How does a reverse mortgage work?

A man researches how a reverse mortgage works.
February 28, 2022 | Jamie Smith

A reverse mortgage is a consumer loan for homeowners aged 62 and up who mostly or entirely own their home. It enables these homeowners to exchange their accumulated home equity and convert it into usable cash. The loan typically does not have to be repaid until the homeowner dies, sells or moves out. Let's take a look at how a reverse mortgage works in a nutshell and whether you should get one.

What is a reverse mortgage?

In plain terms, a reverse mortgage is a loan taken from your home's equity.

Although there are usually no monthly mortgage payments due after the balance is received, homeowners must still pay property taxes, insurance, and maintenance during the term. You also must have a certain amount of equity, usually 50% or more. Most reverse mortgages are structured so that the lender receives ownership of the home after certain conditions are met, such as death of the lendee.

Is a reverse mortgage a good idea?

Although reverse mortgages might be appropriate in some cases, they are often criticized as well. A home is an asset that you can protect, use and pass down. Reverse mortgages turn that asset into cash without having to move, which is nice, but some of that cash will be lost in fees and interest.

If your home is valuable and you prefer to keep living in it, many credit unions and other lenders will suggest other ways of making money from your home. Common strategies include selling it and moving into a more affordable place or renting out part of it.

How do reverse mortgage lenders make money?

One of the main ways banks and other lenders make money on reverse mortgages is because they end up with ownership of the house, which they can sell again or rent.

Signing away equity in your home is a big decision.

Types of reverse mortgages

There are three forms of reverse mortgages, each meeting the needs of different financial situations.

Proprietary reverse mortgage

This is a private loan that is not guaranteed by the government. This form of reverse mortgage often provides a greater loan advance, especially if you own a higher-valued house.

Single-purpose reverse mortgage

Single-purpose loans are the most affordable sort of reverse mortgage. Nonprofits and state and municipal governments provide these loans for specific objectives specified by the lender. Loans may be made available for purposes like repairs or renovations. Other limitations for loan accessibility will apply.

Home equity conversion mortgage (HECM)

An HECM is backed by the United States Department of Housing and Urban Development. They can have more expensive fees than other types, but the funds can be used for almost anything. Borrowers have the option of receiving their funds in a variety of methods, including a lump amount, set monthly installments, a line of credit, or a mix.

HECMs are the most common type of reverse mortgage. Some other HECM requirements are:

  •  Occupy the property as your principal residence. You must not owe any federal taxes.
  • You must own the house fully or have a minimal mortgage balance remaining.
  • The property must qualify as a single-family or multifamily house.
  • You must be able to cover future housing expenses.
  • Be 62 years of age or older.

If you are married, you and your spouse should both be named as co-borrowers on the reverse mortgage loan. If one spouse dies or needs to move out for medical reasons, the other can continue living in the property and receive the money.

Pros and cons of reverse mortgages

Let's go over the core reasons why you might choose or not choose a reverse mortgage. Some of the pros are:

  • You can continue to live in your house as long as you pay your property taxes, insurance, and upkeep the property.
  • You make no monthly mortgage payments, or at least have no obligation.
  • You cannot owe the lender more than the value of the home itself when it is sold.

Some of the cons of reverse mortgages are:

  • Processing fees are much higher compared to other options.
  • Fixed-rate reverse mortgages have stricter amounts than adjustable-rate ones.
  • Reverse mortgages can potentially interfere with qualifications for benefit programs like Medicaid.
  • You can still get your home foreclosed for breaking the terms.
  • You reduce the inheritance you leave for your family.

Do my heirs have to pay off my reverse mortgage?

Heirs of a reverse mortgage lendee have several options. Most reverse mortgages end when the borrower moves, sells the home, or passes away, although they can be paid off deliberately before that point to reclaim the property.

In an estate situation, heirs can sell the property to repay the debt. They can also keep the home and refinance the reverse mortgage balance if the property has enough value. Finally, if the debt exceeds the value of the property, heirs usually opt to give the title back to the lender.

There are alternatives to a reverse mortgage. Speak to an attorney for more information about your particular situation.

Avoid a reverse mortgage with an Alliant mortgage refinance

Alliant has mortgage loan options to fit any budget.

Want to learn more about better mortgage options? Check out these other articles:

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