A reverse mortgage, or “Home Equity Conversion Mortgage,” is a loan option for seniors age 62 and up, with good equity in their homes. It allows borrowers to access a portion of their home equity without needing to sell the home, with the home serving as collateral. It is insured by the Federal Housing Authority, and lenders follow FHA guidelines for qualification.
How Does a Reverse Mortgage Work?
- When a borrower takes a reverse mortgage on their home, the lender pays the borrower based on the amount of home equity they have.
- The borrower can opt for a partial lump sum, monthly payments, or a line of credit — or some combination of the three.
- Funds are paid to the borrower in a lump sum and/or over time, and they create a balance on the loan, which then accrues interest.
- Borrower is responsible for paying taxes and insurance.
- Borrower is not required to make any payments on the loan.
- Loan becomes due when the borrower leaves the home, usually either by moving or passing away.
How Much Loan Can I Get?
- The loan amount is determined by a few factors, most importantly the borrower’s age (or youngest borrower, in the case of a couple), the value of the home, and interest rates.
- Maximum value for homes is up to almost $680,000 this year (but you can still get a loan if your house is worth more).
- Depending on your situation, you can expect to be able to to borrow up to 50-75% of your home’s equity.
- If you have a current mortgage balance, it must be paid off when you take the reverse mortgage (it can be paid off with the new loan or else out of pocket).
Reverse Mortgages Had a “Bad Rep,” But Now Much Safer
Not so long ago, in the years around the financial crisis, a good number of borrowers defaulted on reverse mortgages. In harder times, borrowers found themselves maxing out the loan too quickly, and then having trouble keeping up with taxes and insurance. This caused a number of foreclosures in the years following 2008.
Since then, FHA has mandated stricter guidelines. Borrowers have limited access to the line of credit in the first year. They also must attend counseling from a third-party provider, and mortgage insurance premiums can go up for “big spenders” on credit lines.
These days, the reverse mortgage loan is used by many as a strategic and powerful tool for retirement.
Reverse Mortgage Advantages
- Allows a homeowner to tap into home equity without selling the house.
- Eliminates your monthly mortgage payment.
- Postpone and/or maximize Social Security Benefits.
- Funds freed up for debt payoff or health care expenses.
- Increased income allows “age in place” home improvements.
- Borrower never owes more than the value of the home.
- At payoff time, if home value beats the loan amount, you/heirs keep the difference.
- The line of credit option can be an interesting tool for investment. If you keep the balance to zero, the loan accrues interest in your favor.
Reverse Mortgage Example
For a borrower aged 65, with a house worth $500,000 and owing $100,000, here is what a Reverse Mortgage would look like:
- Loan gets paid off and they’ll no longer have a mortgage payment. Borrower pays taxes and insurance.
- Credit line available of $103,420. $22,200 of that amount would be available when the loan funds and the additional amount of $81,220 would be available after one year.
- Untapped credit gains interest and grows for the borrower, and only what they use accrues interest.
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What You Should Know About Reverse Mortgages
- Since it’s a riskier loan product, closing costs are higher.
- Upfront costs include 2% of the home value, plus mortgage insurance of 1/2% per year.
- Borrower requirements are less strict than other loans (HELOC loans, for example).
- They do create a lien on the property.
- If/when owner is out of the house for a year or more, then the loan becomes due – must sell or refinance to a different loan product.
- You’ll reduce the equity you’re passing on to your heirs.
- You must pay taxes/insurance to protect your asset and not cause a foreclosure.
- If you outlive the loan payments, you’ll still receive them. Neither you or your heirs will be responsible for any deficit, and you won’t suffer any negative credit consequences.
- You won’t have to pay the loan back until you leave the house, but the bank has a lien against the house and holds more and more equity the higher your loan gets.
- If your loan equity is maxed out, your heirs will still have an option to buy back the house at 95% of value from the bank.
- You’ll want to look out for scam artists who like to prey on seniors.
If You’re Not in Your “Forever Home”…
Downsizing — moving to a smaller, less expensive place — is another great way to benefit from your home equity in retirement.
It’s never too early to talk with a professional about your options! Click here to schedule an appointment or call Jessica at 720.514.9540.
Read Using Your House for Income in Retirement, an informative guide written by the Center for Retirement Research at Boston College, for more information on all aspects of this important decision.