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How Reverse Mortgages Work: Payouts, Functions & Costs

Reverse mortgages, also known as home equity conversion mortgages (HECM), provide homeowners age 55+ access to instant cash from the equity that they have built up in their home.

Borrowers may utilize reverse mortgages to age in place while leveraging a portion of their home equity as a source of income. Reverse mortgages can pay off and replace traditional mortgage loans.

Monthly mortgage payments are not required. Instead, borrowers may choose to defer all payback until the last remaining homeowner permanently leaves the home.

Reverse mortgage proceeds may be used in a variety of ways.

This article will break down everything you need to know about reverse mortgages, including the different loan types, payout options, qualifications and more.

What are the benefits of a reverse mortgage?

A reverse mortgage is an excellent tool for homeowners to age in place and live the retirement they have always dreamed of.

Several key benefits make this type of loan an attractive option:

1. No mandatory monthly mortgage payments

Reverse mortgages offer flexible repayment terms. You do not have to make any monthly mortgage payments, as long as you live in your home.

2. You retain ownership of your home

The deed to your home remains in your name and you continue to own your home.

3. You can use the money for anything

The purpose of a reverse mortgage is to help homeowners 55+ live comfortably with no restrictions on the use of the funds.

Senior citizens hanging out in the backyard with fmaily while griling food

How does the reverse mortgage work?

Reverse mortgages were designed to help homeowners 55+ stay in their homes and live a more comfortable retirement.

They can benefit from a reverse mortgage by meeting three primary conditions: be age 62 or older to qualify for the FHA HECM reverse mortgage option and 55+ for non-government options. Borrowers also must a have roughly 50 to 60 percent equity in the home and occupy it as a primary residence.

Reverse mortgages are widely considered the most flexible type of loans available to older homeowners.

Whatever the goals may be during your golden years, a dedicated reverse mortgage professional can help you tailor the loan to your unique needs.

Another advantage is that income requirements are less stringent as opposed to a traditional loan or home equity line of credit. For this reason, homeowners 55+ may have an easier time qualifying for these loans – particularly those on a fixed or limited income.

Because reverse mortgage proceeds can be used without restrictions, borrowers can use the loan proceeds to cover a wide range of expenses.

Step 1: Speak to a reverse mortgage professional.

The first step in getting a reverse mortgage is speaking to a licensed reverse mortgage professional. Because not all mortgage loan originators specialize in reverse mortgages, do some due diligence to find a loan officer who is well versed not only in reverse mortgages, but also retirement income strategies.

Step 2: Submit a loan application.

Next, you’ll complete a loan application, but please realize that this form is not a commitment. You may terminate the application at any time if you change your mind. The application also will enable your loan representative to perform a financial assessment to determine if you qualify for the loan. 

This is a requirement on most reverse mortgage options. During the financial assessment, the lender will examine the borrower’s ability and willingness to comply with the loan requirements. These requirements include paying the property taxes and homeowner’s insurance and properly maintaining the home.

Step 3: Independent HUD Counseling

Both the FHA HECM reverse mortgage and non-government options require an independent counseling session to be performed. The counseling in most cases is performed over the phone, there are some companies that offer face to face counseling. 

This service provided by an independent third-party, typically approved by the U.S. Department of Housing and Urban Development (HUD) ensures the borrower fully understands the reverse mortgage and reviews alternative options, prior to application. All reverse mortgage borrowers and non-borrowing spouses must attend the counseling session.

Step 4: Home Appraisal

After the loan application and counseling session are completed, your lender or broker will order an appraisal to determine the value of your home. The value of the home is an important factor in determining how much equity can be accessed. In addition to the value, the age of the youngest borrower and prevailing interest rates also play a role in how much money one can receive with a reverse mortgage.

Step 4: Underwriting:

Upon receipt of the home appraisal, title and all required borrower documents, the loan will go to an underwriter. Underwriting decisions typically take 48 to 72 hours. If the loan is approved and no other items are needed or required, the underwriter will issue a clear to close (CTC). Upon approval, your loan officer will work with you to finalize the loan.

Step 5: Closing & Funding:

Finally, your loan officer will schedule the loan settlement. The settlement will take roughly one hour and is typically done at the mortgage lender’s office, title company or in the comfort of your own home with an attorney or mobile notary present. 

After completing the settlement paperwork, borrowers have a three-day right of rescission period where they can change their mind and cancel the loan. Once the rescission period expires, the loan will be funded and proceeds will be released in accordance with how the loan was structured.

A group of senior citizens dancing together at a house party

Why use a reverse mortgage

A reverse mortgage can help homeowners 55+ by providing additional funding to cover a variety of lifestyle expenses – providing financial security without any of the hassle.

The funds are available to use at your convenience.

Some common reasons why people take out reverse mortgages include:

1. Eliminate your existing mortgage

When income becomes fixed and options for cash flow are limited and riskier due to age, a reverse mortgage can free up cash by eliminating mandatory monthly payments.

You still retain ownership of the home and get to live there as long as you want. You may make payments of any denomination and any time.

When the home eventually is sold, the loan amount plus any interest and fees that have accrued over time will be due.

With the remaining balance going to your heirs or estate.

2. Aging in place

After spending years in the home, building connections with your neighbors and community, you may not want to leave.

House hunting and relocating can be an ordeal, especially when you factor in the costs associated with selling your home and buying a new one.

A reverse mortgage can provide the funds needed to age in place and make any necessary home renovations or repairs so that you can live comfortably for as long as possible.

3. Making home improvements

Your home is likely one of your biggest investments.

With a reverse mortgage, you can access the equity in your home to make any improvements or updates that you see fit.

For example, you might want to update the kitchen or bathrooms, install a new roof or make your home more accessible with features like grab bars and wheelchair ramps.

Whatever the reason, a reverse mortgage can give you the funds you need to make these improvements without having to dip into your savings.

This can help maintain your home’s value and improve your quality of life.

4. Downsize/rightsize your home

It might make the most sense to move to a new home, and with a reverse mortgage, you can do so without having to take out a new mortgage.

Using the proceeds from your reverse mortgage, you can pay off any existing mortgage you have on the home and cover the costs of buying a new home, like real estate agent fees and closing costs.

This can help make the transition to a new home much smoother and less stressful.

5. Supplementing retirement income

Many seniors find that their Social Security and pension benefits are insufficient to fund their monthly expenses.

A reverse mortgage can provide the extra cash needed to make ends meet.

The funds can cover your mortgage, property taxes, utility bills, groceries and other everyday expenses.

This can help with living a more comfortable retirement without having to worry about covering living expenses or unexpected costs.

6. Help your family financially

Your children or grandchildren might be going through a tough time and need financial assistance. With a reverse mortgage, you can help them out without dipping into your retirement portfolio.

The funds from a reverse mortgage can be used for anything, so you can help your family with whatever they need, whether it’s paying for a down payment on a new home, covering medical expenses or anything in between.

7. Paying off debts

If you have outstanding debts, a reverse mortgage can provide the funds needed to pay them off.

Debt and interest fees can cut into your monthly budget and put a strain on your finances, but with a reverse mortgage, you can use the equity in your home to pay off these debts once and for all.

This can provide some much-needed relief and help you get your finances back on track.

7. Long-term care and medical expenses

A reverse mortgage can provide the needed funds to cover long-term care or medical expenses. This can help ease the financial burden of these expenses and allow you to focus on your health and quality of life.

As you age the risk of developing a chronic illness or needing long-term care increases, a reverse mortgage can provide the peace of mind of knowing that you have the funds to cover these costs if they arise.

8. Life experiences

Retirees may need to tighten their budget, but this does not mean they have to give up their hobbies or travel.

In fact, reverse mortgage proceeds can easily fund one’s dream retirement, whether it’s taking multiple vacations a year or buying an RV to travel across the country.

Whatever the retirement dreams may be, a reverse mortgage can help make them a reality.

How reverse mortgages differ from traditional loans

A reverse mortgage loan is different from a traditional forward mortgage.

With a traditional mortgage, borrowers make a mandatory monthly payment towards the principal and interest of the loan until it is paid off.

With a reverse mortgage, the lender makes payments to the borrower. There are no mandatory monthly payments as long as the borrower lives in the home, keeps it in good condition and pays property taxes and mortgage insurance premiums.

The loan is repaid when the last surviving borrower dies, moves or sells the home.

Types of reverse mortgages

There are three types of reverse mortgages.

Each serves a different purpose and has different features.

Home Equity Conversion Mortgage (HECM)

Home equity conversion mortgages are the most common type of reverse mortgage.

They are backed by the Federal Housing Administration (FHA) and can be used for any purpose.

HECM reverse mortgage loans have fixed or adjustable rates and come in four different disbursement options: a lump sum payout, term, tenure or line of credit. Payout options may also be combined to receive short and long-term benefits.

We’ll discuss in depth the benefits of each disbursement option later in this article.

HECM for purchase

A HECM for purchase allows seniors to buy a new home and get a reverse mortgage loan all in one transaction.

This type of loan is useful for those who want to upsize, downsize or move to a different home that better suits their long-term needs.

You still get the benefit of no monthly mortgage payments as the home remains your primary residence.

Proprietary (Non-Government) Reverse Mortgage

Proprietary reverse mortgages are private loans not backed by the federal government. They are usually better options to borrowers with high-value homes. These homes can be worth up to $10 million.

Proprietary reverse mortgages often have higher loan limits than HECM loans and can also still be used for any purpose.

These loans typically have lower closing costs and no mortgage insurance premiums. They tend to also have higher interest rates, so it’s best to speak with a reverse mortgage professional about which option may be best for you.

Reverse mortgage payout options

Regardless of retirement needs, a reverse mortgage can be a helpful tool. Each type of reverse mortgage payout has its own unique features and benefits.

1. Fixed Monthly Payments (Tenure)

Receive fixed payments while living in the home as the primary residence. The payments only stop when the last remaining borrower passes away or permanently leaves the home.

This can provide a steady source of reliable income to cover your monthly expenses.

2. Term Payout

Receive fixed monthly payments over a certain time period. The amount received each month will not change, even if the home decreases in value.

3. Lump Sum Payout

With a lump sum payout, the borrower receives a large sum of money all at once. 

This can be helpful particularly if a large amount of money is needed for a one-time expense.

With no stipulations on how to use this money, borrowers may spend it as they see fit!

4. Line of credit

A line of credit offers flexibility.

The borrower can take out as much or as little money as needed.

The line of credit will grow over time, providing access to more funds as needs change.

This is a good option for people who are not sure how much money they will need in retirement or for those who want the flexibility to use their reverse mortgage funds when the need arises.

5. Combined Payout Options

This is where the power and flexibility of reverse mortgages come in.

Some people choose to receive a combination of all three types of payments, giving them the most flexibility to cover their needs in retirement.

For example, you could take out a lump sum to pay off debts and use the remainder of the proceeds you qualify for as a line of credit to use as you see fit.

That way, you free up your cash flow and have access to funds if the need arises.

Reverse mortgages are truly a flexible retirement tool that can be tailored to your unique needs and goals.

How much money can you get from a reverse mortgage?

Several factors determine how the reverse mortgage will pay, including the home value interest rate and loan type.

For example, if the home is paid off and worth $300,000, a HECM reverse mortgage could yield a maximum loan amount of about $144,000.

With the lump sum payout option, the borrower will receive the full loan amount all at once. However, it typically will not offer as much as some other options.

With the tenure option, the borrower will receive equal monthly payments for as long as they remain in the home.

With the line of credit option, the maximum borrowing amount will depend on how much the line of credit grows over time and how much was drawn from it.

Reverse Mortgage Interest Rates

Interest rates on the FHA HECM reverse mortgage are on par with rates on traditional mortgage loans. For proprietary loans, rates are generally 1 to 2 percent higher. Both types offer fixed and variable rates.

Fortunately, the borrower will not have to pay any interest on the loan, as long as they live there.

The interest will accrue and be added to the loan balance, which will be due when the loan becomes due and payable.

The only reverse mortgage option with a fixed interest rate is the lump sum (single disbursement) because it gives all the proceeds at once.

The other options have adjustable interest rates, because the money is borrowed money over time and not in one large payout.

Reverse Mortgage Fees

Several fees come with a reverse mortgage, including closing costs, an origination fee and ongoing servicing fees.

The good news is that many of these fees can be rolled into the loan balance, so they don’t need to be paid out of pocket.

Your reverse mortgage lender can give a more accurate fee estimate based on your individual circumstances.

Several programs can help low-income borrowers with the cost of these fees, so be sure to ask your lender about any available options.

A group of senior citizens having a dinner party

Borrower Responsibilities with a Reverse Mortgage

Although there are no mandatory monthly payments, some responsibilities come with a reverse mortgage.

1. You must keep your home in good condition and up to date with any required repairs or maintenance.

This is good for the reverse mortgage borrower and lender because it will keep the home from declining in value.

That way, if you wanted to refinance the reverse mortgage or sell the home, you would be able to get a good price.

2. You must remain current on your property taxes and homeowner’s insurance.

You are still the owner of your home, which makes you responsible for paying your taxes and insurance on the property.

3. Finally, your home must remain your primary residence.

If you move out of your home for more than 12 months, the loan may become due and payable.

These are standard and reasonable terms required on every reverse mortgage loan agreement.

When deciding to get a reverse mortgage, be sure to keep these requirements in mind to make sure you can comfortably cover them.

Reverse Mortgage Lenders

The flexibility of a reverse mortgage has some downsides if you use a lender that doesn’t have your best interests in mind or fully understand how reverse mortgages work.

That’s why a dedicated reverse mortgage lender is recommended to decrease the likely hood of reverse mortgage scams or structuring the deal in a way that’s not advantageous to the borrower.

The best way to avoid these problems is to use an FHA-approved lender that’s a member of the National Reverse Mortgage Lenders Association (NRMLA).

These lenders are held to a high standard and are required to follow best practices when originating and servicing reverse mortgages.

The list of FHA-approved reverse mortgage lenders is available on the Housing and Urban Development (HUD) website.

How Reverse Mortgages are Repaid

As long are you are fulfilling the terms of your reverse mortgage loan agreement, you will not have to worry about making any payments on the loan.

You can choose to pay down the loan. 

Or if the youngest borrower or eligible non-borrowing spouse permanently leaves the home, the loan will become due and payable.

The lender will collect the outstanding loan balance plus any accrued interest and fees at that time.

If the home sale does not cover the full loan balance, you or your heirs are not responsible for making the difference.

Both the FHA HECM and non-government reverse mortgages are non-recourse loans.

A feature that limits the amount owed by the borrower, heirs or estate when the loan becomes due and payable to the appraised home value.

There are several ways to repay a reverse mortgage:

1.Sell: You can sell the home to repay the loan balance in full. This is a good option if you need to move for any reason and want to avoid making monthly payments.

2. Refinance: You can refinance your existing loan into a traditional mortgage. This is only an option if you have enough equity in your home to qualify for a traditional mortgage. Income and credit history also play a role in qualifying for a traditional mortgage.

3. Make partial payments: You can make partial payments on the loan balance to reduce the loan amount. This option is only available if your loan has a growth feature, such as a line of credit or monthly payments.

4. Pay in full: You can pay off the loan balance at any time without penalty. This is a good option if you come into some money or want to avoid accruing interest on the loan.

5. Let the loan mature: If you do nothing, the loan will mature when you permanently leave the home. At that time, the loan will become due and payable.

Is a Reverse Mortgage Right for You?

A reverse mortgage can be a helpful tool for many people 55+.

Before deciding if a reverse mortgage is right for you, it’s important to understand how they work and the requirements.

Be sure to use a reputable and qualified reverse mortgage lender to avoid any problems.

If you think a reverse mortgage might be right for you, talk to a dedicated lender that specializes in reverse mortgages to see if it’s a good option for your situation.

Additional Reads on Reverse Mortgages

Reverse Mortgage FAQ: Learn about common misconceptions and additional benefits of reverse mortgages.

Are Reverse Mortgages Safe: Learn how you are protected, plus additional benefits.

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