What to Know About Reverse Mortgages
Seniors can qualify to tap into their home's equity, but beware of pitfalls
For many people, a home is their biggest investment.
In the third quarter of 2022, the median price for a single-family home in the U.S. (meaning half of prices are higher, half lower) was $398,500, according to the National Association of Realtors. In hot markets such as San Francisco, Seattle and Boston, house prices are much higher.
The problem for most people is tapping that investment.
Selling your abode and moving elsewhere is one solution, but that's a tough call for some people. If you've paid off a big chunk of your mortgage or paid it off entirely, a reverse mortgage can be a solution, but check it out carefully before you decide.
Listen: AARP podcast on reverse mortgages
Your home as a piggy bank
A reverse mortgage is a loan based on the paid-up current value, or equity, in your home. Unlike a conventional mortgage, your lender pays you — in monthly payments, through a variable line of credit or in a lump sum. You don't have to repay the loan until you sell your house, move or die.
Your balance is deducted from the proceeds of the sale when it comes due, and you or your heirs will get any money left over.
The most common reverse mortgage is a home equity conversion mortgage (HECM). These loans are insured by the Federal Housing Administration, a unit of the U.S. Department of Housing and Urban Development (HUD). You may also be able to get a reverse mortgage through your state or local government or through private lenders.
The federal insurance guarantees that if the loan balance exceeds the home's sale price, your heirs won't have to pay more than 95 percent of the appraised value. Mortgage insurance pays the remaining balance.
Here are some of the terms for getting a reverse mortgage.
- Types of housing. You can get a HECM on a single-family home or a two- to four-unit dwelling where the prospective reverse-mortgage client owns one unit. HUD-approved condominiums and mobile homes with a permanent foundation manufactured after June 1976 can qualify, too.
- Eligibility. To qualify for this type of reverse mortgage, you must be at least 62 years old and live in the home as your principal residence. You can't be delinquent on any federal debt, and you must participate in an educational session with a HUD-approved HECM counselor.
- Loan limit. HUD annually sets a cap on HECM borrowing. In 2022, the limit is $970,800.
Reverse mortgages aren't cheap, especially with the Federal Reserve raising interest rates in a bid to put the brakes on inflation. The average rate for a fixed-rate reverse mortgage in November 2022 was around 7 percent, similar to that for a traditional mortgage. The interest is cumulative, so the more you take out initially and the longer you have the loan, the more interest you'll pay.
If you take monthly payments, your loan balance will grow.
You'll have other fees as well. The initial fee for HUD mortgage insurance is 2 percent of the appraised value of the home and 0.5 percent annually.
You'll pay fees for closing costs and loan origination, which are capped at $6,000. What's more, you'll pay loan-servicing fees.
Seek the proper approvals
• Counselors. The first step to getting a home equity conversion mortgage is meeting with a counselor to discuss eligibility and whether a reverse mortgage loan is the right financing option for you.
• Condominiums. To take out a reverse mortgage on your unit, it must be your primary residence and the entire complex must have Department of Housing and Urban Development (HUD) approval, because home equity conversion mortgages are insured by the Federal Housing Administration (FHA), a part of HUD.
• Lenders. Only FHA-approved lenders can issue federally insured reverse mortgages.
• Search a list of approved HECM counselors, or call 800-569-4287 for referrals.
• Check the approval status of your condominium development.
• Search HUD's lender list online — Check the box for reverse mortgages and expand outward geographically if the search comes up empty. Or, ask your loan counselor for a list.
Lenders will expect you to pay home insurance as well as property taxes and possible homeowners association fees, although some will set aside part of the loan proceeds to cover those. Continuing home maintenance is also important to stave off little problems before they become serious and reduce the property's value.
Many homeowners view a reverse mortgage the same way they would a cobra in the bathtub. But that's unfounded, says retirement expert Mary Beth Franklin, a certified financial planner who lives in the Washington, D.C., area.
"It's viewed as a last resort, but it shouldn't be,” she says.
One reason for the bad impression: Under previous rules, a spouse who didn't sign the loan could have the house sold out from under them when the borrower died.
HUD changed those rules in 2017. Now, a surviving spouse can remain in the dwelling, even if their name isn't on the loan, and the balance won't be due until they leave. But that spouse must continue to pay the property taxes and insurance and won't be able to continue borrowing money through the reverse mortgage.
Could be a bridge loan
Many people have more money in home equity than they do in their retirement savings account. And unlike a 401(k) account, payments from a reverse mortgage are tax-free.
In some cases, people who want to delay taking Social Security payments, say, until they reach full retirement age, can use a reverse mortgage as a bridge for a few years. And setting a reverse mortgage line of credit can be handy if you run into unexpected expenses, particularly if you have paid off your mortgage.
The government requires a counseling session for good reason. Reverse mortgages are complicated, a circumstance some scammers exploit to defraud older homeowners. It's good to have someone outline all the costs involved and ensure you are dealing with reputable lenders.
Ideally, you should be able to live off Social Security, a pension and retirement savings when you retire. But you shouldn't overlook your biggest asset: your home.
Editor's note: This article was originally published Oct. 19, 2019. It has been updated with more recent information on housing prices and reverse-mortgage interest rates.
John Waggoner has been a personal finance writer since 1983. He was USA Today's mutual funds columnist from 1989 through 2015 and has worked for InvestmentNews, Kiplinger's Personal Finance, the Wall Street Journal and Morningstar.