What Is a Reverse Mortgage?

A reverse mortgage or home equity conversion mortgage (HECM) is a loan that turns part of your home equity into cash. This loan gives you added income or credit without selling your home or increasing your monthly payments.

Reverse mortgages are popular among people of retirement age, as it gives borrowers more monthly funds and can help pay down other bills. However, a reverse mortgage can also eat up your home equity and ultimately lower your assets.

Keep reading to learn more about how reverse mortgages work, what kinds of reverse mortgages are available, and whether reverse mortgages are right for you.

Reverse Mortgage Definition

While the name "reverse mortgage" may seem confusing, a reverse mortgage is a loan. When you purchased your home, you likely took out a mortgage and make monthly payments; if your mortgage is not paid off, of course.

The payments you make toward paying off your mortgage and the value of your home contribute toward your home equity. Home equity is the value of your property minus any loans owed.

A reverse mortgage borrows against your home equity without increasing monthly payments. When you take out a reverse mortgage or HECM, you can decide to get the money as a lump sum, in monthly payments, or in the form of a credit line.

One of the benefits of a reverse mortgage is that it does not require you to make monthly payments toward the loan. A reverse mortgage only comes due when the borrower passes away, moves out permanently, or sells the home.

How Do Reverse Mortgages Work?

As mentioned above, reverse mortgages borrow against your home equity or the value of your home. In short, you are swapping the value of your home and property for liquid assets or spendable funds.

A reverse mortgage cannot exceed the value of your home, meaning you’ll never owe more than what your home is worth. However, your final payment includes interest and other fees, meaning you may owe more than you borrowed.

That means that even if you sell your home for more than it was worth when you took out the loan, you may have to pay part or all of that money toward the loan balance. That's why paying attention to interest rates before taking out a reverse mortgage is essential: you will always owe more than you borrowed.

Using Home Equity for Funds

Home equity is very high in the United States among seniors. However, you cannot directly spend home equity unless you sell your home, downsize, or take out a home equity loan. As a result, home equity can be hard to use, especially if you want to continue living in your home.

A reverse mortgage is tempting for people looking to keep their homes. Not only does it give them their home equity as spendable funds, but it also lets them stay in their home. Plus, the money you get from a reverse mortgage is not taxed.

When Is a Reverse Mortgage Due?

A reverse mortgage only comes due if the last borrower passes away, sells their home, or moves out permanently. Since reverse mortgages do not have monthly payments, you don't need to worry about defaulting on payments like a traditional mortgage.

However, a reverse mortgage still gains interest over time, which is not tax deductible. Also, while you keep the title to your home, you still have to pay to upkeep the property. You are also in charge of insurance and property taxes.

If you fall behind on upkeep, your lender can use part of your loan to pay for these missed fees or even require you to pay the entire loan back at once.

What Kinds of Reverse Mortgages Are There?

"Reverse mortgage" can mean several different loans, but the general idea behind them is the same. By borrowing against your home equity, you gain disposable income that can go toward home repairs, owed taxes, or general expenses.

Who Offers Reverse Mortgages?

Three general reverse mortgages providers are government entities, bank or mortgage companies, and private loan companies.

State and Local Government Loans

State and local government reverse mortgages are the most secure reverse mortgage option. However, they can be limited. Government loans come with more requirements than other reverse mortgage loan options, including counseling with a federally-approved reverse mortgage counselor. Some nonprofits also offer reverse mortgages, but these are not as readily available.

Bank and Mortgage Company Loans

Both banks and mortgage companies offer reverse mortgages. If you are looking for a mortgage through a non-government program, check if the lender is FHA-approved. FHA-approved lenders can offer HECM and are federally approved to do so.

This approval also ensures the loan is insured, making it more secure for borrowers. In addition, the HECM is the only reverse mortgage insured by the federal government in the United States.

Private Reverse Mortgages

Although many private loan companies may offer reverse mortgages, these are much less safe for borrowers. In many cases, private reverse mortgages are more likely to be scams or to charge high-interest rates.

While private reverse mortgages may be tempting due to a lack of requirements, they are not well-regulated. This lack of regulation means they can offer predatory loans or scam you out of your funds. To avoid scams, be sure to find a government-run or FHA-approved lender.

Types of Reverse Mortgages

Reverse mortgages can be called different things. The type of reverse mortgage depends on several things. Most reverse mortgages get their name from how you use your funds. In some cases, like in the case of the HECM, the name is associated with a federally-backed program.

Single-Purpose Reverse Mortgage

Single-purpose reverse mortgages tend to be the cheapest of the three kinds of reverse mortgages. Like the name says, these loans are meant to be used for one purpose, like home renovations. While these loans are sometimes offered through state and local governments and nonprofits, they are only available in some places.

Home Equity Conversion Mortgage

As mentioned previously, home equity conversion mortgages (HECM) are the only reverse mortgages insured by the federal government. These loans work with the United States Department of Housing and Urban Development (HUD).

While HECM tends to cost more than a traditional mortgage, there are little to no limits to how you use the funds. Borrowers must attend counseling about interest rates and loans before qualifying for a HECM. In addition, all reverse mortgages have closing costs and fees.

Remember that this loan allows you to get your funds in a lump sum (usually less money in total). You can also get gradual payouts over the tenure of the loan, a line of credit, or a combination of all three.

Proprietary Reverse Mortgage

Unlike HECM, proprietary reverse mortgages are not backed by the government. Instead, the lender sets the terms for these loans, which leaves openings for scams or predatory loans. While it is technically easier to get a proprietary reverse mortgage than other loans, be careful. These loans have a high likelihood of scams.

However, since proprietary reverse mortgages have different requirements, many homeowners with higher-value homes tend to go toward proprietary reverse mortgages.

Pros and Cons of a Reverse Mortgage

Here are some of the pros and cons of a reverse mortgage. Remember to consult your financial advisor to determine if reverse mortgages suit you.

Pros of a Reverse Mortgage

• Borrowers can use the lump-sum structure to pay off medical bills or other expenses.
• You cannot go “inside-out” on the cost of your home with a government reverse mortgage.
• There are no monthly payments while you live at your home.
• Line of credit reverse mortgages only gains interest on what you spend.
• You usually only need to repay the loan once all borrowers have passed away or moved out of the home. 
• You still own the title to your home.
• While there are fees and closing costs for the loan, they are usually bundled into the loan. 
• There are HECMs available for buying a new residence.
• Retirees on a fixed income can add to their monthly funds through a reverse mortgage or bridge the gap between when they retire and when their Social Security benefits kick in. 

Cons of a Reverse Mortgage

• Depending on your loan type, you may be limited in how you can spend your funds.
• For government-insured loans, you cannot have any other federal loans to apply for a HECM.
• The qualifications can be restrictive, as the youngest borrower needs to be 62 or older.
• You must have at least 50% home equity or fully own your home to qualify for HECM. 
• There are closing fees and mortgage insurance to consider.
• Interest gained on your reverse mortgage is not tax-exempt.
• Reverse mortgages can lead to several scams, so you must be wary when signing up for one.
• You must still perform upkeep on your property and pay taxes and HOA fees. 
• Your heirs are responsible for repaying the loan. 
• You can only take out a reverse mortgage on your primary residence, and you must live there for most of the year. 

Common Loan Scams

There are ways to avoid getting scammed if you are looking to get a reverse mortgage. First, pay attention to who is offering you a loan. Then, check if the loan company is FHA-approved before providing personal information or signing documents.

Some signs of a reverse mortgage scam are:

• Anything "too good to be true"
• Refusal to explain terms or intentionally confusing terminology
• High-pressure sales strategies.
• Unsolicited emails, mail, calls, etc.
• Companies that advise you not to talk to your financial advisor
• Anyone who charges fees for learning more about reverse mortgages

Below are some of the more common reverse mortgage scams. Remember that new scams pop up all the time, so be smart about who you share your financial information with.

Foreclosure Scams

This scam targets seniors in danger of losing their homes. These lenders promise a reverse mortgage to help stave off foreclosure. However, reverse mortgages still require you to pay home upkeep, taxes, insurance, and homeowner's association (HOA) fees. 

Suppose you're in danger of losing your home because of these fees. In that case, a reverse mortgage will likely not help in the long run and may make things worse, leading to a reverse mortgage foreclosure. The lenders offering this kind of loan take advantage of high closing costs, fees, and interest rates.

Other options can help you keep your home if you are facing foreclosure. Talk to your financial institution or advisor about your options if you're facing foreclosure on your home. 

Home Equity Theft Scams

This scam requires several people working together to pull it off, which is why it's essential to research any institution offering a loan. By working with appraisers, attorneys, and loan officers, these scammers make your home equity seem higher than it is. 

While this makes it look like you'll get more money out of your reverse mortgage, scammers usually take all the money for themselves. This scam leaves the borrower with the closing costs, fees, and little to no home equity. You can avoid this scam by working with FHA-approved lenders and financial advisors and avoiding any deal that seems "too good to be true." 

House Flipper Scams

These scams convince seniors to take out a reverse mortgage on their primary home to buy a new home. The catch to this is that the home they are offering is made to look like a good investment when it has barely been repaired or has underlying issues. 

After the sale is closed, the scammers run off with the extra money, leaving the original owners with a decrepit or dangerous home with little to no value. 

You can avoid this scam by getting a home inspection from a trusted individual. Also, always work with your financial institution when buying a new home. 

Relative or Financial Planner Scams

This scam is unfortunately common and is hard to avoid as it comes from a loved one or a trusted person. These scams involve a relative or loved one convincing you to get a reverse mortgage you don't need so they can "invest" the money. 

Sometimes, this scam happens after a relative is given power of attorney. With power of attorney, an individual can make financial choices on your behalf. 

Unfortunately, most of these scams end with the scammer pocketing the proceeds from the loan. If you feel pressured by a relative into taking out a loan or handing over power of attorney, contact a legal representative or your financial institution.

Veteran Reverse Mortgage Scams

As of 2022, Veterans Affairs (VA) does not offer reverse mortgages, and there are no reverse mortgage “deals” specifically for veterans. If someone offers you a reverse mortgage specifically for veterans or claims there is a reverse mortgage through VA, it is not real and is a scam. 

If you are a veteran and need assistance with your monthly mortgage payments, options are available. Things like VA Interest Rate Reduction Refinance Loans (IRRRL) can help you keep your home, so be sure to reach out directly to the VA to find out more. 

Home Contractor Scams

This is another scam that can be hard to notice. Many homeowners use reverse mortgages to repair and update their homes. However, this scam usually starts with a contractor pointing out issues you were unaware of, often without being asked. 

In most cases, the "contractor" does not have an actual license or charges well over the going rate for repairs. Their repairs may not fix anything or could be potentially dangerous if done poorly.

Many scammers pitch reverse mortgages as "free money" when closing costs and fees are associated with the loan. Always do a background check on any contractors you hire to work on your home. 

If you are looking to take out a loan to do home repairs, several options are available, like a cash-out refinance. Be sure to discuss your options with a financial advisor.

What You Need for a Reverse Mortgage

To get a reverse mortgage, the youngest borrower needs to be 62 or older. While this broadly applies to government-backed reverse mortgages, reverse mortgages are aimed at older borrowers. 

Before you can get a reverse mortgage, you need at least 50% home equity or must own your home outright. You also may not qualify for a reverse mortgage if you have defaulted on other federal loans.

Remember, a reverse mortgage does come with closing costs and fees. Federal reverse mortgages have a beginning 2% mortgage insurance premium, with an 0.5% fee each year. You also need to consider interest rates when taking out a reverse mortgage.

How to Know If a Reverse Mortgage Is Right for You

Always talk with a trusted financial advisor before taking out any loan, including a reverse mortgage. That being said, some people may benefit from a reverse mortgage more than others.

If you are low on savings but have high home equity, a reverse mortgage may be right for you. Reverse mortgages are also helpful for paying off late-in-life medical costs. Borrowers with no heirs or who do not intend to pass down their property are also good fits for reverse mortgages.

If you retired early and are looking to “bridge the gap” between your retirement and Social Security benefits, a reverse mortgage can help.

However, if you cannot take care of your property anymore, a reverse mortgage may not be right for you. Remember, reverse mortgages require you to live in your residence most of the time. If you move to an assisted living facility, you may have to repay the loan.

Reverse mortgages are paid off when the home is sold. If you want to pass down your home to your heirs, you want to avoid taking out a reverse mortgage.

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