How Reverse Mortgages Work


For many people, a home is their single greatest investment.
For many people, a home is their single greatest investment.
Jeff Haynes/AFP/Getty Images

You may have seen advertisements staring celebrities James Garner or Robert Wagner that go something like this… "If you're 62 years of age or older and own your own home…" They're endorsing reverse mortgage loans for older Americans. But is it a good idea, or are they just trying to make a buck?

As you might expect, the American Association of Retired Persons (AARP) is a somewhat more objective source of information. According to the AARP, a reverse mortgage is a loan you borrow against your home that you don't have to pay back for as long as you live there.

For many older Americans, the opportunity to convert the equity in their homes into cash, with no repayment required until they die or sell the home, sounds appealing. Many seniors are "house-rich, cash-poor" -- they own their homes but have minimal income. They may face rising and often unexpected medical expenses, home repairs, or the need to supplement their Social Security benefits. A reverse mortgage allows them access to ready, tax-free cash without selling their homes, and without the burden of monthly payments. The number of reverse mortgages has recently seen a phenomenal increase from 18,000 in 2003 to more than 107,000 in 2007 [source: U.S. Department of Housing and Urban Development].

Before reverse mortgages became available in the late 1980s, retired homeowners who needed cash had few options. They could sell and perhaps buy something smaller, move in with family members or move into a rental property. The other option would be to borrow against the equity in their home, but they would then face monthly loan repayments.

Does the reverse mortgage sound too good to be true? In this article, we'll explore the different types of reverse mortgages available, who's eligible and how much cash a homeowner can expect. We'll also take a look at what everyone should consider before cashing out their home equity.

Different Types of Reverse Mortgages

Fannie Mae is the investor in two reverse mortgage programs, HUD's HECM and Fannie Mae's Home Keeper reverse mortgage.
Fannie Mae is the investor in two reverse mortgage programs, HUD's HECM and Fannie Mae's Home Keeper reverse mortgage.
Alex Wong/Getty Images

There are three different types of reverse mortgages:

  • Single-Purpose Reverse Mortgages are sometimes offered by nonprofit groups or local or state governments. As the name implies, the funds are often limited to a single purpose, such as home renovation or property taxes. Additionally, homeowners must qualify with certain income restrictions. An advantage to this type of loan is often its lower initial cost.
  • Proprietary Reverse Mortgages are tied to private companies that maintain ownership of the loans. The companies choose specific lenders to administer the mortgages. With fewer qualifying restrictions, these loans usually come with substantial upfront fees, such as appraisals, credit reports, origination fees and closing costs. A monthly service fee is also usually charged.
  • Home Equity Conversion Mortgages (HECMs) have become the most popular form of reverse mortgage since their introduction in 1987 [source: Munnell]. These loans, insured by the Federal Housing Administration, are the only reverse mortgages guaranteed by the government to deliver what the loan promises.

In general, you must be at least 62 years of age and occupy the home as your principal residence in order to qualify for a reverse mortgage. You must own your home outright or have a minimal mortgage balance that you can pay off with proceeds from the loan. For most federally insured reverse mortgages, your dwelling must be a single-family home or a two- to four-unit property that you own and occupy. In some cases, townhouses, condominium units and manufactured homes are eligible, too.

The amount of cash you could receive depends on a number of factors, including your age, where your house is located and what it's worth. You may also choose to receive the cash in a lump-sum advance, a credit line account or a fixed monthly loan advance that you receive as long as you stay in your home.

The AARP provides a reverse mortgage calculator to help you calculate and compare approximate estimates for two nationally available reverse mortgage programs.

For most people, their home is their largest financial asset, and obtaining a reverse mortgage is a big step. On the next page, we'll take a look at reasons the reverse mortgage has grown in popularity -- and some of the risks involved.

Benefits and Risks of the Reverse Mortgage

In December of 2007, a Senate Special Committee on Aging discussed the rapid growth of the reverse mortgage and its effect on older Americans.
In December of 2007, a Senate Special Committee on Aging discussed the rapid growth of the reverse mortgage and its effect on older Americans.
Win McNamee/Getty Images

As of 2006, approximately 8,000 Americans turned 60 each day [source: U.S. Census Bureau]. Some of these retirees left the workforce early due to downsizing and now find themselves with smaller pensions and minimal Social Security benefits. Many face exploding health care costs and rising living expenses. Others reach retirement age with outstanding debts they now find difficult to pay on fixed incomes. The appeal of a reverse mortgage's ready cash is obvious.

So what are the benefits and risks involved?

Benefits

  • You're allowed to tap into your home's equity without having to repay the loan, as long as your home is your principal residence.
  • In most cases, the loan doesn't have to be paid back until the last surviving borrower dies, sells the home or permanently moves out.
  • The payout advances are not taxable and bring no risk of losing Social Security or Medicare benefits.
  • With most programs, there are no restrictions on how you use the money.

Risks

  • Upfront costs are generally much higher than with conventional mortgages and are often paid out of the home's equity, reducing the amount of cash available.
  • You're still responsible for real estate taxes, homeowners' insurance and home maintenance. Unless you maintain the home properly, the lender may take back the property.
  • You're responsible for costly mortgage insurance, which protects the lender in case the value of the property decreases or you hold the mortgage over a very long period of time.
  • Since a reverse mortgage is a rising debt loan, the interest continues to accrue, and this increase compounds over time. As the debt increases, the equity decreases. This will reduce assets for your heirs, as the loan balance must be paid off when you permanently move out or you die. However, you or your estate can never owe more than the home's appraised value when it's sold.
  • In some cases, you can lose your house if you vacate it for a prolonged stay in a nursing home, rehabilitation center or hospital. Even though you intend to return home, the lender can require repayment of the full loan balance plus interest.

Before making a decision that can affect your financial security and your future, get all the facts. First, explore other options available to meet your needs. For example, if you need a new furnace and you don't have the cash, there may be state or local assistance programs that can help. If you can't pay your property taxes, you may qualify for a deferred payment program.

If you do decide to take out a reverse mortgage, compare several different plans and discuss your needs with your family and a reverse mortgage counselor. AARP offers counseling through the HUD network of HECM counselors. You can reach a counselor by calling 1-800-209-8085 weekdays and asking for reverse mortgage counseling [source: AARP].

For more information about reverse mortgages and other related topics, see the links on the following page.

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More Great Links

Sources

  • American Association of Retired Persons (AARP). "A New Kind of Loan: In Reverse" http://www.aarp.org/money/revmort/revmort_basics/a2003-03-21-newloan.html (Accessed 5/3/08)
  • American Association of Retired Persons (AARP). "Glossary of Reverse Mortgage Terms." http://www.aarp.org/money/revmort/revmort_basics/a2003-03-28-revmortglossary.html (Accessed 5/2/08)
  • American Association of Retired Persons (AARP). "Reverse Mortgage Calculator." http://www.rmaarp.com/ (Accessed 5/3/08)
  • Dugas, Christine. "Reverse Mortgages aren't for everyone." USA TODAY. 1/17/08. http://www.usatoday.com/money/perfi/retirement/2008-01-17-boomer-reverse-mortgages_N.htm (Accessed 5/3/08)
  • FannieMae. "Money from home: A guide to understanding reverse mortgages." http://www.fanniemae.com/global/pdf/homebuyers/moneyfromhome.pdf (Accessed 5/4/08)
  • Federal Trade Commission: Consumer Protection. "Reverse Mortgages: Get the Facts Before Cashing in on Your Home's Equity. http://www.ftc.gov/bcp/edu/pubs/consumer/homes/rea13.shtm (Accessed 5/3/08)
  • Hansen, Liane. "Some Seniors Victimized in Reverse Mortgage Boom." NPR: Weekend Edition. 3/9/08. http://www.npr.org/templates/story/story.php?storyId=87994065 (Accessed 5/3/08)
  • Munnell, Alicia H. "The role in government in life-cycle saving and investing." The Future of Life Cycle Saving and Investing, Sponsored by Boston University, Federal Reserve Bank of Boston, and the Research Foundation. October 26-27, 2006. http://www.bos.frb.org/economic/conf/lcsi2006/papers/munnell.pdf (Accessed 5/3/08)
  • U.S. Census Bureau. "U.S. Interim Projections by Age, Sex, Race, and Hispanic Origin." http://www.census.gov/ipc/www/usinterimproj/ (Accessed 5/3/08)
  • U.S. Department of Housing and Urban Development. "Home equity conversion mortgages (HECM's)." http://www.hud.gov/offices/hsg/comp/rpts/hecm/hecmmenu.cfm (Accessed 5/3/08)
  • U.S. Department of Housing and Urban Development. "Reverse Mortgages for Seniors." http://www.hud.gov/buying/rvrsmort.cfm (Accessed 5/3/08)
  • Vogt, Katherine. "Reverse mortgages gain favor but aren't for everyone." American Medical News. 7/11/05. http://www.ama-assn.org/amednews/site/free/bica0711.htm (Accessed 5/3/08)