What is a Reverse Mortgage and How Does It Work?
A reverse mortgage is a special type of home loan for homeowners aged 62 and older that allows you to convert a portion of your home's equity into cash. Unlike a traditional mortgage where you make monthly payments to a lender, with a reverse mortgage, the lender makes payments to you. The loan is repaid when the homeowner sells the home, moves out, or passes away.
The most common type is the Home Equity Conversion Mortgage (HECM), which is insured by the Federal Housing Administration (FHA). The amount you can borrow depends on your age, the current interest rate, and your home's value (up to the HECM limit of $1,149,825 in 2024).
What to Expect: Payouts and Costs
One of the most flexible features of a reverse mortgage is how you can receive your funds. You can choose from several payout options:
- Lump Sum: A single, large payment at closing.
- Monthly Payments (Tenure or Term): Receive fixed monthly payments for as long as you live in the home (tenure) or for a set period (term).
- Line of Credit: Draw funds as you need them, only paying interest on the amount you use. This is the most popular option.
- Combination: A mix of the above, such as a partial lump sum and a line of credit.
It's also important to understand the costs, which typically include:
- Upfront Fees: These can include an origination fee, appraisal fee, and other closing costs, often totaling around $2,500 - $6,000.
- Mortgage Insurance Premium (MIP): You'll pay an initial MIP at closing and an annual MIP (0.5% of the loan balance) thereafter. This protects the lender, not you.
- Interest: Interest accrues on the loan balance, which grows over time. Rates can be fixed or variable.
"A reverse mortgage isn't free money—it's a loan that uses your home as collateral. But used wisely, it can be a powerful tool for financial stability in retirement."
The Dos and Don'ts of Reverse Mortgages
Navigating a reverse mortgage requires careful consideration. Here are the essential dos and don'ts to follow.
DO compare offers from multiple lenders to get the best terms and lowest fees.
DO maintain your home and stay current on property taxes and homeowners insurance. Failure to do so can trigger a loan default.
DO consult a financial advisor to understand how a reverse mortgage fits into your overall retirement strategy.
DO use the funds strategically for needs like healthcare, home modifications, or supplementing income.
DON'T forget to consider the impact on your eligibility for government benefits like Medicaid or SSI.
DON'T choose the wrong payout option. A line of credit is often safer than a large lump sum that could be spent too quickly.
DON'T move out permanently. The loan becomes due and payable if the home is no longer your principal residence.
DON'T feel pressured. Reputable advisors will encourage you to take your time and discuss the decision with your family and a counselor.