Explainer: How a Reverse Mortgage Works

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For seniors who are approaching retirement and need additional income or are facing increasing medical costs, a reverse mortgage loan can be the solution. Quite often, older homeowners have either completely paid off the mortgage on their house or have built up considerable equity.

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A reverse mortgage is a way to access those equity funds.

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What Is a Reverse Mortgage?

A reverse mortgage is a loan that lets you borrow against the equity in your home. However, unlike a traditional home mortgage or a home equity loan, you don't have to make monthly mortgage payments to the lender. You can make payments to reduce the loan balance if you choose to, but repayment of the loan is not required.

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Reverse mortgages aren't limited to single-family homes. You can also get a reverse mortgage if you live in a condominium as long as it's your primary residence.

In some cases, a reverse mortgages can be a useful source of funds to supplement retirement income, consolidate debt, make home repairs and improvements and pay for in-home health care

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Consider also​: What Do Banks Use to Determine House Value and Home Equity?

How Does a Reverse Mortgage Work?

Reverse mortgages are based on the amount of equity in your home. The amount of equity in your home is found by subtracting the balance on your outstanding mortgages from the current market value of your home. For example, if your home's value is ​$350,000​ and your mortgage balance is ​$100,000,​ then you have ​$250,000​ worth of equity in your home.

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The loan does not become due until you either move out, sell the house, default on the loan obligations or die. If you pass away, your heirs assume the responsibility for the loan.

Reverse mortgages can have either a fixed rate or an adjustable rate. However, rates on reverse mortgages tend to be higher than rates on traditional mortgages. Although you are not required to make payments on a reverse mortgage, the interest on the loan will accrue and add to the loan balance amount.

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You can receive the loan proceeds from a reverse mortgage as a lump sum, monthly payments or as a line of credit. It depends on what you plan on using the funds for and the type of remote reverse mortgage you receive.

You can make payments to reduce the amount of the reverse mortgage, but you're not required to. You are required, however, to pay property taxes, maintain adequate homeowners insurance and keep the house in good condition. If you fail to follow through on any of these requirements, you could risk defaulting on a reverse mortgage and even possibly face foreclosure.

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Consider also:What Is a P&I Payment on a Mortgage?

How Do You Qualify for a Reverse Mortgage?

To qualify for a reverse mortgage, you must be at least 62 years old and have a minimum of 50 percent equity in your house. Your house must be your primary residence.

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In addition, you'll be required to attend a session with a reverse mortgage counselor who will make a financial assessment of your ability to understand the terms and conditions of a reverse mortgage.

What Are the Different Types of Reverse Mortgages?

Reverse mortgages are available in four types:

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Home equity conversion mortgage (HECM) -​ The U.S. Department of Housing and Urban Development (HUD) and the Federal Housing Administration (FHA) back home equity conversion mortgages. These loans are only available through reverse mortgage lenders approved by the FHA.

The amount of the loan is based on the home's appraised value and is subject to FHA limitations. Currently, for 2021, the maximum loan amount for this type of mortgage is ​$822,372

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HECMs can be slightly more expensive than conventional mortgages, but you can use the funds for almost any purpose you want. You can get your money in a lump sum, as fixed monthly payments or as a line of credit, similar to a home equity line of credit.

Home equity conversion mortgage for purchase -​ If you're planning to downsize and need money to purchase a new home while waiting to sell your current home and get a new loan, a home equity conversion mortgage for purchase could be the way to go. The FHA also backs this type of mortgage.

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Proprietary reverse mortgage​ - Private lenders offer proprietary reverse mortgages. These loans are not subject to the maximum FHA limitations and can be as much as $4 million. You can receive the funds in a lump sum or with monthly payments, and you can use the money for any purpose.

The federal government does not insure proprietary reverse mortgages, and borrowers don't have to pay for mortgage insurance or attend financial counseling sessions. However, due to the lack of federal backing, proprietary reverse mortgages often come with higher interest rates compared to regular HECM loans.

Single-purpose reverse mortgage​ - Single-purpose reverse mortgages are offered by some state and local government agencies and various nonprofit institutions. They are intended for specific purposes, such as paying property taxes or making much-needed home improvements.

In some cases, a reverse mortgages can be a convenient source of funds to supplement retirement income or to pay medical expenses.

How Much Money Can You Borrow?

The amount of money that you can get from a reverse mortgage depends on the type of loan you select, the age of the youngest borrower, current interest rates and the amount of equity in your home. As with a traditional mortgage, reverse mortgage lenders also charge upfront closing costs that include origination fees, underwriting costs and servicing fees. These charges can be deducted from the loan amount and will reduce the amount you receive from your reverse mortgage.

The money you receive from a reverse mortgage is not taxable.

Consider also:Can I Have Two HELOCs From Different Banks?

What Are the Advantages and Disadvantages of a Reverse Mortgage?

Reverse mortgages have the following advantages.

Access to cash​ - If you have built up enough equity in your home, a reverse mortgage can give you access to cash to pay medical expenses, take a vacation or use as income in retirement.

No payment required​ - You don't have to make any payments on a reverse mortgage until you either sell the house, move out or pass away.

Non-recourse​ - Reverse mortgages are non-recourse, which means that you can only owe the amount of your loan even if your house goes down in value.

No taxes​ - The proceeds from a reverse mortgage are not subject to taxes.

Right of occupancy​ - If they are a co-borrower, a surviving spouse has a right to stay in the house in the event the other spouse passes away.

These are the disadvantages you will want to consider before taking out a reverse mortgage.

Mortgage insurance​ - Borrowers must pay mortgage insurance premiums for the life of the loans that are federally backed.

Principal residence​ - If you live someplace else for 12 consecutive months and no other eligible co-borrower lives in the house, the lender could accelerate the loan, and it would be immediately due.

Property taxes and insurance​ - Failure to pay property taxes and maintain insurance could be considered a default and trigger foreclosure proceedings.

Death of borrower​ - If the reverse mortgage is not paid back before you and your spouse die, your heirs must pay off the loan balance or 95 percent of the appraised value of the home in order to keep it and prevent foreclosure.

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