Banks offer a variety of loan products because no single loan is right for everyone. People approach home buying at different stages in their life, with different goals. They also face home selling at different stages. The loan product that's related more closely to selling a home than buying one is the reverse mortgage.
Among loan products, the reverse mortgage might be the most controversial. Critics point to the possibility of losing your home, but that could be said of regular mortgages too—you could lose your home in foreclosure. Some homeowners are in situations where a reverse mortgage is a good option, and they go into the loan knowing that they do not face "losing" the home they were very likely going to sell later anyway, but rather are leveraging the equity to get money now.
A reverse mortgage works like the presale of your home in that it generates income for you now when you need it and can make the most of it, with repayment deferred until you don't need the home anymore. To be blunt, you can't enjoy the proceeds from the sale of your home after you're dead, so a reverse mortgage is a way of spending the proceeds now.
If you're a longtime homeowner with certain circumstances and goals, a reverse mortgage could appeal to you. To help you decide if this loan product makes sense with your lifestyle, we answer people's most common questions about reverse mortgages.
What Is a Reverse Mortgage?
An ordinary mortgage is when you borrow money to buy a home. From the first dollar you pay on the loan principal you start building equity, a fancy term for home ownership. Money flows in one direction, from you to the bank. A reverse mortgage reverses the flow of money from the bank to you by generating payments based on your home's value. The bank wagers that it will earn its money back (plus interest) the day the home sells, if not by some other means. The bank is willing to defer loan repayment until you move, sell, or pass away.
Who Is a Reverse Mortgage Best For?
A reverse mortgage is an income strategy for older homeowners who want to stay in their home, not sell it to fund their golden years elsewhere. A typical way for older homeowners to cash in on the appreciation of their home is to sell after retirement and downsize. This can mean not only buying a smaller home but also a home in a more affordable region now that proximity to jobs and schools is no longer a concern. Downsizing is a fine strategy for older homeowners who want to relocate, but some know they want to stay put. A reverse mortgage is meant for them.
A regular influx of cash can make all the difference to seniors having a hard time making ends meet. A reverse mortgage is but one strategy for retirement income, however. A financial advisor can tell you more options.
Homeowners are still responsible for paying property taxes and homeowners insurance and for regular maintenance. Failure to do so could trigger repayment of a reverse mortgage.
Could I Rent Out My Home and Travel?
A reverse mortgage does not merely let homeowners keep living in their home, it requires it. The loan product is intended to generate income to homeowners while keeping the roof over their head, not to fund relocation to sunnier and less expensive locales. While rental income is a solid moneymaking strategy, it can't be mixed with a reverse mortgage.
According to the Consumer Financial Protection Bureau, every year you must certify in writing that you occupy your home as your principal residence. You can lose your home to foreclosure if you have a reverse mortgage loan and:
- Are absent from your home for a majority of a year for a nonmedical reason; or
- Are absent from your home more than twelve months in a row for healthcare purposes.
Could the Bank Force Me to Repay the Reverse Mortgage Early?
You could do something to trigger repayment, but otherwise the bank defers repayment until you move, sell, or pass away. One way to trigger repayment is to stop using the home as your primary residence, which is why renting it out wouldn't work (see previous question). Other ways to trigger repayment are to neglect home maintenance, to fail to pay property taxes, or to lapse on your homeowners insurance.
Does the Loan Balance Keep Growing?
Yes, it surely does. For the life of the reverse mortgage the balance keeps growing. Rolled into it are the loan principal and the interest, plus the origination fees if you chose to roll those in.
Because a reverse mortgage requires no repayment so long as the homeowner lives in the house, the interest on the loan gets added to the balance every month. It's like a credit card that you keep charging on and never pay, but unlike a credit card, someone will have to pay it after you're gone. Or after you move or sell.
Even though a reverse mortgage might look like it turns your home into an ATM, it's more like turning your home into a credit card. It is debt, with interest and fees and a balance that grows every month.
But Could the Loan Balance Grow Larger Than the Home Is Worth?
Since the balance never stops growing, eventually it could eclipse the home's value, but borrowers (or their estate) are usually not required to pay back any loan balance in excess of what the home is worth. This consumer protection comes with the most common type of reverse mortgage loan, known as a home equity conversion mortgage (HECM). You definitely want to make your reverse mortgage through this FHA program so that you get this important federally backed protection.
The government's Consumer Financial Protection Bureau (CFPB) writes: "When the last remaining borrower passes away, the loan has to be repaid. Most heirs will repay the loan by selling the home. If your loan balance is more than the value of your home, your heirs won’t have to pay more than 95 percent of the appraised value. The remaining balance of the loan is covered by mortgage insurance."
Are All Reverse Mortgage Programs Alike?
No, they aren't. Stick to the HECM type made through the FHA program described above. If your reverse mortgage is not done through the FHA program, it probably won't have the crucial consumer protection that keeps you or your heirs from having to pay back a bloated loan balance larger than the home is worth. If you are considering a reverse mortgage, look into the HECM type and forget the rest.
One stipulation of the FHA program is that you must be at least 62, and so must your spouse (source).
These are just some of the questions people have about reverse mortgages, and we've run out of space. Soon we will tackle some more so that you can make an informed decision about whether this controversial loan product fits your situation.
If you are considering taking out a reverse mortgage, talk with a counselor from an independent government-approved housing counseling agency because a salesperson is not likely to have your best interest in mind.
We answer several more common questions about reverse mortgages here.
- A reverse mortgage keeps you in your home, which, depending on your lifestyle, is a pro or a con.
- If you have few other options for regular cash in retirement and are unconcerned about bequeathing your home, a reverse mortgage is worth considering.
- Make sure any reverse mortgage you consider carries the FHA mortgage insurance so the loan balance will never eclipse the home's value.