a traditional home equity loan or second mortgage, reverse mortgage borrowers do not have to repay the reverse mortgage loan until the borrowers no longer use the home as their principal residence or fail to meet the obligations of the mortgage. With a second mortgage, or a home equity line of credit, borrowers must make monthly payments on the principal and interest. A reverse mortgage is different, because it pays you – there are no monthly principal and interest payments.
41% of people aged 55 to 64 don’t have any retirement savings at all.
Reverse mortgage requirements
- At least one homeowner must be 62 years of age
- You must reside in the home as your primary residence
- Your home must be either a single-family home, two to four-unit owner-occupied home, townhouse, approved condominium unit, or certain manufactured homes
- You must attend an educational HUD-approved counseling session by phone or in person
- You must continue to pay property taxes and homeowners insurance
Reverse mortgage proceeds
A reverse mortgage loan uses a home’s equity as collateral. The amount of money the borrower can receive is determined by the age of the youngest borrower, interest rates and the lesser of the home’s appraised value, sale price, and the maximum lending limit.
Proceeds are typically distributed as:
- Line of credit – draw as needed up to maximum amount
- Lump sum – a lump sum of cash at closing
- Tenure – monthly payments for the life of the loan
- Term – monthly payments for a specific number of years
Note: The adjustable-rate reverse mortgage offers all of the above payment options, but the fixed-rate only offers lump sum.
Proceeds are typically used to:
- Receive additional income to help with living costs
- Consolidate and pay debts – e.g. high interest credit cards
- Buy a new car
- Pay for a care facility (nursing home)
- Repair or renovate the home
- Help the family or grandchildren
- Pay for a vacation
A reverse mortgage can be used strategically as part of a retirement income plan.
Reverse mortgage payment
Borrowers must repay their loans when they sell their home or die. Under new guidelines, if the older spouse dies, the surviving spouse can remain living in the home without having to repay the reverse mortgage balance as long as they keep up with property taxes and homeowners insurance, and they reasonably maintain the home.
The loan does not generally have to be repaid until six months after the last surviving homeowner moves out of the property or passes away. At that time, the estate typically sells the home to repay the balance of the reverse mortgage and the heirs receive any remaining equity. The estate is not personally liable for any additional mortgage debt if the home sells for less than the payoff amount of the reverse mortgage loan.
Because there are no required mortgage payments on a reverse mortgage, the interest is added to the loan balance each month. The rising loan balance can eventually grow to exceed the value of the home, particularly in times of declining home values or if the borrower continues to live in the home for many years. However, the borrower (or the borrower’s estate) is generally not required to repay any additional loan balance in excess of the value of the home.
When the reverse mortgage loan does become due, the borrower’s heirs/estate can choose to repay the reverse mortgage loan and keep the home or put the home up for sale in order to repay the loan. If the home sells for more than the balance of the reverse mortgage loan, the remaining home equity passes to the heirs.
No debt is passed along to the estate or heirs. A reverse mortgage loan is “non-recourse,” meaning that if you sell the home to repay the loan, you or your heirs will never owe more than the loan balance or the value of the property, whichever is less; and no assets other than the home must be used to repay the debt.
Reverse mortgage loans in the U.S. are expected to nearly double to 966,000 by 2030.
So is a reverse mortgage right for you? Reverse mortgage loans are not right for everyone. If you are looking for a short-term loan you may be better suited for a different type of financing. But for those who wish to remain in their homes and need extra income or cash, a Home Equity Conversion Mortgage may be perfect.