How It Works
A reverse mortgage is a loan that is paid back after the home is sold, or when the borrower passes away.
The term “reverse” comes from the fact that unlike a traditional mortgage where the balance decreases over time, a reverse mortgage has a balance that increases over time. This is because interest is added to the principal each month, raising the balance.
The most popular reverse mortgage offered to homeowners 62 and up is the FHA-Insured Home Equity Conversion Mortgage or HECM. These loans can be paid in a lump sum upfront, a line of credit, or monthly cash payments with fixed or variable interest rates. How much a person receives is based on the value of the home, the borrower’s age, interest rates, the results of a financial assessment, and the payout options they choose.
Here is an example. Nancy is a 75-year-old woman who owns a home worth $250,000. She owns the home outright and has enough income to continue paying her property taxes, homeowner’s insurance, and maintenance. Plus, she wants to stay in her home. Nancy decides to have the loan amount paid to her upfront as a lump sum and the lender places a 5% interest on the loan; she could borrow $73,000 and the principle and interest will be due if and when she sells the home or passes away.
Nancy also pays additional costs for receiving a reverse mortgage, including $4,500 origination fees, insurance premium of $4,000 and other out-of-pocket expenses like mandatory counseling fees, appraisals, and other third party costs. In the end, Nancy pays close to $10,000 to complete her loan process.
As with traditional home equity products, the borrower remains responsible for property taxes, insurance, and maintenance.
|Cash Amount||Varies depending on age, interest rate, number of borrowers, and design of payout|
|Cash Payout Design||Option of lump sum, line of credit, or monthly payment, either for a fixed number of years, or lifelong.|
|Repayment Profile||No payments due on principal or interest while the homeowner lives in the property|
|Taxes, Insurance & Maintinance||Responsibility of the borrower|
|Transaction costs||Underwriting fees between $2,500 and $6,000, insurance premiums of 2% of the value of the home, and out-of-pocket costs for mandatory counseling|
What to Consider
There are a lot of mixed feelings about reverse mortgages stemming from reports of predatory marketing and sales practices over time. Over the last few years, however, regulators have introduced many requirements to address these concerns, including mandatory counseling and financial assessments.
Because no principal or interest payments are due until the home is sold, Reverse Mortgages may be a good solution for older adults who want to eliminate monthly mortgage payments, consolidate debt, or increase available funds for retirement.
- Reverse mortgages can be expensive for borrowers and after the latest regulatory changes, an increasing number of older adults may no longer qualify.
- Failure to pay for real estate taxes, insurance, and maintenance could result in foreclosure.
- Reverse mortgages require a homeowner to remain in their home, so they are not able to leave it or rent it out for added income.
- If a homeowner wants to pass the home to someone as an inheritance, there may not be much equity left in the home (if any) once the homeowner passes away. This is because the balance of the mortgage increases over time, and with compounding interest, the debt could equal the property value.
|Best Fit When||Cash needs are structural: cash - either upfront or over time - is needed for living expenses, and not repaid during the borrower's life|
|Considerations||As the debt grows over time, often it ends up accounting for a large share of the property value (if not 100%). Fees associated with a new loan and interest on the loan can be costly.|