For those who are at least 62 years old, taking out a reverse mortgage is one way to supplement your income in your retirement years. As long as you live in the home and have a decent amount of home equity, you are likely to be eligible. However, these programs can be complicated and are not right for everyone. That’s why you should understand all the details before you make a decision.
Below, we explain how a reverse mortgage works, including how much it pays and how much it costs.
What is a Reverse Mortgage?A reverse mortgage is a type of home loan that allows homeowners to convert part of their home equity into cash without needing to sell the property. As the name itself suggests, a reverse mortgage is like a regular mortgage, only, the payments are in “reverse.” The lender makes regular monthly payments to the homeowner, rather than the other way around.
How Does a Reverse Mortgage Work?As we’ve mentioned, reverse mortgages are primarily designed for homeowners over the age of 62 who have built up a significant amount of equity in their homes. If this is the case for you, you may want to learn more about the reverse mortgage process, and the various payout options.
Reverse Mortgage Process
- Homeowner Research + Education: Like with any big decision that you make, it’s imperative that you perform research and weigh your options when it comes to choosing a reverse mortgage. Familiarize yourself with the risks, benefits, and criteria (you’re reading this blog, so you’ve already started to do this!). If your reverse mortgage is an HECM backed by the federal government (FHA), you will be required to undertake reverse mortgage counseling with a counselor who has been approved by the Department of Housing and Urban Development.
- Application: After comparing multiple lenders, fill out the application for your top choice. The application will include details about both your property and your personal financial profile.
- Appraisal: The lender will require a professional appraisal of your home, in order to determine its current value. The current market value is used to calculate the loan amount for which you are eligible.
- Loan Underwriting and Processing: The lender will review your application and documents. At this stage, they may request additional documents, so to cut down on the time the processing will take, it is best to be prepared. It is at this time that the lender will also perform credit checks and other assessments of your financial profile in order to determine whether you are able to keep up with monthly payments and meet your obligations.
- Approval and Closing: Once your application is approved, the lender will send you a Loan Estimate that lays out the terms and various costs of the reverse mortgage. At this point, you will undergo a mandated waiting period (usually three days) during which you are meant to scrutinize the agreement and ask any questions that you have. If you decide to proceed, you will schedule a closing date on which you will sign the agreement.
- Disbursement of Funds: Once you’ve closed on the reverse mortgage, you will need to decide how you want to receive the loan proceeds, which can be in the form of a lump sum, monthly payments, a line of credit, or a combination of these options. It’s worth noting that the lump sum option has a fixed interest rate attached, while the other choices utilize variable interest rates. And while you can switch disbursement methods during the term of the reverse mortgage without refinancing between the variable interest rate options, you can’t switch to the fixed rate lump sum.
- Loan Repayment: As long as you remain living in the home and continue to meet loan requirements such as paying property taxes and insurance costs, you won’t need to make any monthly payments. The loan becomes due when you either move, sell the home, or pass away. In the first two cases, you will repay the loan using proceeds from its sale, or other funds; in the latter scenario, your heirs will need to do so.
How Does Your Payment Method Determine How Much You’ll Get Paid?
On the surface, it doesn’t seem like the payment method would affect how much you can get. However, getting paid out in one lump sum versus monthly payments could affect the principal amount of your loan.
Getting the entirety of your reverse mortgage amount all at once means you could be giving up some money in the future, whereas both the fixed monthly payment option and the line of credit option could pay out more to you over time if your home value goes up.
Reverse Mortgage RequirementsWe’ve touched on a few of these already, but be aware that there are several requirements you must meet to qualify for a reverse mortgage.
- Age: You and any of your co-borrowers (a spouse, for example) need to be at least 62 years of age. The older you are, the more you may be eligible to borrow.
- Home Equity: You must own your home outright or have a substantial amount of equity in it. In some cases, if you have an existing mortgage, you may still qualify for a reverse mortgage if the loan balance can be paid off with the reverse mortgage proceeds.
- Primary Residence: The property must be your primary residence. In other words, vacation homes and investment properties are not eligible for a reverse mortgage.
- Property Type: The property needs to be either a single-family home, or a multi-family property of up to four separate units (one of which you yourself must occupy). Though some condominiums and manufactured homes may also qualify, they must meet specific criteria set by both the lender and the Federal Housing Administration (FHA).
- Property Condition: Your home must meet certain standards to qualify. If it is in poor condition, you may be required to make repairs before the lender will work with you.
- Financial Assessment: The lender’s assessment of your financial profile will need to determine your ability to meet financial obligations throughout the term of your agreement. In other words, they must find that you are able to pay property taxes as well as keep up with maintenance and insurance costs.
- Counseling: If you habe an HECM reverse mortgage, you will need to attend a counseling session with an HUD-approved counselor, who will ensure that you understand the complexities of the reverse mortgage.
- Financial Obligations: This cannot be emphasized enough! You must continue to pay for both property taxes and insurance, as well as any HOA fees.
Requirements will vary by lender, especially between either a Home Equity Conversion Mortgage (HECM), which is insured by the FHA, or a proprietary reverse mortgage, which is offered by private lenders.
Types of Reverse MortgagesThere are three types of reverse mortgages.
- Home Equity Conversion Mortgage (HECM): The most common and widely-used type of reverse mortgage, the HECM, is insured by the Federal Housing Administration (FHA), and provides certain protections for borrowers. As a result, this type of reverse mortgage has strict requirements regarding age and property type. There are often loan limits enforced that are based on the borrower’s age and the home’s appraised value.
- Proprietary Reverse Mortgage: Also known as “jumbo reverse mortgages,” these reverse mortgages are offered by private lenders and are not insured by the FHA. Compared to HECMs, these loans may have different terms, interest rates, and eligibility requirements, as well as be available to homeowners with higher home values. In addition, proprietary reverse mortgages may also offer more flexible disbursement options, making them a better fit for specific financial situations.
- Single-Purpose Reverse Mortgages: Typically offered by state or local government agencies or nonprofit organizations, these loans are designed for specific purposes, such as home repairs and renovations. As such, the funds can only be used for and towards the designated purpose. This type of reverse mortgage frequently has the lowest interest rate of the three.
How Much Money Do You Get From a Reverse Mortgage?
The amount of money you can borrow depends on how much home equity you have available. You typically cannot use more than 80% of your home’s equity based on its appraised value. In 2023, the maximum amount anyone can be paid from a HECM reverse mortgage is $1,089,300. However, most people will be paid much less.
The exact amount the reverse mortgage will pay you depends on a few different factors, including your age, the current home value, and your interest rate. The chart below shows how much of a difference these factors can make it determining the amount of equity you can tap into:
4% interest rate 5% interest rate 6% interest rate 65 year old borrower 49% 43% 38% 90 year old borrower 69% 65% 62%
How Much Does a Reverse Mortgage Cost?
Because a reverse mortgage is a type of loan, there are various costs associated with taking one out. These include interest on the loan, the origination fee, and any set aside fees. Set aside fees include expenses such as getting your home appraised and making any repairs necessary to get your home approved.
An appraisal can cost anywhere from $250 to $1,000 depending on the size of the home and any complications that arise.
Interest rates fluctuate over time but if, for example, your rate is 5%, that means you’ll be charged 5% of the loan value every year – but you won’t need to pay this immediately. Instead, it will be assessed at the end of your loan term or when you sell the home.
In the case of an HECM backed by the FHA, the origination fee is charged by the reverse mortgage lender to cover their cost of processing your loan application. Usually the origination fee is equal to 2% of the first $200,000 of your home’s value and 1% of any amount above that, with a maximum of $6,000. If your home is worth $125,000 or less, the origination fee cannot exceed $2,500.
Here’s an example. If your home is valued at $350,000, you might expect to pay the following origination fee:
$200,000 x 2% = $4,000 $150,000 x 1% = $1,500 TOTAL: $5,500In addition to these fees, you may need to pay mortgage insurance premiums, closing costs, and typical servicing fees from lenders.
Is a Reverse Mortgage Right For You?
You are the best judge of what is the best fit for you. However, if you’re considering a reverse mortgage, here are a few tips to help you mull it over:
A reverse mortgage might be right for you if:
- You are 62 years of age or older
- You have significant equity in your home
- You plan to stay in your home for 5+ more years
- You can afford to continue to pay property taxes, insurance, and other home maintenance costs
A reverse mortgage might not be right for you if:
- You have savings or other means of obtaining funds to cover expenses
- You have family members who depend on you for housing
- You want to leave your home for someone to inherit with no strings attached
Our Alternative to a Reverse MortgageThere are other options to tap into your equity if you need the funds, such as an equity sharing agreement from Unison. With Unison, you can access up to 15% of your home’s current value in cash, in exchange for a portion of the home’s future change in value. If your home increases in value, the company shares the gain. If your home decreases in value, the company typically shares the loss. There’s no monthly payments, and no interest; you simply settle up when you decide to sell your home, or you can buy Unison out at any time during the 30-year term.
Unison doesn’t have an age requirement, so if you’re concerned about saving for your future–whether by consolidating debt now, renovating your home, starting a business, or simply diversifying your investments–you can get started right away instead of waiting for retirement.