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What is a reverse mortgage, and how does it work?

Zoey Le  8-MINUTE READ  September 21, 2022

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If you have equity in your home and are at least 62 years old, you may leverage your equity with a reverse mortgage. Unlike a traditional mortgage, you won’t owe payments on the mortgage monthly, and you can use the funds how you want during retirement.

It can be a great way to use a portion of your home’s equity while remaining in the house. There are, however, specific qualifications you must meet to qualify.

Here’s everything you must know about the home equity conversion mortgage.

The Reverse Mortgage Defined

A reverse mortgage provides supplemental income from your home’s equity if you’re 62 or older. It’s a great way to use your home’s equity that you’ve built up over the years and still enjoy your home.

Most homeowners who use the program own the home without a mortgage, but as long as you have a decent amount of equity in your home, you may qualify. In addition, you don’t have to have a specific need for the funds or tell the lender why you need it.

Like a regular mortgage, you must meet the qualifying guidelines. If you do, you can tap into your home’s equity and stay in your home.

How Does a Reverse Mortgage Work?

As the name suggests, a reverse mortgage gives you the equity from your home, either in one lump sum or as monthly draws, depending on your preference.

You aren’t required to make payments on the funds, but interest accrues like it would on a traditional mortgage. There are also closing fees, some of which you must pay upfronts, such as the appraisal fee and the HECM counseling fee.

Mortgage payments, however, aren’t required until the homeowner sells the home, moves out permanently, or passes away. At that point, you pay the total amount in full from the proceeds of selling the house.

The home equity conversion mortgage is a non-recourse loan, which means you’ll never owe more than the home’s value. If the mortgage balance exceeds the value when you sell the house, you’ll only owe as much as the home’s value.

Who Qualifies? 

Like a traditional mortgage, there are underwriting guidelines you must meet. Even though there isn’t a monthly payment to make, you must prove you can afford the home’s upkeep, property taxes, and home insurance.

In addition, you and any co-borrowers must be at least 62 years old. The amount you borrow is based on the age of the youngest borrower. The longer you wait to take out a reverse mortgage, the more equity you can tap into because you have a lower life expectancy the older you get.

 Other requirements include:

- You must own the home without a mortgage. If you still have a mortgage, it should have a low loan-to-value ratio, and you must use the funds from the reverse mortgage to pay it off.

- You must occupy the property as your primary residence. You can go on vacation or leave for short periods, but you must live in the home most of the year.

- You must attend a U.S. Department of Urban Housing and Development housing counseling session

Who Owns the Home?

Only you own the home when you take out a reverse mortgage, like when you borrow money to buy the house.

The bank has a lien on it, though, as the home is the collateral. So if you sell the house or pass away, the mortgage must be paid in full. If not, the lender can take possession of the home and sell it to recoup their investment.

How you Receive your Money

You can receive your money from a reverse mortgage in several ways:

- Fixed monthly payments - These fixed monthly payments for as long as one borrower lives in the home full-time

- Term payments - Receive fixed monthly payments for a predetermined term, such as 10 or 15 years

- Line of credit - Receive your funds as a line of credit that you can draw on as needed and use until the funds run out

- Combinations - You can also choose a combination of a term and line of credit or fixed monthly payments and line of credit

How Much can you Borrow?

The amount you can borrow varies based on many factors, including:

- The age of the youngest borrower

- Your home’s value

- Today’s interest rates

Common Uses for a Reverse Mortgage

There are many common uses for a reverse mortgage, and there’s no right or wrong way to use them.

 Here’s how many retirees use the funds:

 - Consolidate debt to reduce monthly expenses

- Pay for home repairs or renovations to make it more accessible

- Take care of out-of-pocket medical expenses

- Achieve personal goals

What are the Pros and Cons?

Like any personal finance decision, there are pros and cons to the reverse mortgage. Here’s what to consider.

Pros:

- You don’t owe monthly payments, but you can use your home’s equity

- You can use the funds for any purpose, such as supplementing your retirement income or satisfying a personal goal

- You can stay in your home and use the equity you’ve earned in it

- The funds don’t count as income, so you don’t have to pay taxes on your earnings

Cons:

- You must be able to keep up with your taxes, insurance, and the home’s upkeep, or you risk losing your home

- Your heirs earn less money when you die because they must pay off the reverse mortgage before collecting funds

- It might affect your other retirement benefits, such as social security income

Final Thoughts

A reverse mortgage is a great way to supplement your retirement income when you own your home free and clear (or only owe a small amount).

It allows you to age in place, staying in the home you built equity in without financial trouble. You don’t owe payments on the house until you no longer live there or your heirs inherit the home.

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