As we age, most of us find that the cost of quality health care is far higher than we ever expected. When you’re on a fixed, limited income, the care you need can be hard to afford, even if you have a fair amount of equity in your home. Home equity is the amount of money you would have if your home sold–i.e., the current market value minus anything you still owed on the original mortgage or other liens. A reverse mortgage is one of the financial products available to help pay for health care or other living expenses, designed specifically to help those 62 and older with limited incomes access the equity they have in their home.
Here, we’ll explain the basics of a reverse mortgage and, importantly, under what circumstances it makes sense to consider one. There are other methods of accessing the equity in your home and, depending on your particular circumstances, a home equity loan or line of credit, or a home equity investment might be better for you.
The basic concept of a reverse mortgage is pretty simple. Understanding whether or not a reverse mortgage is the right solution for your particular circumstances is more complicated.
Aren’t reverse mortgages bad? Not necessarily. Reverse mortgages got a justifiably bad rap in the 1990s as a result of predatory loans that ended in folks losing their homes. However, reverse mortgages are not intrinsically bad, and a government-insured reverse mortgage can be exactly the right kind of financial help some people need. After we explain what a reverse mortgage is, we’ll cover the circumstances in which one can be a good option, and, at the end of this article, we’ll talk about the protections that have been put in place since the 90s to make reverse mortgages safer and better products for the intended borrowers.
What is a reverse mortgage?
A reverse mortgage is a loan in which the lender pays you in exchange for equity in your home. The proceeds of the loan can be paid in the following ways:
- Lump sum, the only option with a fixed interest rate
- Equal month payments (i.e., annuity or a tenure plan) for as long as a borrower lives in the home. A line of credit may be added to this option in the original loan agreement.
- Term payments, which are equal monthly payments for a set period of the borrower’s choosing, such as 10 years. A line of credit may be added to this option as well.
- Line of credit, in which the borrower can access the money available as needed, paying interest only on the funds actually borrowed.
Regardless of which option a borrower chooses, only 60% of the total loan proceeds, also known as the initial principal, will be available in the first year. For example, if a borrower receives a loan of $250,000 she will only be able to access $150,000 of that money in the first 12 months.
When the borrower moves out for more than 12 months, sells the home, or dies, the loan becomes due. Until then, the borrower makes no loan payments, and the money the lender pays you is not taxable, as it’s not considered income by the IRS. Generally, the loan is paid off by the sale of the home.
In other words, in a reverse mortgage, as the lender pays you for the equity in your home, the loan balance goes up, and how much of your home you own (your equity in the home) goes down.
Here’s a situation in which a reverse mortgage would be a good option:
Elaine is an 80-year-old widow who owns her home in Los Angeles. She receives $700 a month in social security and another $100 from her IRA, and she uses that $800 a month for living expenses, including food and gas. Unfortunately, she has recently been diagnosed with a chronic illness that will require her to have a caregiver, which will cost another $1,200 a month.
Elaine’s home is worth about $800,000 on the current market. She has a 30-year mortgage, which she has paid off with the exception of the remaining $125,000. With a reverse mortgage, Elaine can access $109,240 in cash at closing and can have access to another $156,160 after 12 months. Alternatively, she could access a line of credit of up to $195,800, from which she must draw a minimum of 25% or a maximum 90% at closing. She also has the ability to draw upon or repay the line of credit over a 10 year period.
How do you qualify for a reverse mortgage?
There are rules about who qualifies for a reverse mortgage, as well as guidelines that suggest who is likely to actually benefit from a reverse mortgage, rather than being financially harmed by one. First, we’ll cover the rules that apply to reverse mortgages, including the closing costs, which are significant.
Over 90% of reverse mortgages, according to the FDIC, are home equity conversion mortgages (HECM). Sometimes referred to as Federal Housing Administration or FHA reverse mortgages, these mortgages are only available through FHA-approved lenders and are insured by the FHA, which is part of the U.S. Department of Housing and Urban Development (HUD).
To qualify for an HECM reverse mortgage borrowers must
- be at least 62 years old and own a home which is in good shape
- have at least 50% equity in their home based on a current appraisal, not the original cost of the home. (This means you can get a reverse mortgage on a home for which there is still an outstanding mortgage balance.)
- live in the home as their principal residence
- keep up with property tax and home insurance payments, as well as any home maintenance and repair costs, during the life of the loan
- be counseled by a HUD-approved reverse mortgage counseling agency about eligibility, alternatives, and the financial implications of the reverse mortgage
- not owe any federal debt, including income taxes or student loans
Some of these conditions can be met with money from the reverse mortgage. For example, if you owe money on federal taxes, the home’s “forward” mortgage (that is, the original one from when the home was originally purchased), or the house requires repairs, money from the reverse mortgage can be used to pay these costs.
In terms of how much money a reverse mortgage is likely to offer you, the upshot is, the older you are, the more equity you have in your home, and the lower the interest rate on the mortgage, the more money you’ll be eligible for.
A reverse mortgage can be right for you, if you:
- Have paid down a significant portion of your mortgage.
- Are having difficulty making your monthly housing payments, but have the ability to continue paying for your homeowners insurance, property taxes, and home maintenance.
- Do not need all your cash up front.
- Cannot qualify for a cash out refinance or a home equity loan due to limited cash flow or poor credit.
- Do not mind leaving less–or no–equity in your home to your heirs.
- Plan on or desire staying in your home.
The ideal reverse mortgage borrower is someone well over 62 on a limited income who owns most or all of their own home, which is in good condition. The borrower plans to live in the home for as long as possible but is not necessarily planning to leave it to an heir, as there will be less—or no—equity left in the home after the reverse mortgage is paid off.
How much does a reverse mortgage cost?
Although borrowers don’t make any loan payments until they are no longer in the home, they must pay the property taxes, home insurance (and any homeowners’ association fees) and keep the home in good condition. If the property taxes are not paid, the lender can foreclose on the loan, as in a forward mortgage. Foreclosure means the lender takes possession of the property immediately in order to sell it.
Reverse mortgages mean no monthly loan payments, but they are frontloaded with fees that are typically higher than other home loans, most of which are usually rolled into the cost of the loan. (The lender’s fee is capped at $6,000. See table.) In addition to those closing costs, there are a few ongoing fees that continue to get charged over the life of the loan. Thus, the loan and its fees are accruing interest as the loan ages. This is another reason that, unlike the “forward” mortgage used to buy a home, borrowers owe more on a reverse mortgage over time, not less.
The closing costs of the loan, except for the counseling fee, can be paid for with funds from the reverse mortgage, but the total amount of money you receive from the loan will be less.
Is a reverse mortgage the right solution for you?
Reverse mortgages are straightforward in concept, but, in practice, they have a lot of complex moving parts that affect borrowers, non-borrowing spouses, and heirs. When it comes to figuring out whether or not a reverse mortgage is the right solution for an individual (and their family), there are a number of questions that need to be answered, beyond whether or not the borrower technically qualifies.
- Where is most of your equity?
- How long are you planning to stay in the home? Will someone else living in the home need to stay after the borrower has left?
- Were you planning to leave the home to an heir without a mortgage?
Reverse mortgages were designed to help older and retired folks who own most or all of their own home but don’t have enough cash, either for living expenses or medical costs. Those with more cash or not on a limited, fixed income can likely qualify for other types of loans that may better serve their needs, and that will have lower closing costs.
Because a reverse mortgage means that the lender is paying you in exchange for equity in your home, this kind of loan works well for people planning to stay in the home for as long as possible and aren’t planning on leaving the property to an heir(s). Typically, a reverse mortgage is paid off by selling the home when the borrower permanently moves out or dies. Thus, a reverse mortgage likely isn’t appropriate for those who will need to move for medical or other reasons or those planning to leave their home to an heir(s).
What happens to a non-borrower spouse if the borrower dies/moves out?
If the non-borrowing spouse qualifies as an “Eligible Surviving, Non-Borrowing Spouse” on the borrower’s HECM loan, that spouse may continue to live in the mortgaged property after the death of the last surviving borrower, as long as the following conditions are met:
- The non-borrowing spouse is named in the loan documents as a Non-Borrowing Spouse.
- The non-borrowing spouse lived in the home at the time of closing on the loan and the home continues to be the spouse’s principal residence.
- The HECM is not in default for failure to pay property taxes or make hazard insurance payments, or any reason other than the last borrower's death or because the last surviving borrower has moved into a healthcare facility for more than 12 consecutive months.
- The borrower and spouse were legally married at the time the HECM closed and remained married until the HECM borrower's death.
Children and other relatives and dependents who are not listed as borrowers will not be able to stay in the home once the loan is due without paying it off.
Are reverse mortgages "bad"?
The short answer is: No, but they aren’t the right option for everyone. Alternatives like home equity loans should also be considered, to avoid ending up with a financial product that isn’t a good match for a family’s circumstances. Think of it like this: Reverse mortgages aren’t bad, but there are bad reverse mortgages.
Here’s the longer answer to that question. In the 1980s, reverse mortgages gained a bad reputation after some borrowers found themselves “underwater,” that is, owing more money on the mortgage than the house was worth, and others were taken advantage of by predatory lenders. Foreclosures increased and surviving spouses who were not listed as borrowers on the loan could lose their homes. Since the 1990s, various legislation has passed to better protect reverse mortgage borrowers.
During the 2000s, counseling policies were improved, origination fees were capped, and cross-selling, that is, selling additional financial products, was prohibited. HUD also reduced the total amount of money that can be borrowed, known as the principal limit, increased mortgage insurance premiums, and lowered the interest floor rate 0.5%, in order to reduce the number of foreclosures.
More recently, the Reverse Mortgage Stabilization Act of 2013 limited the amount borrowers can access in the first year of the loan; created the life expectancy set-aside (LESA) an escrow account funded from the loan proceeds for those borrowers whose risk of defaulting is higher; and made it somewhat easier for non-borrowing spouses to stay in the home after the borrower is no longer living there.
Reverse mortgages can still be technically “underwater,” in that the balance on a reverse mortgage can grow higher than the home’s value. However, an FHA-insured HECM loan means that lenders cannot get that money from the borrower or their heirs. This is called a “non-recourse clause.” The proceeds from the sale of the house cover the borrowers’ and heirs’ financial obligation, and those mortgage insurance premiums attached to the loan cover lender losses if the loan is worth more than the property. In other words, the up-front and ongoing mortgage insurance premiums borrowers pay on the loan ensure that they (or their heirs) don’t get stuck owing more money than their home is worth.
Getting a proprietary reverse mortgage, that is, one not insured by FHA, can mean higher costs and other financial drawbacks. For example, because these types of reverse mortgages are not insured by the federal government, there are no limits to what they can charge. Neither will they necessarily have a non-recourse clause. Like all financial products, there are credit cards that charge interest rates and fees significantly higher than the national average; reverse mortgages are no different. That’s why it’s essential to compare the terms of multiple options. Choosing the product with the lowest APR, a financial calculation that includes interest rate and fees being charged, will cost the borrower the least to repay. Borrowers may also want to take into consideration other loan terms and the quality of customer service when choosing from multiple options.
The takeaway: Despite their high closing costs, reverse mortgages can be an excellent solution for folks in particular circumstances, but they are definitely not the right financial product for everyone over 62 years of age who need more cash for care.
*sometimes referred to as a second mortgage
Reverse Mortgages and Medicaid
While reverse mortgage payments will not limit your ability to obtain Medicaid, they can still have an impact because of asset limits. If you or your loved one currently receive Medicaid benefits and are considering a reverse mortgage, it’s highly recommended to speak to an Elder Law Attorney, Geriatric Care Manager, or other informed professional before moving forward. You risk the possibility of losing Medicaid benefits from your reverse mortgage payments counting towards your qualifying income.