If you look up reverse mortgage in the dictionary, you’ll get a definition like this:
A reverse mortgage is a financial agreement in which a homeowner relinquishes equity in their home in exchange for regular payments, typically to supplement retirement income.
Seems straightforward enough, but reverse mortgages are a bit more complicated than they seem on the surface. If it sounds like a home equity loan, it’s because they’re similar. In fact, a reverse mortgage is a type of home equity loan that is only available to homeowners aged 62 and up. The homeowner borrows against his or her home, but the loan doesn’t have to be paid back monthly. Instead, the loan is only due for repayment after the homeowner moves out or passes away. Typically, reverse mortgages are considered a last resort source of retirement income. They’re not for everyone and are not to be entered into lightly. Here are a few of the basics of reverse mortgages.
How does it work?
The term reverse mortgage comes from the nature of the loan. Instead of paying the bank each month, the borrower receives a payment and retains ownership of the home. To be eligible for a reverse mortgage, the borrower must own their home outright or have a small mortgage balance that can be paid off at closing with proceeds from the reverse mortgage loan. In addition, everyone on the deed—not just the primary borrower—must be age 62 or older. The home must also be the borrower’s primary residence.
What can the money be used for?
There are no restrictions on what the money one receives can be used for. Some motivations for getting a reverse mortgage might be to pay for health care expenses, pay off debt, finance home improvements, or simply supplement retirement income.
When does it have to be paid back?
The loan is due to be paid back whenever the borrower sells or otherwise vacates the home. As long as they are living in the home, they are not required to make any monthly payments toward the loan. However, the borrower must continue to pay property taxes, homeowners insurance, and homeowners association fees if applicable.
What are some caveats?
First, understand that the costs associated with getting a reverse mortgage are generally higher than they are with a traditional mortgage. Expect higher than average closing costs and a higher interest rate. Borrowers should also realize that they’re essentially cashing in on their home’s equity, which lowers the value of the home and leaves less for their heirs later on.
If you’re thinking of applying for a reverse mortgage, it’s a good idea to speak with a financial counselor first to explore all avenues and sources of extra income. Another good rule of thumb is to recruit a younger individual, such as an adult child, to help make sure everything is in order. Be aware as well that anyone interested in taking out a reverse mortgage must go through mandatory counseling from an independent third party approved by the Department of Housing and Urban Development or a national counseling agency such as AARP.
