TV commercials for reverse mortgages commonly extol the benefits of a guaranteed tax-free income for homeowners aged 62 and older. However, reverse mortgages can be expensive and, in come cases, put a person's biggest asset—their home—at risk.
- A reverse mortgage can provide a lump sum of cash or a regular income stream to homeowners over age 62.
- There are several types of reverse mortgages, the most common being home equity conversion mortgages, or HECMs, which are insured by the federal government.
- Reverse mortgages can be expensive, compared to other types of loans.
- They can also put the borrower at risk of foreclosure and losing their home in certain cases.
- A spouse who qualifies may be able to remain in the home if their spouse dies or moves into a nursing home.
What Is a Reverse Mortgage?
A reverse mortgage allows a homeowner with sufficient equity in their home to draw on that equity for income. Unlike a home equity loan or line of credit, which the homeowner has to pay back on a regular schedule, the income from a reverse mortgage need not be paid back until the homeowner leaves the home, sells it, or dies. At that time, the loan balance, interest, and accrued fees must be paid in full, usually with the proceeds from selling the home.
For homeowners with few or no other assets, a reverse mortgage can provide a much-needed income supplement in retirement. It can also help pay for medical bills or other unexpected expenses. However, it has some potential drawbacks worth noting.
How Reverse Mortgages Work
The most common type of reverse mortgage is a Home Equity Conversion Mortgage (HECM), which is issued through private lenders but insured by the Federal Housing Administration. HECMs are available only to borrowers over the age of 62.
Lenders can also issue their own proprietary reverse mortgages, often with higher loan limits than HECMs and sometimes without the same age restrictions. In addition, some states and municipalities offer single-purpose reverse mortgages, designated for a specific use, such as home repairs or tax payments.
The amount that a person can borrow will depend on a number of factors, including their age (and that of any co-borrowers), their loan's interest rate, and the appraised value of their home.
Reverse mortgages can be structured in a number of ways. The borrower can receive the money as a single lump sum, in the form of a credit line that they can draw on as needed, or as a series of regular monthly payments for a set period of time or for as long as they live in the home.
Downsides of Reverse Mortgages
While reverse mortgages can be useful in some instances, they also have downsides that anyone who's considering one needs to be aware of. Those include:
Relatively High Fees
As mentioned, lenders can offer slightly different products under the reverse mortgage banner. But they all charge an assortment of fees, and a reverse mortgage will typically be more expensive than a regular mortgage.
Before taking out a HECM, borrowers must receive counseling from a HUD-approved reverse mortgage housing counseling agency. Typically that will be free or involve a modest fee. The counselor should explain all of the likely costs and how they work.
The following fees apply to HECMs, but other kinds of reverse mortgages will have similar lists of their own.
Origination fee. With a HECM, the lender can charge either $2,500 or 2% of the first $200,000 of your home's value, whichever is greater, plus 1% of the amount over $200,000. The amount can't exceed $6,000.
Real estate closing fees. As with a regular mortgage, reverse mortgages can rack up a variety of closing costs, including a home appraisal and inspection, title search, recording fees, mortgage taxes, and a credit check of the applicant, among others.
An initial mortgage insurance premium. This is typically equal to 2% of the home's value.
Borrowers can pay these upfront costs with their own money or use the loan proceeds to pay for them. In addition, borrowers can expect ongoing expenses, including:
Interest. The interest on a reverse mortgage accumulates, adding to the amount the borrower or their heirs will have to pay back at the end. Unless the borrower takes the money in a lump sum, the interest rate will be variable, meaning that it can rise or fall.
Servicing fees. These monthly fees reimburse the lender for its ongoing costs, such as making payments and processing paperwork. HECM rules limit these fees to no more than $30 for fixed-rate loans or variable-rate loans that adjust just once a year and no more than $35 for variable loans that adjust monthly.
Annual mortgage insurance premium. This will be 0.5% of the outstanding loan balance every year. As such, it will rise over time as the borrower draws out more equity.
Again, these numbers apply to HECMs and may be higher or lower with other types of reverse mortgages. Either way, borrowers will be in for a lot of fees, which has been a traditional complaint with these types of loans.
Ineligibility for Certain Government Benefits
In some instances, a reverse mortgage can affect a homeowner's eligibility for government benefits.
If the homeowner wants to receive benefits from Medicaid, the joint federal and state health insurance program for some low-income and elderly Americans, their eligibility will be based on both their income and their assets. Income from a reverse mortgage won't count against them, but if they received a lump sum from the reverse mortgage, that will be included among their assets. If their total assets exceed the limit for their state, they will have to spend down the money in order to be eligible.
Similarly, money from a reverse mortgage lump sum can affect a person's eligibility for Supplemental Security Income (SSI), a federal program for low-income individuals. SSI also sets limits on assets (which it refers to as "resources"), currently $2,000 for individuals and $3,000 for couples.
A reverse mortgage will not affect Social Security or Medicare benefits.
Lenders Can Foreclose in Some Instances
When homeowners take out a reverse mortgage, they agree to keep the property in good repair and to continue to pay real-estate taxes, homeowners insurance premiums, and any association or related fees out of their own pocket. Failure to do so can allow the lender to foreclose on the property and evict the homeowner.
Other Family Members Can Be Evicted
Once the borrower or borrowers on a reverse mortgage die or leave the home for a certain length of time, the reverse mortgage can become due and payable. In the past, this sometimes meant that a spouse who wasn't listed as a borrower in the loan agreement (often because they hadn't reached age 62 when their spouse took out the loan) could be evicted.
Major reforms enacted in 2014 and 2021 for HECMs issued after those dates expanded the protections for some spouses. In particular, those who qualify as eligible non-borrowing spouses can now remain in the home for the rest of their lives.
Under the 2014 rules, eligible non-borrowing spouses must have been legally married to borrower when the reverse mortgage closed and remained married to them until the borrower's death. For couples who were prohibited by law from marrying before the closing because of their gender, the survivor was eligible if the couple legally married before the death of the borrower and remained married until that person's death. The non-borrowing spouse must also have lived in the property at the time of the closing and continued to live there as their principal residence.
The 2021 rules broadened eligibility, so that if the borrower didn't die but instead moved into a nursing home or similar facility, their spouse could still remain in the home. Prior to then, the spouse would have had to pay off the mortgage after one year.
Spouses who don't meet these requirements must still pay off the loan if they wish to remain in the home. That's also true for any other heirs, such as children, who may be living there. Otherwise they will need to sell it.
The good news, such as it is, is that if they can sell it for more money than is needed to pay off the loan, they get to keep the difference. And even if the loan balance exceeds the sale price, they won't have to make up the difference as long as they sell it for at least 95% of its appraised value.According to the Consumer Financial Protection Bureau, "the lender will take the proceeds from the sale as payment on the loan, and the FHA insurance will cover any remaining loan balance."
As an alternative, they can simply turn it over to the lender and walk away.
Smaller Inheritances and Greater Hassles for Any Heirs
A reverse mortgage can also deplete much of the homeowner's wealth, especially if their home is basically all they have, leaving little behind for their heirs.
That said, it is their home to do with as they decide, and it may be better for them to take out a reverse mortgage than to rely on their family for financial assistance. And it is certainly better than having to live out their last years in poverty.
But leaving a home with a reverse mortgage to the heirs (other than an eligible spouse) also puts a burden on them. In general, they'll have 30 days after receiving a due and payable notice from the lender to pay off the debt, either by selling the home, buying it themselves, or signing it over to the lender. However, some lenders will extend that period by up to six months. That can be helpful, for example, if an heir wants to keep the home but needs to obtain financing in order to do so.
What Are Alternatives to a Reverse Mortgage?
How Much Money Can a Homeowner Get With a Reverse Mortgage?
The amount of money someone can get with a reverse mortgage depends on their age and the age of any co-borrowers, the value of the home, and the interest rate on the loan. The current maximum for a HECM is $1,089,300. Private loans can have higher limits but may also have higher interest rates.
Can a Borrower Cancel a Reverse Mortgage?
A borrower can cancel a reverse mortgage within three days of the loan closing without paying any financial penalties. This is known as "the right of rescission."?
The Bottom Line
A reverse mortgage can allow an older homeowner to tap the equity that has built up in their hone over the years without having to sell it or move out. However, these loans can be expensive and also have some disadvantages for the borrower's heirs, so it's worth considering the alternatives.