An Overview of Reverse Mortgages

by Tony Kendzior, CLU, ChFC \ 7 April 2022

This was written to help me help others better understand the new reverse mortgage. I’ve been a financial planner for over 45 years and recently became a fully qualified mortgage broker under Florida law. You can find my official mortgage related information on the last page.

Some of you have known me for many years. My motivation for becoming a licensed mortgage broker is that millions of Americans who retire every year soon discover they simply don’t have enough money to last.

Some of them go back to work, some of them hope to die early, and some of them discover that a reverse mortgage is part of a long-term solution. If you or someone you know fits this profile, please forward this to them.

There are many myths, misperceptions and simple lack of accurate information about Reverse Mortgages. While I found much of the following online, I’m convinced it’s a comprehensive, short and accurate overview. If you’re serious and up to the challenge, read every word and don’t ignore the numbered links to more information.

What Is a Reverse Mortgage?

A reverse mortgage is a collateralized loan that doesn’t require monthly payments. A homeowner, someone age 62 or older, may have considerable home equity that can be used as collateral to borrow money. It might come in a lump sum, a fixed monthly payment, or simply an available line of credit. Remember, it’s a REVERSE mortgage and not a FORWARD mortgage which requires incremental payments to the lender. A reverse mortgage doesn’t require the homeowner to make any incremental loan payments. [1]

Instead, the entire loan balance, up to a limit, becomes due and payable when the borrower dies, moves out permanently, or sells the home. Federal regulations require lenders to structure the transaction to make sure the loan amount won’t exceed the home’s value. Even if it does, through an unexpected drop in the home’s market value or if the borrower lives longer than expected, the borrower or borrower’s estate won’t be held responsible for paying the lender the difference thanks to the program’s mortgage insurance. [1]

Turn Home Equity into Cash

Reverse mortgages, properly structured, effectively provide much-needed cash for seniors whose net worth is mostly tied up in their existing home equity. Yes, these loans can be costly and complex, as well as subject to scams. My intent here is to teach you how reverse mortgages work and how to protect yourself from the pitfalls, to help you make an informed decision about whether such a loan might be right for you or someone you care about.

According to the National Reverse Mortgage Lenders Association, homeowners ages 62 and older held about $10.19 trillion in home equity in the third quarter (Q3) of 2021. Mindful that probably involves millions of dwellings, it still marks an all-time high since measurement began in 2000. It represents a significant wealth that could be as source of incremental funds for those in retirement who are worried about being able to pay whatever bills they have as the years pass. [2]

Remember, home equity is only usable wealth if you either sell, downsize or borrow against that equity. That’s why a reverse mortgage might be a very welcome source of funds, especially for retirees with limited incomes and few other assets. So many unexpected risks appear as people age, that being able to access additional funds provides the ability to diversify their income and reduce investment risk, sequence of returns risk, and longevity risk.

How a Reverse Mortgage Works

With a reverse mortgage, instead of the homeowner making payments to the lender, the lender makes payments to the homeowner. The homeowner gets to choose how to receive these payments (we’ll explain further in the next section) and only pays interest on the proceeds received. The interest is rolled into the loan balance so that the homeowner doesn’t pay anything up front, while at the same time retaining title to the home. Over the loan’s life, the homeowner’s debt increases and their home equity decreases.

As with a forward mortgage, the home is the collateral for a reverse mortgage. When the homeowner moves or dies, the proceeds from the home’s sale are used to repay the reverse mortgage’s principal, interest, mortgage insurance, and fees. Any sale proceeds beyond the accumulating loan amount go to the homeowner (if still living) or the homeowner’s estate (if the homeowner has died). In some cases, the heirs may choose to pay off the mortgage so that they can keep the home.

Reverse mortgage proceeds are not taxable. While they might feel like income to the homeowner, the Internal Revenue Service (IRS) considers the money to be a loan advance. [1]

Types of Reverse Mortgages

There are three types of reverse mortgages. The most common is the home equity conversion mortgage (HECM). The HECM represents almost all of the reverse mortgages that lenders offer on home values below the conforming loan limit (set annually by the Federal Housing Finance Agency) and is the type that you’re most likely to get, so that’s what we’re talking about here. Also called a Federal Housing Administration (FHA) reverse mortgage, this type of mortgage is only available through an FHA-approved lender. [3]

If your home happens to be worth more than the FHA limits, you can look into a jumbo reverse mortgage, also called a proprietary reverse mortgage. [4]

When you take out a reverse mortgage, you can choose to receive the proceeds in one of six ways:

  1. Lump sum: Get all the proceeds up front when your loan closes. This is the only option that comes with a fixed interest rate. The other five have adjustable interest rates.
  2. Equal monthly payments (annuity): For as long as at least one borrower lives in the home as a principal residence, the lender will make steady payments to the borrower. This is also known as a tenure plan.
  3. Term payments: The lender gives the borrower equal monthly payments for a set period of the borrower’s choosing, such as 10 years.
  4. Line of credit: Money is available for the homeowner to borrow as needed. The homeowner only pays interest on the amounts actually borrowed from the credit line.
  5. Equal monthly payments plus a line of credit: The lender provides steady monthly payments for as long as at least one borrower occupies the home as a principal residence. If the borrower needs more money at any point, they can access the line of credit.
  6. Term payments plus a line of credit: The lender gives the borrower equal monthly payments for a set period of the borrower’s choosing, such as 10 years. If the borrower needs more money during or after that term, they can access the line of credit. [1]

It’s also possible to use a reverse mortgage called a “HECM for purchase” to buy a different home than the one in which you currently live. [5]

In any case, you will typically need at least 50% equity—based on your home’s current value, not what you paid for it, to qualify for a reverse mortgage.

Would YOU Benefit from a Reverse Mortgage?

A reverse mortgage might sound a lot like a home equity loan or a home equity line of credit (HELOC). Indeed, similar to one of these loans, a reverse mortgage can provide a lump sum or a line of credit that you can access as needed, based on how much of your home value you’ve paid for and your home’s market value. But unlike a HELOC, you don’t need to have an income or good credit to qualify, and you won’t have to make loan payments while you occupy the home as your primary residence. [6]

A reverse mortgage is the only way to access home equity without selling the home for seniors in situations like these:

  • don’t want the responsibility of making a monthly loan payment
  • can’t afford a monthly loan payment
  • can’t qualify for a home equity loan or refinance because of limited cash flow or poor credit

What Is Required for a Reverse Mortgage?

  • Property Type

If you own a house, a condominium, a townhouse, or a manufactured home built on or after June 15, 1976, then you may be eligible for a reverse mortgage. Under FHA rules, cooperative housing owners cannot obtain reverse mortgages since they don’t technically own the real estate they live in; they own shares of a corporation. In New York, where co-ops are common, state law further prohibits reverse mortgages in co-ops, allowing them only in one to four-family residences and condos.

  • Age, Equity, and Fees

While reverse mortgages don’t have income or credit score requirements, they still have rules about who qualifies. You must be at least 62 years old, and you must either own your home free and clear or have a substantial amount of equity (at least 50%). Borrowers must pay an origination fee, an up-front mortgage insurance premium, other standard closing costs, ongoing mortgage insurance premiums (MIPs), loan servicing fees (sometimes), and interest. The federal government limits how much lenders can charge for many of these items. [7]

  • Counseling

The U.S. Department of Housing and Urban Development (HUD) requires all prospective reverse mortgage borrowers to complete a HUD-approved counseling session. This counseling session, which usually costs around $125, should take at least 90 minutes and cover the pros and cons of taking out a reverse mortgage given your unique financial and personal circumstances. [8] It should explain how a reverse mortgage could affect your eligibility for Medicaid and Supplemental Security Income (SSI). The counselor should also review the different ways the proceeds can be received.

  • Collateral Protection

Having a reverse mortgage in place comes with responsibilities. You must stay current on property taxes and homeowners insurance (and homeowners association fees, if you have them) and keep the home in good repair. If you stop living in the house for longer than one year, even if it’s because you’re living in a long-term care facility for medical reasons, then the rules say you have to repay the loan, which often means selling the house. [1]

What Are the Costs of a Reverse Mortgage?

The Department of Housing and Urban Development (HUD) adjusted insurance premiums for reverse mortgages in October 2017. Since lenders can’t ask homeowners or their heirs to pay up if the loan balance grows larger than the home’s value, the insurance premiums result in a pool of funds that lenders can draw on if the need arises.

One change was an increase in the up-front premium, from 0.5% to 2.0%, for three out of four borrowers and a decrease in the up-front premium, from 2.5% to 2.0%, for the other one out of four borrowers. The up-front premium used to be tied to how much borrowers took out in the first year, with homeowners who took out the most paying the higher rate. That’s from needing to pay off an existing mortgage. Now, all borrowers pay the same 2.0% rate. The up-front premium is calculated based on the home’s value, so for every $100,000 in appraised value, you pay $2,000. That’s $6,000 on a $300,000 house, for example. In fact, the fee is capped at $6,000, even if your home is worth more.

All borrowers must also pay a mortgage insurance premium (MIP) of 0.5% (formerly 1.25%) of the amount borrowed. This change saves borrowers $750 a year for every $100,000 borrowed and helps offset the higher up-front premium. It also means that the borrower’s debt grows more slowly, preserving more of the homeowner’s equity over time, providing a source of funds later in life, and increasing the possibility of being able to pass down the home to heirs. [7] [9]

Reverse Mortgage Interest Rates

Only the lump sum (single disbursement) reverse mortgage, which gives you all available proceeds up front once your loan closes, has a fixed interest rate. The other five options have adjustable interest rates, which may make sense since you’re borrowing money over many years, not all at once, and interest rates are always changing. [10] Variable-rate reverse mortgages are tied to a benchmark index, often the Constant Maturity Treasury (CMT) index.

In addition to one of the base rates, the lender adds a margin of one to three percentage points. So, if the index rate is 2.5% and the lender’s margin is 2%, then your reverse mortgage interest rate will be 4.5%. As of January 2022, lenders’ margins ranged from 1.5% to 2.5%. Interest compounds over the life of the reverse mortgage, and your credit score does not affect your reverse mortgage rate or your ability to qualify (though it does affect whether the lender may require a Life Expectancy Set Aside account for your property taxes, homeowners insurance, and other required property charges). [11]

How Much Can You Borrow with a Reverse Mortgage?

The proceeds that you’ll receive from a reverse mortgage will depend on the lender and your payment plan. For a Home Equity Conversion Mortgage (HECM), the amount you can borrow will be based on the youngest borrower’s age, the loan’s interest rate, and the lesser of your home’s appraised value or the FHA’s maximum claim amount, which is $970,800 as of Jan. 1, 2022. [12]

However, you can’t borrow 100% of what your home is worth, or anywhere close to it. Part of your home equity must be used to pay the loan’s expenses, including mortgage premiums and interest. Here are a few other things that you need to know about how much you can borrow:

  • The loan proceeds are based on the age of the youngest borrower or, if the borrower is married, the younger spouse, even if the younger spouse is not a borrower. The older the youngest borrower is, the higher the loan proceeds.
  • The lower the mortgage rate, the more you can borrow.
  • The higher your property’s appraised value, the more you can borrow.
  • A strong reverse mortgage financial assessment increases the proceeds that you’ll receive because the lender won’t withhold part of them to pay property taxes and homeowners insurance on your behalf. [4]

How much you can actually borrow is based on what’s called the initial principal limit. The federal government lowered the initial principal limit in October 2017, making it harder for homeowners, especially younger ones, to qualify for a reverse mortgage. On the upside, the change helps borrowers preserve more of their equity.

The government lowered the limit for the same reason that it changed insurance premiums. Over time, the mortgage insurance fund’s deficit had nearly doubled. Keep in mind, this fund is used to pay lenders and protects taxpayers from reverse mortgage losses.

To further complicate things, you can’t borrow all of your initial principal limit in the first year when you choose a lump sum or a line of credit. Instead, you can borrow up to 60%, or more if you’re using the money to pay off your forward mortgage. If you choose a lump sum, the amount that you get up front is all you will ever get. If you choose the line of credit, then your credit line will grow over time, but only if you have unused funds in your line.

Avoiding Reverse Mortgage Scams

With a product as potentially lucrative as a reverse mortgage and a vulnerable population of borrowers who may either have cognitive impairments or be desperately seeking financial salvation, scams abound. Unscrupulous vendors and home improvement contractors have targeted seniors to help them secure reverse mortgages to pay for home improvements. In other words, to help them make money. The vendor or contractor may or may not actually deliver on promised, quality work; they might just steal the homeowner’s money.

Relatives, caregivers, and financial advisors have also taken advantage of seniors either by using a power of attorney to reverse mortgage the home, then stealing the proceeds, or by convincing them to buy a financial product, such as an annuity or whole life insurance policy, that the senior can only afford by obtaining a reverse mortgage. All reverse mortgage applicants need to be very careful to make sure such a transaction is in their best interest and that of the party promoting the idea.  These are just a few of the reverse mortgage scams that can trip up unwitting homeowners. [1]

Do This to Avoid Foreclosure from a Reverse Mortgage

Another danger associated with a reverse mortgage is the possibility of foreclosure. Even though the borrower isn’t responsible for making any mortgage payments and therefore can’t become delinquent, a reverse mortgage does require the borrower to meet certain conditions. Failing to meet these conditions could allow the lender to foreclose.

As a reverse mortgage borrower, you are required to live in the home and maintain it. If the home falls into disrepair, it might not be worth a fair market value when it’s time to sell. Yes, there’s mortgage insurance in play, but keeping the home in good repair typically leads to a better outcome.

Reverse mortgage borrowers are also required to stay current on property taxes and homeowners insurance. Again, the lender imposes these requirements to protect its interest in the home. If you don’t pay your property taxes, then your local tax authority can seize the house. If you don’t have homeowners insurance and there’s a house fire, the lender’s collateral is damaged.

About one in five reverse mortgage foreclosures from 2009 through 2017 was caused by the borrower’s failure to pay property taxes or insurance, according to an analysis by Reverse Mortgage Insight. [13]

Is a Reverse Mortgage Expensive?

Home equity conversion mortgages (HECMs), the most common type of reverse mortgage, bring a number of one-time fees and ongoing costs. The most significant of these are origination fees, closing costs, and mortgage insurance premiums, along with the interest the borrower accumulates on the loan balance. [7]

When Do You Have to Repay a Reverse Mortgage?

The lender will require the borrower to repay the reverse mortgage if the borrower does any of these things:

  • sells the home
  • resides outside the home for more than a year
  • passes away
  • fail to maintain the property
  • stops paying homeowners insurance premiums or property taxes

There are some exceptions to these rules for eligible non-borrowing spouses who want to keep living in the home after their borrowing spouse passes away.

Can You Owe More Than the Home Is Worth with a Reverse Mortgage?

Your loan balance could grow higher than your home’s value, but lenders can’t go after borrowers or their heirs if the home turns out to be underwater when the loan is due. A primary reason why mortgage insurance premiums are added monthly to the outstanding loan balance is to maintain a fund that covers lenders losses when this happens.

Can You Refinance a Reverse Mortgage?

Yes, you can refinance a reverse mortgage. Because of the origination fee, upfront mortgage insurance premium, and other closing costs, refinancing a reverse mortgage should be reserved for situations where a spouse needs to be added to the loan, more equity is needed, or the interest rate can be lowered substantially. [14]

The Bottom Line

A reverse mortgage can be a helpful financial tool for senior homeowners who understand how the loans work and what tradeoffs are involved. Ideally, anyone interested in taking out a reverse mortgage will take the time to thoroughly learn about how these loans work. That way, no unscrupulous lender or predatory scammer can take advantage of them, they’ll be able to make a sound decision even if they get a poor-quality reverse mortgage counselor, and the loan won’t come with any unpleasant surprises.

Even when a reverse mortgage is issued by the most reputable of lenders, it’s still a complicated product. Borrowers must take the time to educate themselves about it to be sure that they’re making the best choice about how to use their home equity. Further, they should shop around and not go with the first lender who solicits their business. Rates and fees can vary widely among lenders; the federal government does not set reverse mortgage rates. [15]

Here is the business card I created to include all relevant information about my activities as a reverse mortgage broker: