How do reverse mortgages work?

How do reverse mortgages work?

When you have a regular mortgage, you pay the lender each month to buy your home over time. You take out a loan the lender pays you with a reverse mortgage. Reverse mortgages take a portion of the mortgage payment on your home and convert it into payments on your behalf—a type of advance payment on equity or accumulated amortization on your home mortgage ., en español). Usually, the money you get is tax-free. Generally, you do not have to pay the money back as long as you live in your home. When you die, sell your home, or move, you, your spouse, or heirs will repay the loan. Sometimes this means that you will have to sell your house to raise the money to repay the loan.

There are three types of reverse mortgages: single-purpose reverse mortgages—offered by some state and local government agencies and nonprofit organizations; private reverse mortgages—which are personal loans; and federally insured reverse mortgages, known as Home Equity Conversion Mortgages or HECMs.

If you take out a reverse mortgage of any kind, you receive a loan that you take against the accumulated amortization on your home mortgage. You retain title to your home. But instead of paying the monthly mortgage payments, you receive an advance on a portion of the accumulated amortization on your home mortgage. The money you get is usually taxable and won’t affect your Social Security or Medicare benefits. The loan must be repaid when the last surviving borrower dies, sells the home, or no longer lives in the property as their primary residence. In certain situations, a spouse who is not the loan owner may remain in the home. Some factors about reverse mortgages to consider:

  • They have fees and other costs. Reverse mortgage lenders typically charge an origination fee and additional closing costs, as well as service fees over the life of the mortgage. Some lenders also charge mortgage insurance premiums (for federally-insured HECM loans).
  • The amount owed increases over time. As you obtain money through a reverse mortgage, interest is added each month, calculated on the outstanding balance. This means that, over time, the total amount of your debt increases as the interest on your loan is added.
  • Interest rates may change over time. Most reverse mortgages have variable rates tied to a financial index and change based on market conditions. Variable-rate loans tend to offer more options in how you get your money through a reverse mortgage. Some reverse mortgages—mostly HECMs—offer fixed rates but tend to require you to take out your loan as a balloon payment at closing. The total amount you can borrow is often less than what you could get with an adjustable-rate loan.
  • Interest is not tax-deductible every year. Reverse mortgage interest is not deductible from income tax returns until the loan is paid off, in whole or in part.

You have to pay other costs related to your home. When you take out a reverse mortgage, you retain the title to your home. This means you are responsible for paying property taxes, insurance, utilities, fuel, maintenance, and other expenses. And if you don’t pay your property taxes, don’t have a homeowner’s insurance policy, or don’t maintain your home, the lender may require you to repay the loan. When applying for a mortgage, you have to undergo a financial evaluation.

  • Consequently, your lender may require you to set aside an amount “in reserve” to pay your taxes and insurance during the loan. This “in reserve” amount reduces the number of funds you can receive as payments. And you are still responsible for maintaining your home.
  • What about your spouse? In certain situations, if you took out a HECM loan and signed the loan papers but your spouse did not, your spouse may continue to live in the home even after you die, provided your spouse pays taxes and insurance and continue to hold the property. But your spouse will stop receiving money from the HECM because they were not part of the loan agreement.
  • What can you leave to your heirs? Reverse mortgages can consume the accumulated amortization on your property, which means fewer funds for you and your heirs. Most reverse mortgages have a clause called “non-recourse.” This means that you or your heirs cannot owe more than your home is worth when you repay the loan and when the house is sold. Generally, if you have a HECM mortgage and you or your heirs want to pay off the loan and retain possession of the home rather than sell it, you would not have to pay more than the home’s appraised value.  

Types of reverse mortgages

When you’re considering whether a reverse mortgage is a suitable option for you, also consider which of the three types of reverse mortgages might best fit your needs.

Single-purpose reverse mortgages are the least expensive option. These mortgages are offered by some state and local government agencies and nonprofit organizations, but they are not available everywhere. These loans can only be used for a single purpose specified by the lender. For example, the lender might state that the loan can only be used to pay for home repair or improvement costs or property taxes. Most low- and moderate-income homeowners can qualify for these types of loans.

Private reverse mortgages are loans backed by the same private companies that originate them. You can get a higher loan advance with a private reverse mortgage if you own a high-value home. So if your home has a higher appraised value and a small mortgage, you may qualify for more funds.

Home Equity Conversion Mortgages (HECMs) are federally insured reverse mortgages backed by the Department of Housing and Urban Development (HUD). HECM loans can be used for any purpose.

HECMs and private reverse mortgages can be more expensive than traditional home loans and have high upfront costs. This is important to consider, especially if you plan to stay in your home for a short period or if you plan to borrow a small amount of money. The amount you can borrow with a HECM or private reverse mortgage depends on several factors:

  • Your age.
  • The type of reverse mortgage you choose
  • The appraised value of your home
  • Current interest rates
  • A financial assessment of your willingness and ability to pay property taxes and homeowners insurance

In general, the older you are, the higher the accumulated amortization on the value of your home, and the less you owe on your home, the more money you can get.

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By Cary Grant

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