What is a reverse mortgage? These days financial institutions and advisors are increasingly marketing these products to retirees. But what exactly are they? How do they work? What are the benefits and pitfalls?
To get you started, here are answers to some frequently asked questions:
What is a reverse mortgage? At its core, a reverse mortgage is exactly what it sounds like: instead of you paying the bank to live in your home the bank pays you to live in your home. Another way to think about it is like this: with a regular mortgage you take out a loan from the bank and pay it back until the balance is zero. With a reverse mortgage you receive money from the bank and the balance of what you owe grows larger over time.
- Why would I want one? A reverse mortgages allows you to tap into the equity in your home without selling it. They can be especially useful for people who need cash to cover expenses or to pay off debts. An added benefit is that the money usually isn’t taxed.
So when do I pay the bank back? The loan gets repaid when the home is no longer your primary residence. Basically, once you either die or move the home gets sold and the bank gets its money.
Do I still own my home? Yes. A reverse mortgage is just like a regular mortgage — you own the home not the bank. The title remains in your name. However, as with a regular mortgage, your home is used as collateral to secure the loan.
What’s in it for the lender? Banks loan money to make money. So why do they offer reverse mortgages? The first reason is that a reverse mortgage is a pretty safe bet. A bank will offer you a reverse mortgage for less than the current value of your home — so it knows that it can get its money back. Plus most reverse mortgages are insured by the federal government (more on that later), so there’s a safety net for the banks. Also, the bank can make a lot of money on a reverse mortgage. The loan is offered with interest, so what you or your heirs owe steadily grows over time. The money will come from the sale of your house, not out of your pocket, but it’s still going to the bank eventually.
Who qualifies for a reverse mortgage? At minimum everyone on the title of the home has to be 62 years old or older.
How much money can I get? It varies depending on your age, interest rates, the amount your home is worth and other factors. Generally the older you are the more money you’ll get from a lender.
How do I get my money? Reverse mortgages can be paid out as a lump sum, a regular payment, a line of credit, or a combination of these.
Is it safe? Most reverse mortgages are Home Equity Conversion Mortgages (HECMs). That means that the federal government provides a safety net on them. Make sure to check with any potential lender about whether the mortgage they’re offering is a HECM or not. What is a HECM? Essentially if you get the loan from a lender and your home declines in value the government covers the difference. This means you or your heirs should never owe any money other than what comes from your home. This insurance is paid for by a federal fund that is financed by an extra fee on the mortgage.
What are my obligations? If you get a reverse mortgage you’re required to use the home as your primary residence, keep it in good condition and pay any property taxes/condo fees/insurance premiums.
What should I be careful about? If you’re applying for a reverse mortgage and someone tries to sell you additional products (annuities, personal insurance, home repairs) be weary. You are under no obligation to buy anything from your lender.
Can you suggest any more resources? This page from the Department of Housing and Urban Development is a good starting point. This report from the FDIC is a bit of a heavy read, but it does cover some common pitfalls. Finally this guide is a great resource, but know that it comes from an association of lenders so take the advice with a grain of salt.
Photo by Rusty Clark via Flickr.