What Is a Reverse Mortgage? Types, How They Work, Pros & Cons

What Is a Reverse Mortgage?

A reverse mortgage allows older homeowners to tap their home equity for money to use for other purposes. It’s essentially a loan against a home that you either own outright or have a small mortgage on that can be paid off with the reverse mortgage funds, leaving you extra cash to use as you like. Learn more about the pros and cons of reverse mortgages, including the typical criteria to get one. 

How a Reverse Mortgage Works

Reverse mortgages are designed for older homeowners who own their homes and need a source of money. The most common type of reverse mortgage is the Federal Housing Administration’s (FHA) Home Equity Conversion Mortgage (HECM), which is for homeowners 62 and over. You must have at least 50% equity in your home for these loans, and the home must be your primary residence. 

You may find some private reverse mortgages are available to younger homeowners, such as those 55 and older. They may have different equity criteria as well. But homeowners taking out a reverse mortgage have either paid down their mortgage and have no loan, or have a small loan amount. 

A reverse mortgage lets you keep the title to your home while you access your equity. As opposed to a traditional mortgage, you don’t make monthly mortgage payments toward a reverse mortgage. However, interest and fees are added to the loan balance every month, which lowers the amount of home equity.

If you are approved for a reverse mortgage, you might receive proceeds in one lump sum, a series of monthly payments, or a line of credit. Then, you must pay property taxes and homeowners insurance and keep up with home maintenance. A reverse mortgage is paid back once you no longer live in the home and the home is sold.

Interest Rates on Reverse Mortgages 

Typically, the interest rate for a reverse mortgage is higher than the interest rate for a regular mortgage but on par with interest rates for home equity loans and home equity lines of credit (HELOCs). The interest rate for a reverse mortgage may be fixed or adjustable.

Several factors can affect your interest rate on a reverse mortgage. First, rates will vary by lender. 

As with a traditional mortgage, a lender will review your credit history as part of the approval process. Although lenders rely less on your credit as a determining factor for approval, it can play a role in what interest rate you are offered. Having a better credit score and better credit history, including a record of making on-time payments and a low debt balance, can result in a lower interest rate.

Eligibility Criteria for a Reverse Mortgage

Not every homeowner can take out a reverse mortgage. Just like with traditional mortgages, you must meet the lender’s criteria as well as other factors. Eligibility criteria for an HECM include:

• You must be over age 62.
• The mortgage must be on your primary residence.
• You must have no late payments in the past 24 months for property-related expenses, such as mortgage payments, property tax bills, and insurance premiums.
• You must complete a government-approved counseling session.

A reverse mortgage lender will review your credit history, but these loans don’t have specific credit score or income requirements like traditional mortgages.

Types of Reverse Mortgages

Generally, there are three types of reverse mortgages:

• Home equity conversion mortgages (HECMs): Most reverse mortgages are HECMs, which are insured by the Federal Housing Administration (FHA), a division of the U.S. Department of Housing and Urban Development.
• Proprietary reverse mortgages: Geared toward borrowers who own higher-value homes, proprietary reverse mortgages are offered by some private lenders. These loans aren’t government-insured and may have different lending criteria.
• Single-purpose reverse mortgages: Some state government agencies, local government agencies, and nonprofit organizations offer single-purpose reverse mortgages. These funds must be used for a stated purpose, such as to pay taxes or make home improvements.

Pros & Cons of a Reverse Mortgage

Pros Explained

• Flexibility with loan funds: You have flexibility when using proceeds from a reverse mortgage. You might put the money toward additional income, home improvement projects, debt payoffs, or retirement savings, for example.
• Less stringent loan requirements: Lenders generally have no minimum credit score or income requirements for a reverse loan, although they will review your credit history for past delinquencies and other factors.
• Ability to remain in your home: When you want to tap your equity for cash, a reverse mortgage is a solution that allows you to stay in your home. You can then delay mortgage payments until you no longer occupy the home.

Cons Explained

• Age requirements: You generally have to be an older homeowner to get a reverse mortgage. For the most common type of reverse mortgage, and the only one backed by the U.S. government, you must be 62 or older.
• Interest rates and costs: Interest rates for reverse mortgages tend to be higher than those for traditional mortgages. Among the upfront and ongoing expenses are lending fees, closing costs, loan servicing fees, government-mandating counseling, homeowners insurance, property taxes, and annual mortgage insurance.
• Impact on estate: A homeowner with a reverse mortgage can leave the home to their heirs, but the heirs must repay the mortgage.

The Bottom Line

A reverse mortgage can be a great option for older homeowners who need an extra source of funds. It allows you to tap into your home’s equity without needing to make monthly loan payments or sell your home. But a reverse mortgage does come with drawbacks, such as the need to keep up with home maintenance, homeowners insurance premiums, and property tax payments. Consider consulting with a financial advisor to learn how a reverse mortgage may fit into your overall financial plan.