Reverse mortgages are a type of loan available to people age 62 or older that enable homeowners to convert a portion of the equity built up in their primary residence into cash. Often, retirees use reverse mortgages to pay medical bills or to supplement their retirement income.
Unlike a conventional mortgage, where the borrower makes monthly payments to the lender, a reverse mortgage loan takes some of the equity in the home and turns it into fixed monthly payments to the borrower.
With a reverse mortgage, the homeowner gets to retain the home’s title. The payments received are not usually taxable and shouldn’t affect Social Security or Medicare benefits.
Read on to learn more about how reverse mortgages work:
Types of reverse mortgages
There are three types of reverse mortgages:
Single-purpose reverse mortgages
Backed by some state or local governments or certain non-profit agencies, single-purposes reverse mortgage proceeds must be used for a specific purpose, such as paying for home repairs or to pay property taxes. As a result, these are usually taken in smaller amounts, which makes them the least expensive type of reverse mortgage.
Proprietary reverse mortgages
Also called jumbo reverse mortgages, proprietary reverse mortgages are backed by private lenders or banks. These products are meant for homeowners with highly-valued homes and are not insured by the FHA. Interest rates on these are higher, although fees may be lower.
Federally-insured reverse mortgages
Also known as a home equity conversion mortgage (HECM), this is the most popular reverse mortgage variant. These are backed by the Department of Housing and Urban Development or the Federal Housing Authority (FHA). The borrowing limit for a home equity conversion mortgage is based on the borrower’s age and the home’s value. They can come with a fixed interest rate or an adjustable interest rate.
What are common risks and limits of reverse mortgages?
There are quite a few rules, limitations, and risks to reverse mortgages, so these products are not suitable for everyone.
Here are some important things to know or consider before you apply for one:
- You must remain in your home.
- If you still have a mortgage, you must have enough equity in your home to pay off your outstanding loan balance.
- All homeowners listed on the reverse mortgage paperwork must be at least 62 years old.
- Your home must be approved by the FHA. As a result, typically only single-family homes qualify for reverse mortgages.
- Origination fees associated with reverse mortgages tend to be much higher than those of conventional mortgages—sometimes tens of thousands of dollars. These fees are typically rolled into the loan.
- If you live with someone and they aren’t on the reverse mortgage paperwork, they could be evicted if you die. Eviction is also possible under other circumstances, too, such as if you move out of the home for more than one year.
- If you plan on selling the house or moving out, you only have six months to repay the reverse mortgage. This applies even if you’re moving into an assisted-living facility or nursing home.
Can your spouse stay in the home if you die?
In most cases, a borrower’s spouse must be a co-borrower on the reverse mortgage to be able to remain in the house should the borrower pass away. Otherwise, your spouse is considered a “non-borrowing spouse” and may have to move out of the home.
For home equity conversion mortgages, when the reverse mortgage was assigned determines if a non-borrowing spouse can stay.
If the reverse mortgage was assigned on or after August 4, 2014, a non-borrowing spouse may remain in the home after the borrower’s death, provided that:
- they have the legal property title;
- they were married to the borrower from the time the mortgage was assigned until the time of your death;
- they were specifically named as the non-borrowing spouse on the reverse mortgage contract at the time of assignment;
- the home is their current principal residence–and has been since the time the reverse mortgage was assigned; and
- they continue to fulfill the obligations of the reverse mortgage, such as keeping up with home maintenance and paying property taxes and homeowners insurance on a timely basis.
If the reverse mortgage was assigned before August 4, 2014, the lender may foreclose on the home. However, they may allow a non-borrowing spouse to remain in the home by assigning the mortgage to them, provided they meet certain requirements.
Can I add my spouse as a co-borrower on an existing reverse mortgage?
Depends on your lender. You may have to refinance to a new reverse mortgage to add your spouse as a co-borrower. Unfortunately, if you take the refinance route, you will likely have to pay those costly fees again.
What happens if my home is passed as inheritance?
If you wish to pass on your home to your children or other non-spouse beneficiaries, they will have about 30 days following your death to decide what they want to do with the property. Some lenders may allow them more time.
To keep it the home, the lesser of the balance of the reverse mortgage or 95% of the home’s appraised value must be paid off. As a result, many heirs wind up having to take out a new mortgage on the house to pay off an existing reverse mortgage in order to keep the home.
If the home is sold, the proceeds of the sale will be applied to the outstanding reverse mortgage balance.
Get professional advice before applying
While they can be beneficial under the right circumstances if used correctly and can help retirees stay in their homes longer, reverse mortgages can be difficult to understand and risky. Many reverse mortgage lenders are known for using aggressive sales tactics on older homeowners.
That’s why, if you’re considering one, you should get an outside opinion first to confirm that a reverse mortgage is right for you. Depending on your financial situation, there may be better options available. A professional financial advisor can help you decide if a reverse mortgage is right for you and which of the three available types is best if so — and help protect you from hidden fees or unnecessary limits.
If you’re not working with a financial advisor or are looking for a second opinion about your financial plan, we can help. Request a no-cost, no-obligation consultation with a member of our nationwide advisor network today!