How Does a Reverse Mortgage Work?

Reverse mortgages can appear confusing, but they’re not as difficult to understand as they may initially seem. These loans have gone through a dramatic transformation over the past decade. They are now powerful financial planning tools that could help you age in place, afford costly home repairs, pay for healthcare expenses, or pursue a lifelong dream. But first, it’s important to understand how reverse mortgages work.

Here’s what you need to consider when deciding if a reverse mortgage is a good option for you.

What Is a Reverse Mortgage?

A reverse mortgage is a loan that lets qualified homeowners ages 62 and older take cash from their home’s equity while still living there. Converting that equity into one-time or periodic payments sent by the lender or using it as a line of credit allows you to enjoy the financial benefits of your home’s equity without selling it.

The most common type of reverse mortgage, a home equity conversion mortgage (HECM), is the only one insured by the federal government. It’s available only through a Federal Housing Administration (FHA)-approved lender.

Some state and local government agencies and nonprofits also offer something called a single-purpose reverse mortgage. In addition, some lenders offer proprietary reverse mortgages.

You can opt to receive your loan in a few ways, including a lump sum, a line of credit, or monthly payments. A combination of these three methods is also available. And as long as you uphold all loan obligations, including living in the property as your principal residence, paying property charges such as property taxes and insurance, and maintaining the home, you don’t have to repay a reverse mortgage loan until you move out, sell the home, or pass away.

Who Qualifies for a Reverse Mortgage?

To be eligible for a reverse mortgage, you must:

• Be at least 62 years old for a HECM
• Be current on any federal debt or it must be paid in full at closing with proceeds from HECM
• Own your home outright or have a significant amount of equity
• Live in the home as your principal residence
• Be financially able to pay property taxes, homeowners’ insurance, HOA fees if applicable, home maintenance, and other associated homeownership costs
• Participate in a consumer information session with a HUD-approved HECM counselor

How much you’ll be able to borrow depends on your age, the current interest rate, and the home’s appraised value.

What Are the Benefits?

A reverse mortgage offers several benefits to borrowers, including confidence in the process. Government oversight means that HECM lenders are regulated and monitored. Other benefits include:

• You receive a supplemental income that can help with expenses after retirement when income drops.
• The IRS considers the payments you receive as “loan proceeds,” not income, so you don’t pay taxes on it. However, you should consult with a tax professional.
• The loan doesn’t need to be repaid until you move, sell, or pass away.
• In the event of the borrower’s death, a qualifying surviving spouse whose name isn’t on the HECM loan can remain in the house, subject to FHA requirements.
• You can use a specific type of reverse mortgage, a HECM for purchase, to buy a home if you have cash for the down payment.

How to Apply

As with any loan, you’ll need to complete an application to determine if you qualify. The application process for a HECM starts with an FHA-approved lender and a mandatory meeting with a counselor from an independent, HUD-approved housing counseling agency. Some proprietary lenders require this as well.

If approved, you’ll pay typical lending fees—closing costs and interest—as well as FHA-specific mortgage insurance for HECM loans.

If you’re enrolled in Supplemental Security Income (SSI) or Medicaid programs, check before applying to ensure that reverse mortgage income won’t disqualify you for that aid.

Whether you apply for a HECM or a proprietary reverse mortgage, talk to different lenders so you can compare interest rates, fees, and reputations. Ask friends for insights from their experiences, too.

If it looks like a reverse mortgage might be the right solution for you, understanding the process, terms, risks, and rewards will help you make an informed decision that suits your retirement lifestyle. And as with all major financial decisions, it’s always best to consult with a financial advisor.

This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.