Key Takeaways
- Reverse mortgages convert home equity into cash for borrowers age 62+.
- Borrowers can receive payments as a lump sum, monthly payments, or a line of credit.
- Borrowers have flexibility in the use of reverse mortgage funds.
- Commonly used HECM loans are insured by the Federal Housing Administration (FHA).
- Reverse mortgages require a financial assessment and financial counseling.
- Reverse mortgage payments are tax-free but may affect eligibility for public benefits.
Reverse mortgages are a loan option for homeowners age 62+ that convert home equity into cash with no monthly payments required. Loan balances grow over time with interest and loan repayment occurs when a borrower permanently leaves, sells, or passes away.
Borrowers can receive reverse mortgage funds as a lump sum, monthly payments, or a line of credit (the most popular option). While they don’t make ongoing payments, like a traditional mortgage, they must pay property taxes, homeowners insurance, and maintenance costs.
This article includes a description of reverse mortgages and key “need to know” concepts including basic features, federally insured HECM mortgages, and reverse mortgage “nevers,” myths, expenses, pitfalls, and tax implications.
Reverse Mortgage Basics
Reverse mortgages help older homeowners convert home equity into spendable cash without having to move. Advantages include: tax-free supplemental income for living costs and discretionary expenses, no monthly mortgage payments, flexibility in the use of funds (e.g., debt repayment, healthcare, travel, and home improvements), and the ability of borrowers to age in place.
In addition, a line of credit grows over time due to a combination of unused funds and accrued interest. Example: If your initial line of credit is $100,000 and you only use $20,000, the remaining $80,000 may grow by several percentage points each year, increasing future borrowing power.
HECM Reverse Mortgages
There are two types of reverse mortgages: private loans and HECM loans, which are the most common type. “HECM” stands for Home Equity Conversion Mortgage. HECM loans are insured by the Federal Housing Administration (FHA), which is part of the U.S. Department of Housing and Urban Development (HUD). Key features of HECM loans are line of credit growth; a primary residence requirement; loan limits based on age, home value, and interest rates; and mandatory counseling with a HUD-approved housing counselor prior to loan approval.
Reverse Mortgages and Financial Planning
The current view of reverse mortgages is as a financial planning tool and not just a last resort.
In addition to providing needed income in later life, reverse mortgages have other uses. For example, they can serve as a “standby fund” for long-term care expenses and a “delay bridge” so people don’t have to withdraw equity assets during market downturns or claim Social Security early.
Occupancy and Property Obligations
Reverse mortgages require the property to be the owner’s primary residence. The borrower must live in the home a simple majority of the year (6 months + 1 day). When single borrowers or both borrowers in a couple leave permanently, the loan comes due.
Ongoing borrower obligations are basic maintenance, property taxes, homeowners insurance, and HOA fees, if applicable.
Typical Reverse Mortgage Borrowers
An outdated stereotype of reverse mortgage borrowers is desperate widows in their 80s with no other income options. However, the borrower profile has shifted significantly over the past decade. Borrowers are increasingly in their late 60s and early 70s, with many using HECMs as proactive planning tools.
While loan eligibility begins at age 62, reverse mortgage usage increases with age because older borrowers can access more home equity. Their shorter life expectancy means less accumulated interest and a lower risk that the loan balance will exceed the home’s value. Therefore, lenders can safely allow more upfront borrowing for older borrowers.
Four “Nevers” of Reverse Mortgages
- Homeowners NEVER give up the title to their home.
- Homeowners or heirs can NEVER owe more than the home’s value.
- Homeowners who meet property obligations NEVER have to move, even if they reach the loan limit.
- Homeowners are NEVER required to make monthly payments, but voluntary payments are accepted.
Five Reverse Mortgage Myths
“Reverse Mortgages Are Scams”
Fact: Major FHA reforms since 2013 substantially strengthened reverse mortgages with a financial assessment requirement, non-borrowing spouse protections, and federally mandated HUD-approved counseling. What IS a scam is deed fraud, where fraudsters posing as lenders or “housing helpers” trick seniors into signing over the deed to their home.
“The Bank Will Take My Home”
Fact: Borrowers retain the title to their home throughout the life of the loan. The lender holds a lien just like a traditional mortgage. Loan repayment triggers are: last borrower permanently leaves the home, home is sold, final borrower passes away, and borrower fails to meet obligations (e.g., insurance).
“My Kids Will Inherit Debt”
Fact: HECMs are non-recourse loans. This means that the lender can never seek more than the home’s appraised value. FHA insurance covers any shortfall and heirs have zero liability. Heirs can sell the home, repay the loan, and keep any proceeds; pay off the loan balance and keep the home; or walk away with no personal financial obligation. They typically have six months to sell, repay, or refinance.
“You Have to Be Broke to Get One”
Fact: A reverse mortgage is not a sign of financial failure. Rather, a growing body of peer-reviewed research supports the strategic use of HECMs as a standby line of credit. Experts often recommend opening a HECM while you are eligible, leaving it untouched while available credit grows, and drawing funds during market downturns instead of selling securities at a loss.
“I’ll Outlive the Loan and Lose Everything”
Fact: A HECM has no fixed repayment term. The loan doesn’t come due on a set date but when a borrower permanently leaves the home. Temporary absences do not trigger loan repayment. Even if the loan balance exceeds the home value, borrowers are not evicted because of insurance protection built into reverse mortgages.
Financial Assessment
This is a required underwriting step for most reverse mortgages, especially HECMs. It is designed to ensure that borrowers can meet ongoing obligations tied to the home. Lenders review borrowers’ income, cash flow, and credit history.
If concerns exist, lenders may require a life expectancy set-aside (LESA) where a portion of reverse mortgage proceeds is reserved to pay taxes, insurance, and/or maintenance.
Non-Borrowing Spouse Protections
Prior to 2014, there were no protections for non-borrowing spouses. Loans matured at the borrower’s death and younger spouses could lose the home. Today, eligible non-borrowing spouses may remain in the home if they were married at the time of loan closing, remain in the home, and continue to meet property obligations.
Reverse Mortgage Expenses
Upfront costs for reverse mortgages are significant. First there is the mortgage insurance premium (MIP) that guarantees that borrowers (or heirs) will never owe more than the home’s value when the loan is repaid and protects lenders if the home sells for less than the loan balance when the borrower leaves.
Upfront MIP is 2% of the home’s appraised value (e.g., $10,000 on a $500,000 home). In addition, there is an origination fee of up to $6,000, based on home value, and standard closing costs such as title insurance and an appraisal fee. Ongoing costs include 0.5% per year of the outstanding loan balance.
Reverse Mortgage Pitfalls
The loan balance grows over time as interest and MIP compound. Thus, the amount of home equity available to heirs decreases as the balance grows.
Reverse mortgages are also very expensive if borrowers plan to move within a few years. Upfront costs can consume much of the equity. Many housing experts suggest a minimum five-year time horizon to justify the costs of a reverse mortgage. For short-term liquidity, selling the home or a traditional home equity line of credit (HELOC) may be more cost-effective.
Tax Implications
Reverse mortgage payments are not considered taxable income for federal and state income taxes. Rather, they are loan advances, with funds received by borrowing against home equity. Loan proceeds, however, may affect eligibility for needs-based benefits such as Medicaid, SSI, and housing or utility assistance.
Strong Candidates for Reverse Mortgages
- Borrowers who are “house rich and asset poor”
- Borrowers with expenses that are creating cash flow stress
- Borrowers who are financially stable and seeking a buffer asset
- Borrowers concerned about sequence of returns risk in early retirement
- Borrowers not focused on maximizing an inheritance for heirs
- Borrowers committed to staying in their home long-term
Poor Candidates for Reverse Mortgages
- Borrowers with a short-term horizon in the home before moving
- Borrowers who cannot meet ongoing property obligations
- Borrowers with title complications (e.g., liens, irrevocable trusts)
- Borrowers who rely on (or anticipate using) means-tested benefits
- Borrowers age 62 to 67 that may have limited initial borrowing power
- Borrowers with a history of unpaid bills or debts and overspending
In Summary
Reverse mortgages can enhance retirement planning. However, they are complex, costly, and not for everyone. Potential borrowers should understand these loans thoroughly, especially fees, payout options, and their impact on heirs and public benefits. Seek professional advice as needed.
