How Does A Reverse Mortgage Work?

By Eric Tyson, Robert S. Griswold

What is a reverse mortgage? A reverse mortgage is a loan against your home that you don’t have to repay as long as you live there. In a regular, or so-called forward mortgage, your monthly loan repayments make your debt go down over time until you’ve paid it all off. Meanwhile, your equity is rising as you repay your mortgage and as your property value appreciates.

With a reverse mortgage, by contrast, the lender sends you money, and your debt grows larger and larger as you keep getting cash advances (usually monthly), make no repayment, and interest is added to the loan balance (the amount you owe). That’s why reverse mortgages are called rising debt, falling equity loans. As your debt (the amount you owe) grows larger, your equity (that is, your home’s value minus any debt against it) generally gets smaller. However, your equity could increase if you’re in a strong housing market where home values are rising nicely.

If your financial goal is to preserve the equity in your home, you may be able to conservatively structure your reverse mortgage so you limit the amount of equity you pull out of your property to the estimated increase in home values anticipated over future years. Now predicting future real estate appreciation is definitely an inexact science. But real estate values do generally rise over time, and you may find that if you’re modest in the amount of money you receive from the lender, you haven’t eroded your home equity as much as you thought.

Reverse mortgages are different from regular home mortgages in two important respects:

To qualify for most loans, the lender checks your income to see how much you can afford to pay back each month. But with a reverse mortgage, you don’t have to make monthly repayments. Thus, your income generally has nothing to do with getting a reverse mortgage or determining the amount of the loan.

With a regular mortgage, you can lose your home if you fail to make your monthly repayments. With a reverse mortgage, however, you can’t lose your home by failing to make monthly loan payments — because you don’t have any to make!

A reverse mortgage merits your consideration if it fits your circumstances. Reverse mortgages may allow you to cost-effectively tap your home’s equity and enhance your retirement income. If you have bills to pay, want to buy some new carpeting, need to paint your home, or simply feel like eating out and traveling more, a good reverse mortgage may be your salvation.

Keep reading to discover reverse mortgage pros and cons.

Who can get a reverse mortgage?

Of course, reverse mortgages aren’t for everyone. Alternatives may better accomplish your goal. Also, not everyone qualifies to take out a reverse mortgage. Specifically, to be eligible for a reverse mortgage:

You must own your home. In the early years of reverse mortgages, as a rule, all the owners had to be at least 62 years old. Now, in a couple, you may qualify for a reverse mortgage if one person is at least 62 years of age and the other person is younger than that. However, such a couple will qualify for lower reverse mortgage money due to the younger spouse because “life expectancy” is part of the calculation.

Your home generally must be your principal residence — which means you must live in it more than half the year.

For the federally insured Home Equity Conversion Mortgage (HECM), your home must be a single-family property, a two- to four-unit building, or a federally approved condominium or planned-unit development (PUD). Reverse mortgage programs will lend on mobile homes with foundations that meet the U.S. Department of Housing and Urban Development (HUD) guidelines but won’t lend on cooperative apartments.

If you have any debt against your home, you must either pay it off before getting a reverse mortgage or, as most borrowers do, use an immediate cash advance from the reverse mortgage to pay it off. If you don’t pay off the debt beforehand or don’t qualify for a large enough immediate cash advance to do so, you can’t get a reverse mortgage.

One final and important point about qualifying for a reverse mortgage: Lenders are now required to perform a financial assessment analyzing the prospective borrower’s financial situation, including credit history and monthly income and expenses. Lenders pay particular attention to whether borrowers have enough cash flow to pay their property tax and home insurance bills.

How much money can you get and when?

The whole point of taking out a reverse mortgage on your home is to get money from the equity in your home. How much can you tap? That amount depends mostly on your home’s worth, your age, and the interest and other fees a given lender charges. The more your home is worth, the older you are, and the lower the interest rate and other fees your lender charges, the more money you should realize from a reverse mortgage.

For all but the most expensive homes, the federally insured Home Equity Conversion Mortgage (HECM) generally provides the most cash and is available in every state.

In general, the most cash is available for the oldest borrowers living in the homes of greatest value over current debt (net equity) at a time when interest rates are low. On the other hand, the least cash generally goes to the youngest borrowers living in the homes of lowest value (or with high current debt) at a time when interest rates are high.

The total amount of cash you actually end up getting from a reverse mortgage depends on how it’s paid to you plus other factors. You can choose among the following options to receive your reverse mortgage money:

  • Monthly: Most people need monthly income to live on. Thus, a commonly selected reverse mortgage option is monthly payments. However, not all monthly payment options are created equal. Some reverse mortgage programs commit to a particular monthly payment for a preset number of years. Other programs make payments as long as you continue living in your home or for life.

Not surprisingly, if you select a reverse mortgage program that pays you over a longer period of time, you generally receive less monthly — probably a good deal less — than from a program that pays you for a fixed number of years.

  • Line of credit: Instead of receiving a monthly check, you can simply create a line of credit from which you draw money by writing a check whenever you need income. Because interest doesn’t start accumulating on a loan until you actually borrow money, the advantage of a credit line is that you pay only for the money you need and use. If you have fluctuating and irregular needs for additional money, a line of credit may be for you.

This is also the preferred way to access funds if your financial goal is to limit the equity you pull from your home to its increase in value. The size of the line of credit is either set at the time you close on your reverse mortgage loan or may increase over time. Generally, during the first 12 months, you can receive up to but no more than 60 percent of the maximum loan allowed.

  • Lump sum: The third, and generally least beneficial, type of reverse mortgage is the lump-sum option. When you close on this type of reverse mortgage, you receive a check for the entire amount that you were approved to borrow. Lump-sum payouts usually make sense only when you have an immediate need for a substantial amount of cash for a specific purpose, such as making a major purchase or paying off an existing or delinquent mortgage debt to keep from losing your home to foreclosure.

Ironically, but also a blessing, when your financial troubles are caused by falling behind on your mortgage payments, you can get a reverse mortgage to tap the remaining equity in your home to assist in resolving your immediate pending foreclosure.

  • Mix and match: Perhaps you need a large chunk of money for some purchases you’ve been putting off, but you also want the security of a regular monthly income. You can usually put together combinations of the preceding three programs.

Some reverse mortgage lenders even allow you to alter the payment structure as time goes on. Not all reverse mortgage programs offer all the combinations, so shop around even more if you’re interested in mixing and matching your payment options.

When do you pay the money back?

Some reverse mortgage borrowers worry about having to repay their loan balance. Here are the conditions under which you generally have to repay a reverse mortgage:

  • When the last surviving borrower dies, sells the home, or permanently moves away. “Permanently” generally means that the borrower hasn’t lived in the home for 12 consecutive months.
  • Possibly, if you do any of the following:
    • Fail to pay your property taxes
    • Fail to keep up your homeowners insurance
    • Let your home fall into disrepair

If you fail to properly maintain your home and it falls into disrepair, the lender may be able to make extra cash advances to cover these repair expenses. Just remember that reverse mortgage borrowers are still homeowners and therefore are still responsible for taxes, insurance, and upkeep.

What do you owe?

The total amount you will owe at the end of the loan (your loan balance) equals

  • All the cash advances you’ve received (including any used to pay loan costs)
  • Plus all the interest on them — up to the loan’s nonrecourse limit (the value of the home)

If you get an adjustable-rate reverse mortgage, the interest rate can vary based on changes in published indexes. The greater a loan’s permissible interest rate adjustment, the lower its interest rate initially. As a result, you get a larger cash advance with this type of loan than you do with loans that have higher initial interest rates.

You can never owe more than the value of the home at the time the loan is repaid. True reverse mortgages are nonrecourse loans, which means that in seeking repayment the lender doesn’t have recourse to anything other than your home — not your income, your other assets, or your heirs’ finances.

How do reverse mortgages affect your government-sponsored benefits?

Social Security and Medicare benefits aren’t affected by reverse mortgages. But Supplemental Security Income (SSI) and Medicaid are different. Reverse mortgages will affect these and other public benefit programs under certain circumstances:

Because they don’t count as income, loan advances on a reverse mortgage generally don’t affect your benefits if you spend them during the calendar month in which you get them. But if you keep an advance past the end of the calendar month (in a checking or savings account, for example), it counts as a liquid asset. If your total liquid assets at the end of any month are greater than $2,000 for a single person or $3,000 for a couple, you could lose your eligibility.

If anyone in the business of selling annuities has tried to sell you on the idea of using proceeds from a reverse mortgage to purchase an annuity, you need to know that annuity advances reduce SSI benefits dollar for dollar and can make you ineligible for Medicaid. So if you’re considering an annuity and if you’re now receiving — or expect that someday you may qualify for — SSI or Medicaid, check with the SSI, Medicaid, and other program offices in your community. Get specific details on how annuity income affects these benefits.