A reverse mortgage is typically paid back either when you sell the home or when the homeowner passes away. They are a relatively common way for older homeowners to supplement their retirement accounts, but they can also be a drain on your assets if you’re not careful. Here’s how they work. A financial advisor can help you create a financial plan with additional sources of retirement income.
What Is a Reverse Mortgage?
A reverse mortgage is a loan that you take out against a home that you already own. In this sense it is, as the name suggests, the reverse of borrowing money to buy the house originally.
Most reverse mortgages are a form of home equity loan known as a home equity conversion mortgage. This means that you can borrow up to the value of your equity in the house, which is defined as the amount of the home’s value that you don’t owe to any lender.
For example, say you bought a house for $300,000. You have paid $200,000 of this mortgage and still owe $100,000. You have had the house reappraised and it is currently worth $507,000, the average sale price for a new home at time of writing. Your equity is the value of the house ($507,000) less the remaining debt that you owe on the house ($100,000). In other words, you have $407,000 in equity on this home.
A reverse mortgage is structured differently than an ordinary loan in that you don’t receive the money in one lump sum. Instead, you receive a series of guaranteed monthly payments from the lender for the rest of your life. The lender calculates these payments based on your life expectancy and the amount of equity in your home, and their goal is to loan you no more than the home is worth. For example, someone with $100,000 in equity and a 10-year life expectancy might receive a reverse mortgage worth $10,000 per year, paid monthly.
Reverse mortgages are intended to supplement a household’s retirement income. The idea is that retirees can tap into the value of their home without having to sell the house. For this reason in most, if not all, cases reverse mortgages are legally restricted to people age 62 and older.
Why You Should Be Careful With Reverse Mortgages
Reverse mortgages are a tricky area of finance because they’re a frequent subject of scams and predatory lending.
There is nothing inherently illegitimate about a reverse mortgage. While not necessarily common, these are mainstream financial products that can be useful for the right person. However, they are also relatively complicated loans and in most cases are restricted by law to people over the age of 62. This has made them extremely popular for bad actors targeting the elderly.
The upshot is this: Be careful when researching, shopping for or taking out a reverse mortgage. As with with other financial moves, you should consult a qualified financial expert before taking out a reverse mortgage, as it can save you an enormous amount of trouble in the long run.
How Do You Pay Back a Reverse Mortgage?
Ordinarily a reverse mortgage enters repayment under two conditions: sale of the property or death of the homeowner. With a few exceptions discussed below, so long as you stay in your home a reverse mortgage will not enter repayment during your lifetime. Instead the lender gets repaid from your estate.
Sale of property is a standard clause on most, if not all, home equity loans. If you sell the house you must repay the loan with the proceeds of the sale.
Death of the homeowner is a clause specific to reverse mortgages.
A reverse mortgage enters collection after the homeowner passes away. In the case of a married couple or other joint title, the mortgage enters collection after the last titled owner dies. When this happens your estate has two options.
First, the lender can collect the house as payment for the mortgage. Like an ordinary mortgage the lender cannot claim more than the value of their loan. This means that when they sell the house, they can only keep the amount that the deceased actually borrowed. Anything else returns to the estate and passes on to the heirs.
Unlike a standard mortgage a reverse mortgage cannot go underwater. While lenders structure their loans around your equity in the house, this isn’t a foolproof system. If someone outlives their life expectancy, for example, they may end up borrowing more than the home is worth. The same can happen as interest accumulates or if the value of the home declines. In all cases a lender cannot collect more from the estate than the home. If selling the house doesn’t cover the full value of the loan, they write off the rest.
Second, your heirs do not have to hand over the house. Instead, they can choose to pay off the loan. In that case they will keep the house.
Paying Off a Reverse Mortgage
A reverse mortgage enters collection upon your death. When that happens, your heirs and your estate either pay off the loan or turn over the house.
If your heirs choose to turn over the house, as discussed above, this satisfies the loan entirely. If your heirs choose to pay off the mortgage they must pay the lesser of:
- The value of the loan
- The currently appraised value of the house
If your heirs pay the appraised value of the house, they pay 95% of the home’s current value. This is known as the 95% rule. Unless your heirs make alternative arrangements with the lender, they must pay off the loan within 30 days of the homeowner’s death. The lender can approve repayment extensions in 90-day increments as it sees fit.
Anyone can repay off a reverse mortgage. The money can come from your heirs personally, from your estate or from third parties. Repaying a reverse mortgage does not necessarily give someone an interest in the house. If the lender takes the property, someone can buy the house from them. If someone repays the loan, the house passes to your heirs through the standard process of estate law.
Finally, heirs can either refinance a reverse mortgage or take out a new mortgage. In this case, your heirs will take out a standard mortgage on the property. They will use that to repay the reverse mortgage and begin making monthly payments on the new loan. This is a common approach for people who want to keep a home but who don’t have the money to repay a reverse mortgage up front.
Unusual Circumstances Can Also Trigger Repayment
In most cases, you repay a reverse mortgage when you sell the house or your estate repays the loan after your death. However, a few unusual circumstances can also trigger repayment. Most often, this happens if you move out of the house or if the property becomes legally defective.
For most reverse mortgages, you must repay the loan if the house isn’t your primary residence anymore. This often happens if someone moves in with family or enters an assisted living facility. Ordinarily a family will sell the house at the same time. But if you choose to keep your home you will still have to repay the loan.
You must also repay a reverse mortgage if the property becomes legally defective. For example, if you fail to pay property taxes, homeowner’s association fees or fail to maintain property insurance, you will have to repay the loan. Lenders require this because the property can’t guarantee the loan anymore. They don’t want to inherit a property that has a tax lien or watch as an uninsured house burns to the ground.
In all cases, repayment follows the rules above. You must repay the lesser of the outstanding balance on the loan or 95% of the property’s value.
A reverse mortgage can enter repayment under several circumstances. Most of the time they enter repayment after the borrower’s death or if someone sells the house. In all cases, either you or your heirs can repay the value of the loan or the current value of the house, whichever is lesser.
Tips for Retirement Planning
- Will you need a reverse mortgage? SmartAsset’s retirement calculator can help you figure out set and track how much money your will need for retirement.
- A financial advisor could help you put a retirement plan together for your needs and goals. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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