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A Guide to Reverse Mortgages - What You Need to Know

What exactly is a reverse mortgage and how does it work? Trust & Will explains what you need to know about reverse mortgages.

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

According to a recent study, only half of Americans have enough savings for retirement. Further, 39 percent of Americans aren’t saving for retirement at all. This means that an increasing number of retirees will be forced to find creative methods of funding their retirement. Here, a reverse mortgage is a possible retirement financing option. What is a reverse mortgage? This guide will define what a reverse mortgage is, how it works, and answer your most burning questions.

What is a Reverse Mortgage? 

A reverse mortgage is a type of loan made using one’s home equity. Not anyone can take out a reverse mortgage. To qualify, you must be a homeowner aged 62 years or older, and you must have built up a substantial amount of equity in your home.

Those who qualify can borrow against their home value and receive a lump sum, fixed monthly payments, or a line of credit to be used at their discretion. Unlike a traditional mortgage, reverse mortgage borrowers don’t have to make monthly mortgage payments. Instead, the loan balance becomes due in full when any of the following scenarios take place:

  • Homeowner passes away

  • Homeowner moves out of the home permanently

  • Homeowner sells the home

How Does a Reverse Mortgage Work?

When a homeowner takes out a reverse mortgage, instead of making payments to the lender, the lender is making payments to the homeowner. They can choose how they’d like to receive their loan payments, such as in a lump sum, through monthly payments, or by opening up a line of credit. 

The homeowner does not have to make any payments for the loan. The only payment they technically make is the interest payment, but it’s rolled into the total loan amount. When using a reverse mortgage, the homeowner’s equity decreases while the debt increases over time. The home is used as collateral for both traditional and reverse mortgages. 

While the homeowner gets to keep the home title, they essentially do not get to retain any equity in the home. When they pass away, or decide to sell the home, the balance of the loan is due in full. If they were to sell the home, the proceeds must be used to pay back the loan principal, interest, fees, and mortgage insurance. Any proceeds in excess of the balance due can be retained by the homeowner. If the homeowner passes away, the reserve mortgage balance must be paid out of the estate. The heir(s) may need to sell the home, or pay off the mortgage if they wish to keep the property.

While the loan payments may feel like a form of income, they are not taxable. The Internal Revenue Service (IRS) treats reverse mortgage payments as loan advances.

How Do You Pay Back a Reverse Mortgage?

The most common method of paying back a reverse mortgage is to sell the home. The proceeds are used to pay back the loan. Any proceeds in excess of the amount of the loan can be kept by the seller. 

There are cases when the loan becomes due because the homeowner (the borrower) passed away. This means that the loan must be handled by the estate and the homeowner’s heirs. Here are some options used to repay the reverse mortgage loan:

  • User other existing assets in the estate

  • Sell the home and use the proceeds

  • Purchase the home for the loan balance or 95 percent of the appraised home value (the lesser of the two)

  • Refinance the reverse mortgage into a traditional mortgage

  • Sign the title to the lender and walk away from both the loan and the home

Are There Different Types of Reverse Mortgages?

There are three types of reverse mortgages: single-purpose reverse mortgages, home equity conversion mortgages, proprietary reverse mortgages:

  • Single-purpose reverse mortgages: This type of loan is backed by the government and is thus the least expensive option. Homeowners who elect to take out this type of loan can expect to pay less in interest and other fees  compared to other types of reverse mortgages. The single-purpose reverse mortgage is not widely available across the United States; it isn’t available in every state. Further, as its name indicates, it can only be used for one purpose and lenders restrict how it can be used. It may not be a good fit for an individual who needs general access to cash for various purposes. It’s a better fit for those with a specific purpose for the loan, such as fixing up the house or making repairs.

  • Home equity conversion mortgages (HECM): HECMs are backed by the U.S. Department of Housing and Urban Development This loan is expensive relative to traditional home loans; it also comes with higher up-front costs. HECMs don’t have any income limitations or medical requirements and can be used for any purpose. For these reasons, they’re the most popular type of reverse mortgage. 

Because the costs are higher, HECMs require counseling before an application can be submitted. The counseling process ensures that the applicant is fully aware of the costs and payment options. They may also be provided with some nonprofit or government alternatives if available. The applicant’s age, home value, and market interest rates determine how much they can borrow.

  • Proprietary reverse mortgages: Last but not least, proprietary reverse mortgages are backed by private lenders instead of by the federal government. In 2022, the lending limit for an HECM is $970,800. If your property is worth more than this limit, then you may want to look into this option. Because these loans aren’t backed by the government, they don’t require up-front insurance premiums, allowing borrowers to borrow more. 

When shopping for a reverse mortgage, be sure to consider all of your options. One isn’t automatically better than another. Your age, home equity, and any applicable loan limits will all influence where you can secure the best deal. Be sure to compare interest rates, fees, and obtain quotes from each type of loan provider before making your choice.

Frequently asked questions about reverse mortgages

So far, we’ve reviewed what a reverse mortgage is, how it works, and different reverse mortgage options. Before you can decide whether or not a reverse mortgage is the right choice for you, you’ll need some additional insights. Here are the answers to some of the most burning questions about reverse mortgages.

What is the downside of getting a reverse mortgage?

There are several downsides associated with getting a reverse mortgage. First, you must consider all of the costs. You are looking at lender fees, closing costs, and insurance fees. Although these costs and fees are wrapped into your loan balance, that means that you’ll have even more debt and less equity.

Second, you should be aware that you won’t be able to enjoy your mortgage interest deduction. Come tax time, you won’t be able to deduct the interest paid on a reverse mortgage. You will only be able to claim this perk when you’ve paid off the loan.

Last but not least, a reverse mortgage could inadvertently put you in jeopardy. The first type is home foreclosure. Many seniors make the mistake thinking that their home can’t get foreclosed upon because they don’t have to make a monthly payment. However, the home can still get foreclosed upon if you ignore your other housing duties, such as your property taxes or HOA dues. The second type is other program agreements. If you’re participating in Medicaid or Supplemental Security Income (SSI),  your reverse mortgage could potentially obstruct your eligibility. Be sure to consult with a professional before taking out a reverse mortgage. 

Why would someone get a reverse mortgage?

Most seniors experience a reduction in their income when they retire. In some unfortunate cases, the cost of living could feel overwhelming compared to their slim retirement income. This scenario is becoming increasingly likely; many Americans are having trouble saving up for retirement at all. For many, a mortgage is the single largest expense. A reverse mortgage can help supplement an individual’s existing income so that they can continue covering their expenses. In addition, a reverse mortgage can sometimes help a senior age in place, instead of having to move and buy or rent a home in a different location. 

What happens to my reverse mortgage after I die?

When you pass away, your reverse mortgage loan becomes due and payable. You may be wondering how you’re expected to pay off a loan if you’re no longer around. This is where your estate plan comes in. 

Your heirs will be given 30 days after receiving the due notice from the lender to take action. They can either buy the home, sell the home, or turn the home over to the lender to satisfy the debt. Here, you have an opportunity to increase your heir(s)’ options through your Estate Plan. For instance, you can designate a different source of funds to help them pay off the loan so that they don’t lose the house. Our guide “reverse mortgage after death & estate planning” helps explain how to arrange your estate in the context of a reverse mortgage. 

Can you sell your house if you have a reverse mortgage?

Selling your house when you have a reverse mortgage can be tricky, but it can be done. If you successfully sell your home, keep in mind that the balance of your reverse mortgage becomes due. You’ll likely have to use your home sale proceeds to pay off the balance, unless you have another source of funds. If your home value has appreciated and sells for more than your reverse mortgage balance, then you get to pocket the difference. However, if your home value depreciates relative to your loan, then you’ll be forced to make up the difference. 

Learn more about reverse mortgages

What is a reverse mortgage? A reverse mortgage isn’t the type of mortgage that might come to mind at first. It’s not a loan that you obtain to finance a home. Rather, it’s a loan obtained using your pre-existing home equity. Reverse mortgages are typically taken out by seniors who have already built up a considerable amount of equity in their own home, and need to take out a loan to supplement their retirement income. It’s not ideal to have to take out a reverse mortgage, but it is a financing option that could really help out someone when they’re in a pinch and need help covering the rising cost of living. 

To learn more about reverse mortgages, be sure to check out our other guides:

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