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How Does a Reverse Mortgage Work?

Many seniors try to pay off their mortgages before they leave their full-time jobs. But this isn’t possible for everyone. If your mortgage payments are eating up a large chunk of your retirement income, you may be desperate for a solution. Fortunately, there may be some financial relief available in the form of a reverse mortgage. Here’s a breakdown of how reverse mortgages work.

What Is a Reverse Mortgage?

A reverse mortgage is a financial tool for qualifying senior homeowners. It supplements their income by allowing them to take advantage of the equity they’ve built in their homes.

There are three kinds of reverse mortgages. Proprietary reverse mortgages come from private lenders and offer larger loans to seniors with high-value homes. Single-purpose reverse mortgages are issued by organizations such as nonprofits and only allow seniors to use their payments to cover the cost of specific expenses. Finally, there are home equity conversion mortgages (HECMs). These mortgages are backed by the Federal Housing Administration. You can use HECM funds for just about any purpose.

Reverse Mortgage Eligibility

You must be at least 62 years old to qualify for a reverse mortgage. If you own a house with someone else (like a spouse, a significant other or a sibling), this rule applies to both of you.

Reverse mortgages are only available for primary residences. If you still have a mortgage, you’ll be required to use your reverse mortgage payout to eliminate that debt. But you may not qualify if you haven’t paid off most of your existing home loan.

The FHA has some additional requirements for homeowners interested in applying for its HECM program. Their primary residence must be a single-family home, a multi-family home or an approved condo or manufactured home. They’ll be expected to meet certain financial criteria and must be able to pay fees, property taxes and insurance payments.

How Does a Reverse Mortgage Work?

How Does a Reverse Mortgage Work?

If you believe you’re eligible for a reverse mortgage, you’ll need to find an approved lender. If you want a loan backed by the FHA, you’ll also need to see a HUD counselor.

Once you’re approved for a reverse mortgage, you’ll never have to worry about paying a monthly mortgage bill again. And you won’t have to sell your house. You’ll receive tax-free payments from your lender in the form of monthly payments, a line of credit or a lump-sum payment (or a combination of the three).

If you want to change the way you receive your reverse mortgage payout, you can do so for a small fee. And if you choose to go with a line of credit, you can potentially earn more money as your credit limit grows over time.

A number of factors determine how much you can borrow, including your age and the appraised value of your home. The older you are, the more you’ll be able to borrow. But if you apply for a reverse mortgage as a couple, the age of the younger applicant will affect the size of your payout. If you get a reverse mortgage through the HECM program, your loan amount will depend on your home’s value, its sale price or the FHA mortgage limit ($625,500), whichever is less.

Interest rates also affect reverse mortgage loan amounts. In most cases, reverse mortgages have variable interest rates (tied to an index) that move along with the market.

Reverse Mortgage Costs

Reverse mortgages come with many different fees and closing costs, including mortgage insurance and loan origination fees. If these costs get rolled into the loan balance, you’ll pay less upfront.

Even though you won’t have to pay a monthly mortgage bill, your lender will expect you to pay for property taxes, insurance premiums, utilities and maintenance costs. If you fail to keep up with these payments, you could lose your home. That’s why it’s important to review your budget before jumping into a reverse mortgage. Some borrowers must set aside funds that their lenders can use to cover the cost of taxes and insurance.

Reverse Mortgage Repayment

How Does a Reverse Mortgage Work?

Borrowers aren’t obligated to repay their reverse mortgage loans until they move out, sell their homes or die. At that point, the entire loan becomes due. You also may be asked to pay it back early if you fail to respect the terms of your loan,

When your loan comes due, you or your heirs could pay it off by selling the house. If you die and your heirs can’t pay off your debt using any other assets from your estate, the lender may begin foreclosure proceedings.

Keep in mind that your reverse mortgage loan balance will grow over time as interest accrues. Eventually, you may use up all of your home’s equity. If that happens, there will be less for your loved ones to inherit. But fortunately, when it’s time to pay off the loan, borrowers (or their heirs) rarely owe more than what the home is worth.

Reverse Mortgage Cancellation

If you get to the closing table and realize that a reverse mortgage isn’t right for you, don’t worry. In most cases, you legally have three days to cancel the loan. You shouldn’t be subject to any penalties, as long as you send your lender a letter explaining that you want to cancel your reverse mortgage loan agreement.

After successfully canceling your reverse mortgage loan, you can expect to receive a refund of any money you’ve spent within 20 days. To be on the safe side, it’s best to keep track of any paperwork related to your loan.

Final Word

Should you take out a reverse mortgage? In order to answer that question, you’ll need to consider everything that goes into applying for a reverse mortgage, including the costs and fees you’ll have to pay. Don’t forget to take your heirs’ opinions into consideration, since they’ll have to pay off your loan if you pass away.

Tips for Retirement

  • You might want to consult a financial advisor before you make any decisions that can impact your retirement funds and stability. Most advisors offer the option for a one-time financial plan if you don’t wish to start a long-term relationship.
  • If you’re not quite retired yet but see the deadline on the horizon, make sure you know how much you need to retire. You don’t want to have your sights set on a date that doesn’t allow you to meet your financial goals in time.
  • Many retirees opt to move to warmer states as well as places that are more friendly tax-wise to those on a fixed income. Check out SmartAsset’s list of the best places to retire.

Photo credit: ©iStock.com/tzahiV, ©iStock.com/Johnny Greig, ©iStock.com/FotoSpeedy

Lauren Perez, CEPF® Lauren Perez writes on a variety of personal finance topics for SmartAsset, with a special expertise in savings, banking and credit cards. She is a Certified Educator in Personal Finance® (CEPF®) and a member of the Society for Advancing Business Editing and Writing. Lauren has a degree in English from the University of Rochester where she focused on Language, Media and Communications. She is originally from Los Angeles. While prone to the occasional shopping spree, Lauren has been aware of the importance of money management and savings since she was young. Lauren loves being able to make credit card and retirement account recommendations to friends and family based on the hours of research she completes at SmartAsset.
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