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For seniors living on fixed incomes, making ends meet can be a challenge. As of 2018, half of all Americans 65 and older had less than $24,224 in yearly income. One way many seniors choose to bring in extra income is to take out a reverse mortgage. A reverse mortgage allows you to tap into the equity you have in your home by using your home itself as collateral for a loan.
How a Reverse Mortgage Works
Reverse mortgages are designed for people who are retired and plan to stay in their homes for the long term, own their homes outright or have substantial equity, and need extra money to help with daily expenses. Typically, these are seniors who are living on a pension or Social Security without much other retirement income. As health care and cost of living expenses rise, their fixed income may not keep pace with their financial needs.
A reverse mortgage allows these homeowners to extract the equity they have built up in their homes by using their homes as collateral for a loan. The amount you can borrow is based on a combination of factors, including the borrower's age, the appraised value of the home and current interest rates. The loan proceeds can be taken as a lump sum, line of credit, fixed monthly disbursement, or a combination of a line of credit and a monthly disbursement. Learn more about how reverse mortgages work.
Types of Reverse Mortgages
There are three types of reverse mortgages:
- Single-Purpose Reverse Mortgage: Nonprofit organizations or state and local government agencies sometimes offer this type of reverse mortgage. The lender restricts the purposes the mortgage proceeds can be used for. For instance, you might be able to use a single-purpose reverse mortgage only to pay your property taxes or to make improvements to the home.
- Home Equity Conversion Mortgage: This is the most popular type of reverse mortgage and offers the most flexibility. HECMs are insured by the Federal Housing Administration (FHA) and are limited to a maximum of $725,525 as of 2019. The proceeds of the loan can be used for any purpose you want.
- Proprietary Reverse Mortgage: If your home is worth more than $725,525, or if your home doesn't meet the FHA standards for a HECM, you may want to look into a proprietary reverse mortgage. Offered by private lenders, these loans can be used for any purpose, and there's no limit on the amount you can borrow.
What Are Reverse Mortgage Requirements?
The requirements for getting a single-purpose or proprietary reverse mortgage vary depending on the lender. All HECMs have the same requirements:
- The home must be your primary residence.
- You must either own the home outright or have substantial equity in it.
- The property itself must meet FHA standards and flood requirements. It must be either a single-family home, a manufactured home, a condominium approved by the Department of Housing and Urban Development (HUD) or a two- to four-unit home with the borrowers living in one of the units.
- The borrowers must be age 62 or older.
- Borrowers must be able to pay the expenses associated with the home, such as property taxes, homeowners association fees and homeowners insurance, without the assistance of the loan.
- Borrowers are required to meet with a HUD-approved HECM counselor to discuss the reverse mortgage.
- Borrowers must be creditworthy and cannot be delinquent on any federal debt.
What Credit Score Do I Need for a Reverse Mortgage?
You don't need a specific credit score to qualify for a reverse mortgage. However, lenders will assess your finances to make sure that you can pay the costs associated with your home and still have enough to live on. They'll also review your credit report to make sure you're generally creditworthy. Specifically, they'll check for:
- Payment history for mortgage and installment loans for the last two years
- Revolving credit payment history
- Collections, charge-offs, judgements or delinquent FHA-insured mortgages
If you are delinquent on any federal loans, you will not be eligible for a HECM. If your credit report shows that you have defaulted on debt in the past or that you frequently make late payments to creditors, the reverse mortgage lender may ask you to set up a Life Expectancy Set Aside (LESA) account to be approved. You'll put money into this account to cover the cost of property taxes and homeowners insurance. If at some point you aren't able to pay these costs yourself, your lender can tap into the LESA to do so.
A LESA can add substantially to the cost of a reverse mortgage, so before you apply, be sure to check your credit report for anything that could make it difficult to get approved without setting up a LESA.
What Are Reverse Mortgage Advantages?
A reverse mortgage offers several advantages for people who are retired and need extra income.
- Home equity is more accessible to retirees than many other types of financing. Many seniors don't have enough income to qualify for loans that require immediate repayment, such as a home equity line of credit or a second mortgage. It's easier to qualify for a reverse mortgage.
- As long as you are living in your home; keeping current on property taxes, homeowners insurance and other associated home expenses; and maintaining the home in good condition, you won't have to repay the loan.
- Because the IRS classifies the payouts as a loan advance, a reverse mortgage offers tax-free income in most cases (although you should always consult a tax professional to be sure how taxes apply in your situation).
What Are Reverse Mortgage Drawbacks?
While reverse mortgages offer some appealing advantages, there are also some significant disadvantages to a reverse mortgage that you should be aware of.
- Although reverse mortgages are tax-free, they aren't without cost. You'll have to pay for an appraisal of your home's value; cover substantial closing fees, including a loan origination fees, servicing fees and third-party fees; and make ongoing mortgage insurance payments. You'll also accrue interest on the amount paid out to you. Depending on how you choose to receive your loan disbursements, this may be calculated as fixed or variable interest; be sure you know which applies in your case.
- The loan must be repaid when you die, sell your home or move out of the home. This can cause problems if your house is part of the inheritance you hope to leave to your children. Unless your heirs can afford to pay off the loan, the lender will sell the house to do so. (Your heirs will receive any money that's left over.)
- If more than 12 months pass during which you aren't using the home as your primary residence, the loan will come due. This can happen if you have to stay in a rehab facility after a fall or need to move in with your children for an extended period after surgery or a medical issue. If you have a reverse mortgage, you will have to repay the loan to prevent the bank from selling your home to recoup the loan.
- If one spouse is under age 62, they may have to be removed from the property deed for the older owner to qualify for a reverse mortgage. Removing their name on the title can put the non-borrower spouse at risk. If the borrower dies, the non-borrower will no longer receive reverse mortgage disbursements. Worse, they could lose their home if they can't pay off the loan.
Is a Reverse Mortgage the Right Option for Me?
If you are struggling with living expenses in retirement, is a reverse mortgage a good choice? That depends.
- As long as you can easily pay the costs associated with your home, such as property taxes, a reverse mortgage may offer the extra income you need to cover other costs, such as health care. However, if you're already struggling to cover the costs of homeowners insurance, property taxes and home maintenance and repairs, a reverse mortgage probably isn't right for you.
- If you are planning to move out of your home in the near future, a reverse mortgage isn't a good option. Reverse mortgages are best for those who plan to remain in their homes for the long term.
- A reverse mortgage isn't the only way the equity in your home can help finance retirement. Another alternative is downsizing to a smaller home and using the proceeds from the sale of your current home for living expenses. This can also help you meet non-financial needs, such as finding a home that's close to your adult children, requires less yard work or is more suitable for aging in place.
As you weigh your options, a good place to start is by getting a free credit report to see if there are any issues that might hold you back from getting a reverse mortgage.