How does a Reverse Mortgage Work?

You’re a senior citizen, in need of cash to fund your retirement, with your life savings tied up in home equity – are you a prime candidate for a reverse mortgage?

A reverse mortgage is a special type of home loan, earmarked only for homeowners who are 62 and older with a substantial amount of home equity to tap into, according to the Consumer Financial Protection Bureau (CFPB). And their uptake is on the rise across the country: in 2021, over 49,200 reverse mortgages were taken out while that number increased to 64,489 in 2022, the National Reverse Mortgage Lenders Association estimates.

It makes sense: the average price for a single-family home in 2023 is roughly $363,000, the National Association of Realtors says. Whether you’ve nearly paid off your mortgage or you own your home in full, that’s a lot of home equity homeowners can turn to for supplementing their day-to-day living.

This is why reverse mortgages are one of several options elderly homeowners can tap into if they’re short on cash during retirement, alongside products like home equity loans and home equity lines of credit.

If you’re curious about reverse mortgages, look no further. Here’s our guide to reverse mortgages, how they work, how to qualify, and how much they may cost you compared to your other choices.

What is a reverse mortgage?

A reverse mortgage is like a traditional mortgage, allowing homeowners to borrow money using their home as collateral for the loan, according to the CFPB.

In a nutshell, reverse mortgages allow seniors to tap into the equity of their homes while deferring payment of the loan. You’ll receive monthly payments, a revolving line of credit, or a lump sum payment – depending on your preferences – but you won’t have to pay back a penny on the reverse mortgage until a later date. There are no monthly mortgage payments: instead, you’ll need to pay back the entirety of your reverse mortgage when you sell your property, move out of the house, or pass away. This total amount includes the principal amount you’ve borrowed, along with interest and fees.

The longer you have your reverse mortgage sending payments out to you, the more you’ll owe over time. Essentially, as your loan balance increases, your home equity decreases.

Just like a traditional home loan, when you take out a reverse mortgage, the title to your home remains in your name and you’re still responsible for paying taxes, insurance, repairs, and maintenance.

These loans are helpful to seniors who have built up a sizeable amount of home equity, and who now need to tap into their nest egg to supplement their income.

Are there different types of reverse mortgages?

There are. The CFPB lists three kinds of reverse mortgage products available to seniors. They include:

• Conventional reverse mortgages provided by Federal Housing Administration (FHA)-approved lenders. These are the most common reverse mortgages, and because they’re insured by the FHA, they follow conforming loan limits set by the federal government.
• Proprietary reverse mortgage loans that are not FHA-insured. You’ll find these kinds of reverse mortgages are typically set aside for borrowers with plenty of home equity because they’re sitting on high-value homes.
• Single-purpose reverse mortgage loans are offered by state and local governments. This last option includes loans that are meant to help homeowners with low incomes.

How do I qualify for a reverse mortgage?

• You must be at least 62 years old. Reverse mortgages are a special type of home loan available to seniors who are homeowners. If you’re below this age, you’ll need to investigate other home equity loan products.

Unlike many other loan products, reverse mortgages don’t come with income or credit score requirements. Aside from age, the CFPB says other reverse mortgage eligibility requirements include:

• Your property must be your principal residence. This means you must live in this home for most of the year.
• You must own the home outright or have a low mortgage balance. Ideally, you own the home outright, meaning there is no outstanding mortgage on it anymore. If not, you should have at least 50 percent home equity.
• You must not owe any federal debt. While credit card debt or lines of credit won’t rule you out as a reverse mortgage candidate, the CFPB says you shouldn’t owe any federal debt, such as federal income taxes or federal student loans. You may, however, use money from the reverse mortgage loan to pay off this debt.
• You must have liquid cash assets. Just like lenders want you to have savings on hand for emergencies when you’re applying for a traditional mortgage, they’ll also expect that you have enough of your own money set aside – or have part of your reverse mortgage funds siphoned off at your loan closing – to take care of ongoing property charges, including taxes, insurance, maintenance, and repair costs. Essentially, your lender wants to know that you have enough cash flow to keep your home – the asset that’s acting as collateral on your loan – in great shape.
• Your property must be kept in good condition. Because your lender gets paid once you sell your home, it’s in their best interests that you keep this asset in top-notch shape. If your house doesn’t meet the required property standards, they’ll insist on specific repairs or renovations that must be made before you can qualify for a reverse mortgage.
• You must receive financial counseling. The U.S. Department of Housing and Urban Development says all reverse mortgage loan applicants must complete a HUD-approved counseling session. This 90-minute session helps candidates consider their eligibility, the long-term financial implications of taking out a reverse mortgage (on them and their families), and the other loan options available to them. It also helps candidates understand how a reverse mortgage could affect their eligibility for government benefits like Supplemental Security Income.

How much can I borrow from a reverse mortgage?

That depends. Every year, the FHA sets loan limits for Home Equity Conversion Mortgages and in 2023, the limit was $1,089,300. That’s a substantial increase from 2022’s $970,800 – 2023 is also the first-time reverse mortgage loan limits surpassed $1 million.

But this doesn’t mean you can take out a seven-figure reverse mortgage. Other factors come into play too, including:

• Your age (and the age of the youngest borrower on the loan). The older you are, the higher your loan amount increases.
• Your home’s appraised value and your home equity. You can’t borrow 100 percent of what your home is appraised at because you must account for loan expenses, like origination fees, insurance premiums, interest, and charges.
• Your financial situation. You’ll have to jump through some hoops to show you’re a responsible borrower – even if you’re putting your home equity on the line. If you put your best financial foot forward, you’ll score a lower interest rate, which means freeing up more of your home equity for your own usage.

How much will a reverse mortgage cost me?

Here’s the catch: However convenient they are for seniors who need cash but don’t want to sell their property, reverse mortgages are an expensive way to borrow money. They’re more costly than other types of financing.

You can pay for the costs of a reverse mortgage through your financing, which means you can cover any charges through the payments you receive instead of out of your pocket. You’ll have fewer funds available to you, though.

Reverse mortgages come with expenses that are similar to closing on a brand-new home loan. You’re responsible for costs like loan origination fees, mortgage insurance premiums, loan servicing fees paid to your lender throughout the entirety of your loan, and third-party charges for an appraisal, title search, inspections, and credit checks, according to the U.S. Department of Housing and Urban Development.

All in all, this can add up to a bill in the thousands of dollars.

When do I have to repay a reverse mortgage loan?

There are a few major instances that would trigger your reverse mortgage to go into repayment, including:

• When you sell your home. Once your home is sold and no longer under your ownership, you’ll need to repay the entirety of your reverse mortgage, typically with the proceeds of the sale.
• When it’s no longer your primary residence. If you move out, transfer to an assisted living facility for more than 12 months, or spend more time in a vacation home, you’re no longer counting your home as your primary residence, triggering the repayment of your loan.
• When you transfer the title of your home into someone else’s name. If you want to list your spouse or children as a co-borrower on your reverse mortgage, they must be at least 62 years old and meet the existing requirements of your loan. You’ll then need to refinance your loan to include the new applicants.
• When you stop paying homeowners’ insurance premiums or property taxes. Just like with a traditional mortgage, you must keep up with your insurance and property tax payments to keep your home loan going. You’ll also need to keep your home in good condition, maintaining it as a valuable asset for resale.
• When you pass away. Your heirs will have to sell your home and apply the proceeds towards paying off your reverse mortgage to your lender.

How soon should my heir repay my reverse mortgage?

You may be thinking about any financial burden you may leave your loved ones once you pass away. Your heir has about 30 days from receiving the payable notice to repay your loan. Their options include selling the home or turning the property over to your lender.

Your heir will never have to repay more than the full loan balance or 95 percent of the home’s appraised value, whichever is less, according to Consumer Affairs.

You can plan your reverse mortgage financing carefully so your lender can recoup their costs from selling your home or transferring the deed to them. Depending on how much home equity you use, you could leave your heirs with money left over too.

What are my other options instead of a reverse mortgage?

Between the eligibility criteria and the hefty costs involved, reverse mortgages aren’t for everyone. While they can be a lifesaver option for seniors who want to stay put in their homes but don’t have any other savings to draw from, there are other options on the table. They include:

• Other home equity loans. Do some number-crunching to see if choices like a home equity line of credit or home equity loan work for your financial situation. They may be a cheaper way to borrow cash while dipping into your home equity. They come with monthly payments you’ll need to stay on top of, though.
• Refinancing your property. Interest rates may have gone down or home values may have steadily crept up, making the conditions right for refinancing your home loan to snag lower monthly mortgage payments. Look at the length of time you’re signing up for though – if you’re nearing retirement, it may not be wise to agree to a new 25-year mortgage. Think of the big picture and what’s feasible in the long run for managing your mortgage and monthly expenses.
• Downsizing. If your mortgage is simply too big and burdensome, it may be worth looking at putting up your home for sale and using the net proceeds to buy a more affordable, easier-to-manage property.
• Waiting. If you sign up for a reverse mortgage too young, you may run out of home equity when you’re older, making it even harder to make ends meet in the final chapters of your life.
• Lowering your expenses. Do some careful budget planning, taking stock of your various income streams, including your pension and government-provided benefits. You can also look into state and local programs that help seniors with bills and day-to-day expenses.

Bottom Line

Reverse mortgages are a great option for seniors with home equity they can tap into to help cover costs in retirement. These kinds of loans come with a big caution, though: you need to fully understand the hefty costs involved and the implications – on you and your loved ones – of using up your home equity.

These are complicated loans, so if you’re considering reverse mortgages, talk to your lender or a financial advisor before proceeding. It’s also worth scoping out your alternatives to help you make a sound final decision.