What Is a Reverse Mortgage and How Does a Reverse Mortgage Work? The Good, the Bad, and the Ugly
Written by Courtland Young, Senior Real Estate Specialist
NMLS #1692428 | CA BRE #01468400
Mortgage Loan Services
If you are 62 or older and own a home, you may have heard some very different opinions about reverse mortgages.
Some people believe a reverse mortgage means the bank takes your house. Others worry that their heirs will automatically lose the home. Some homeowners see a reverse mortgage as a valuable retirement-planning tool, while others believe it is too expensive or risky.
So, what is a reverse mortgage, and how does a reverse mortgage work?
The answer is more straightforward than many people realize.
A reverse mortgage is a type of home loan that allows eligible homeowners, generally age 62 or older, to borrow against the equity in their home. Unlike a traditional mortgage, the borrower generally does not make monthly mortgage payments toward principal and interest. Instead, the loan balance generally increases over time as the homeowner receives money and interest and certain fees are added to the balance.
The most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM), which is insured by the Federal Housing Administration (FHA) and administered under the U.S. Department of Housing and Urban Development (HUD).
A reverse mortgage is not right for everyone. But for some homeowners, it can provide another way to use home equity during retirement while continuing to live in the home.
Let's take a closer look at the Good, the Bad, and the Ugly of reverse mortgages and separate the facts from some of the most common misconceptions.
What Is a Reverse Mortgage?
A reverse mortgage is a loan that allows an eligible homeowner to access some of the equity in their home without selling the home.
With a traditional mortgage, you typically make monthly payments to the lender and gradually reduce the amount you owe.
With a reverse mortgage, the process generally works in the opposite direction. Instead of making monthly principal-and-interest payments to the lender, the homeowner can receive money from the lender according to the terms of the loan. Interest and certain fees are added to the loan balance, so the amount owed generally grows over time.
How Does a Reverse Mortgage Work?
For an FHA-insured HECM, the amount a homeowner may be able to access depends on several factors, including the age of the youngest borrower or eligible non-borrowing spouse, the current interest rate, and the lesser of the home's appraised value, the applicable FHA HECM mortgage limit, or the sales price.
The money may generally be received through options such as:
The specific options available depend on the type of reverse mortgage and the terms of the loan.
An important distinction is that a reverse mortgage is still a loan. You are borrowing against your home equity. It is not free money, and the balance must eventually be repaid.
THE GOOD: Potential Benefits of a Reverse Mortgage
You Can Access Home Equity Without Selling Your Home
One of the primary reasons homeowners consider a reverse mortgage is the ability to access home equity while continuing to live in the home.
With an HECM, the title to the home generally remains in the homeowner's name. The home serves as collateral for the loan, similar to a traditional mortgage.
This can be particularly important for homeowners who want to remain in their longtime home rather than sell and move.
You May Be Able to Eliminate an Existing Monthly Mortgage Payment
If you still have an existing mortgage, reverse-mortgage proceeds can potentially be used to pay off that mortgage at closing, provided the borrower qualifies and has sufficient proceeds.
Eliminating an existing required mortgage payment may improve monthly cash flow during retirement.
However, this does not mean the homeowner has eliminated all housing expenses. Reverse-mortgage borrowers remain responsible for required property charges, including property taxes and homeowners insurance, as well as maintaining the property.
You Can Potentially Use the Money for a Variety of Purposes
HECM proceeds can generally be used for purposes the borrower chooses.
Depending on the homeowner's circumstances, the money could potentially be used to:
The important point is that the homeowner is accessing borrowed funds secured by the home. A reverse mortgage should therefore be considered as part of an overall financial strategy rather than simply as additional income.
The Unused Portion of an HECM Line of Credit May Have a Growth Feature
An HECM line of credit can have a growth feature on the unused portion of the available principal limit.
This is important to understand correctly. The growth feature does not mean the homeowner is earning interest on money sitting in a bank account, and it is not an investment return. It is a feature of the available borrowing capacity under the HECM.
Your Credit Score Is Not the Only Factor
Reverse-mortgage eligibility is different from a conventional mortgage approval.
For an HECM, lenders conduct a financial assessment and consider the borrower's ability to meet ongoing obligations associated with the property. Other requirements also apply.
The amount available to the homeowner is influenced by factors such as age, interest rate and property value.
THE BAD: What Are the Disadvantages of a Reverse Mortgage?
Let's be honest.
A reverse mortgage has costs, creates debt and can reduce the amount of equity available in the home over time.
Interest and certain fees are added to the loan balance. As the balance grows, the homeowner generally has less remaining equity in the property.
That is one of the most important considerations when deciding whether a reverse mortgage is appropriate.
You Still Own the Home, But You Still Have Responsibilities
One of the biggest reverse-mortgage misconceptions is that the lender automatically owns the house.
That is not how an HECM works.
The title to the home remains with the homeowner. However, the home is collateral for the loan, and the homeowner must continue meeting the obligations of the loan.
For an HECM, those responsibilities include:
Failure to meet these obligations can cause the loan to become due and payable and can potentially lead to foreclosure.
The Loan Balance Generally Goes Up
This is one of the biggest differences between a traditional mortgage and a reverse mortgage.
With a traditional mortgage, making monthly principal-and-interest payments generally reduces the loan balance.
With a reverse mortgage, the balance generally increases because money is advanced to the homeowner and interest and certain fees are added to the balance.
As the loan balance increases, the homeowner's remaining equity may decrease.
Reverse Mortgages Have Costs
Reverse mortgages can involve several costs, including interest, mortgage insurance premiums for HECMs, origination charges, closing costs and servicing-related costs, depending on the loan.
The CFPB recommends comparing reverse-mortgage offers, including interest rates, fees and other costs, before choosing a lender.
For some homeowners, particularly those who plan to remain in their home for many years, the costs may make sense in relation to the financial benefits. For others, a different strategy may be more appropriate.
THE UGLY: What You Really Need to Understand
The "ugly" part of a reverse mortgage is not necessarily that the product is bad.
It is that the loan has important rules and long-term consequences that need to be understood before signing the documents.
When Does a Reverse Mortgage Have to Be Repaid?
A reverse mortgage generally becomes due and payable when the last surviving borrower dies, sells the home, or no longer lives in the home as their principal residence.
The loan can also become due and payable sooner if the borrower fails to meet important loan obligations, such as paying property taxes and homeowners insurance or maintaining the property.
For HECM borrowers, special rules can apply to eligible non-borrowing spouses and periods of extended absence from the home.
What Happens to Your House When You Die?
This is one of the questions homeowners ask most often:
Will my children inherit my house if I have a reverse mortgage?
A reverse mortgage does not automatically transfer ownership of the home to the lender.
When the last borrower dies, the HECM generally becomes due and payable. The heirs may have options that can include selling the property and using the proceeds to satisfy the loan or paying the loan balance through other available funds if they want to keep the home.
An FHA-insured HECM is also a non-recourse loan. Generally, the borrower or the borrower's estate will not be required to repay more than the value of the home when the loan becomes due, subject to the HECM program's rules.
This is an important protection for borrowers and their estates.
Can the Bank Take Your House?
Not simply because you have a reverse mortgage.
With an HECM, the homeowner retains title to the property.
However, the home is collateral for the loan. If the borrower fails to meet the loan obligations, foreclosure can ultimately become a possibility.
That is why it is important to understand the responsibilities associated with a reverse mortgage before obtaining one.
Who Qualifies for a Reverse Mortgage?
For the most common type of reverse mortgage, the FHA-insured HECM, borrowers generally must:
Additional eligibility and property requirements apply.
Not every property qualifies, and the amount a homeowner can access varies based on several factors.
What Types of Reverse Mortgages Are Available?
There are three broad categories of reverse mortgages:
1. Home Equity Conversion Mortgage
The HECM is the most common reverse mortgage and is insured by the Federal Housing Administration.
HECMs are available through FHA-approved lenders and can generally be used for a variety of purposes.
2. Proprietary Reverse Mortgages
Proprietary reverse mortgages are private reverse-mortgage products that are not FHA-insured.
They may be designed for homeowners with higher-value properties and can have different terms and requirements from HECMs.
3. Single-Purpose Reverse Mortgages
Some state and local governments and nonprofit organizations offer single-purpose reverse mortgages.
These programs generally restrict how the funds can be used and may have specific income or eligibility requirements. Availability varies by location.
Are Reverse Mortgage Proceeds Taxable?
Reverse-mortgage proceeds are generally treated as loan proceeds rather than ordinary taxable income.
However, individual tax circumstances can vary, and receiving loan proceeds can have implications for certain needs-based programs depending on how the funds are handled.
Homeowners should discuss their specific situation with a qualified tax professional or financial professional before making decisions based on tax assumptions.
Does a Reverse Mortgage Affect Social Security or Medicare?
The FTC states that reverse-mortgage proceeds are typically tax-free and generally do not affect Social Security or Medicare benefits.
However, needs-based programs can have different rules. Homeowners receiving benefits such as Supplemental Security Income should understand how reverse-mortgage proceeds and assets could affect eligibility.
Because government benefit rules can be complicated, homeowners should consult an appropriately qualified professional before making decisions based on benefit eligibility.
Is a Reverse Mortgage Right for You?
This may be the most important question of all.
A reverse mortgage is not automatically good, and it is not automatically bad.
It is a financial tool that may make sense for some homeowners and may be inappropriate for others.
A reverse mortgage may be worth exploring if you are 62 or older, have substantial home equity, want to remain in your home, need additional retirement cash flow, or want another way to access home equity.
But you should also consider how the loan could affect your future financial flexibility, your remaining home equity, your heirs and your ability to move later.
The CFPB and FTC both recommend considering alternatives and understanding the costs and obligations before moving forward.
Potential alternatives can include:
The best option depends on your individual circumstances.
Reverse Mortgage Counseling Is Required for HECM Loans
Before obtaining an FHA-insured HECM, prospective borrowers must complete counseling with an approved housing counseling agency.
The purpose of counseling is to help homeowners understand the reverse mortgage, its costs and requirements, and potential alternatives.
This is an important consumer protection and should be viewed as an opportunity to ask questions before making a long-term financial decision.
Reverse Mortgage Questions Homeowners Often Ask
What is a reverse mortgage?
A reverse mortgage is a loan that allows eligible homeowners, generally age 62 or older for an HECM, to borrow against the equity in their home without selling the property. The most common type is the FHA-insured Home Equity Conversion Mortgage.
How does a reverse mortgage work?
A reverse mortgage allows an eligible homeowner to access home equity through loan proceeds. Depending on the loan, funds may be available through a line of credit, monthly payments, a lump sum in certain circumstances, or a combination. Interest and certain fees are generally added to the loan balance, causing the balance to increase over time.
Does the bank own my house with a reverse mortgage?
No. With an HECM, the homeowner retains title to the home. The property serves as collateral for the loan.
Do you make monthly payments on a reverse mortgage?
Generally, HECM borrowers do not make monthly mortgage payments toward principal and interest. However, borrowers remain responsible for property taxes, homeowners insurance, property maintenance and other required obligations.
What happens to a reverse mortgage when the homeowner dies?
When the last surviving borrower dies, the HECM generally becomes due and payable. Eligible heirs may generally sell the home and use the proceeds to satisfy the loan or use other funds to pay the loan if they want to retain the property.
Can you lose your home with a reverse mortgage?
Yes, if you fail to meet the loan's requirements. For an HECM, important obligations include paying property taxes and homeowners insurance, maintaining the home and using it as your principal residence. Failure to meet these obligations can lead to default and potentially foreclosure.
Is a reverse mortgage free money?
No. A reverse mortgage is a loan secured by your home. Interest and certain fees are added to the loan balance, which generally increases over time.
The Bottom Line
So, what is a reverse mortgage and how does a reverse mortgage work?
A reverse mortgage is a loan that allows eligible homeowners to access a portion of their home equity while continuing to live in the property.
The most common type is the FHA-insured HECM, available to homeowners age 62 and older who meet applicable requirements.
The potential benefit is greater access to home equity and retirement cash flow without selling the home.
The tradeoff is that the loan balance generally increases over time, available home equity can decrease, the loan has costs and the homeowner must continue meeting important obligations.
For some homeowners, that tradeoff may be worthwhile.
For others, another financial strategy may be better.
The key is understanding how the loan works before deciding whether it is right for you.
Let's Talk About Your Options
If you're 62 or older and have significant equity in your San Diego-area home, I'd be happy to help you understand how a reverse mortgage works and whether it may be worth exploring for your situation.
There is no obligation to move forward.
We can discuss your goals, explain the available options, review the basic costs and responsibilities, and help you understand the questions you should ask before making a decision.
You've worked hard to build equity in your home.
Let's explore whether your home equity can help support the retirement you worked so hard to build.
Courtland Young
Senior Real Estate Specialist
NMLS #1692428 | CA BRE #01468400
Mortgage Loan Services
San Diego Real Estate & Mortgage
858-337-6317
