What is a reverse mortgage?

In a reverse mortgage, your lender takes ownership over your home, and pays out part of its equity to you as long as you live there.

Zack Sigel 1600

Zack Sigel

Published October 4, 2018

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KEY TAKEAWAYS

  • Reverse mortgages let you gradually sell the equity in your home to the bank.

  • The bank will own the home, but you can live there until you die or move out.

  • The reverse mortgage will need to be paid back, usually when the bank assumes ownership of the home.

  • You need to be at least 62 years old to take out a reverse mortgage.

When you take out a mortgage, your lender pays for your home and you pay them back every month until the mortgage term ends. After that, you own the home outright.

But say you want to use some of the equity your home has gained over the years to receive some cash against its value. You can sell the home, but then you have to leave, and you may have to downsize. Another option, if you’re at least 62 years old, is to take out a reverse mortgage.

A reverse mortgage is a type of loan in which your lender becomes the owner of the home once again. However, this time the lender pays you for the home, and they’ll continue paying you until they own the home outright or you die.

Reverse mortgages are not for everyone. If you sell the home, the lender can collect the proceeds to pay off the remaining loan balance. But more importantly, you may receive more profit by skipping the reverse mortgage altogether and selling your home at market rates.

Read on:

How does a reverse mortgage work?

Once your house is paid off and you’re eligible to receive a reverse mortgage, your lender will loan you a sum of money using your home’s equity as collateral. Equity is the value your home has gained on the market minus the remaining mortgage balance and any tax liens. A reverse mortgage, which is also called a home equity conversion mortgage (HECM), lets you tap into that equity without having to move out of your home.

Similar to a home-equity loan, the reverse mortgage payment can be either a monthly installment or a lump sum. You can use it to pay big expenses, such as medical treatment, other loan balances, or even just to pay basic living expenses or take a vacation. Some lenders also offer a reverse mortgage line of credit in addition to the cash payment that works like a home-equity line of credit (HELOC).

The difference between a reverse mortgage and a home-equity loan or HELOC is that you don’t have to pay back the reverse mortgage. It chips away at your home equity until the lender owns the house instead, although you get to keep living there as long as you live.

Many major banks have gotten out of the reverse mortgage business, and even the number of smaller lenders who offer reverse mortgages is decreasing all the time because it’s often not a very profitable product.

Who’s eligible for a reverse mortgage?

The eligibility requirements for a reverse mortgage are:

  • You must be at least 62 years old; and
  • Your mortgage must be fully or mostly paid off, or
  • You have a lot of equity on your home.

Unlike “forward” mortgages, there are no income requirements, and you don’t need to have good credit. However, in order to get the most money out of your HECM, you need to stay in the home.

How much does a reverse mortgage cost?

The biggest downside to reverse mortgages is that they cost a lot of money. You’ll not only pay interest on the unpaid loan balance; you may also pay any or all of the following fees:

  • Origination and closing fees
  • Appraisal and home inspection fees
  • Loan servicing fees
  • Mortgage insurance premiums, including both up-front and monthly charges
  • Recording and titling fees
  • Mortgage taxes

Most of these fees should look similar to anyone who’s taken out a mortgage. In some cases, the U.S. Department of Housing and Urban Development regulates reverse mortgage fees and limits how much a lender can charge you.

However, even paying a minimal amount of these costs can seriously curb the value of taking out a reverse mortgage. After all, if your home has equity, you shouldn’t be spending it on additional costs.

Beyond the fees your lender could charge you, you’ll still need to continue paying your regular maintenance fees and property taxes. If you have homeowners insurance, you’ll need to keep paying that, too.

Although you’ll have to pay these fees, you probably won’t have to pay them out of pocket. That’s because they’ll likely be taken out of the equity of your home when you sell the house and move out. While that means you won’t be directly responsible for paying the costs, they could end up leaving your heirs with less money.

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When should I take out a reverse mortgage?

Before you decide to take out a reverse mortgage, consider your other options. While HECMs allow you to stay in your home even as you tap into its equity, it might be more cost-effective to sell your home and use the proceeds to downsize into a smaller one. But there are some situations when reverse mortgages make sense.

You need cash now

Selling your home is a complicated process that could last for a long time. If you need cash immediately, a reverse mortgage may come in handy. This is sometimes called being “cash poor and house rich.” Since you deserve to live a comfortable life in retirement, a reverse mortgage may provide cash where retirement savings and Social Security payments fall short.

You don’t want to leave your home

With a reverse mortgage, you can stay in your home even after all the equity has dried up. If you leave the home, or die, then the lender gets the property.

When is a reverse mortgage a bad idea?

By the time the reverse mortgage is paid off, your home may not have any equity left. That means if you try to sell the home, the proceeds will go the lender to pay any remainder of the reverse mortgage.

Likewise, if you die, your heirs will only benefit from the value of the home left over after the lender has taken its rightful share. Often, this means your loved ones get nothing from the sale of the home and won’t be able to live there after you’re gone.

Anyone who lives with you but doesn’t co-own the home with you could also be out of luck. If you move out or die, this person will have to move out. He or she can’t remain in the home because the lender owns it.

As you age, you’ll have less of a need for a large house. If the housing market is doing well, selling your home and using the profits to purchase a smaller house can leave you with more cash than a reverse mortgage would. You also get to keep the home, and even pass it on your loved ones when you die.

Finally, because so many banks no longer offer reverse mortgages, it may become harder and harder to find a lender you trust to offer you favorable terms. As with any loan, be extra careful before you sign on the dotted line; have a friend or relative look at the terms and conditions and be sure to get everything in writing. Less scrupulous HECM lenders have been caught taking advantage of the elderly and swindling them out of their homes.

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