How Reverse Mortgages Work

By Britt Erica Tunick

Anyone who watches television has at some point more than likely seen an advertisement touting reverse mortgages. From Robert Wagner to Henry Winkler, and now Tom Selleck, there has been no shortage of celebrities promoting reverse mortgages as an easy source of cash for senior homeowners.

As the name suggests, a reverse mortgage is a type of loan that allows a homeowner to take equity out of their home. Available to anyone 62 years or older, who owns their home outright or has a significant amount of equity already paid into the mortgage on their home, reverse mortgages allow a homeowner to extract money from their home — whether by taking a lump payment or receiving monthly payments — without having to pay the money back so long as they still live in that home. Only Home Equity Conversion Mortgages (HECMs) are insured by the U.S. Federal Government, however, and these are only available through FHA-approved lenders. When the borrower leaves their home, repayment of the loan is due. This includes whatever interest terms were agreed to at the time the reverse mortgage was taken out and based on how much equity has been removed from the home.

The maximum amount an individual or couple can extract from the value of their home, as well as the interest rates that will ultimately need to be repaid, are based on the age of the youngest individual taking out the loan, as well as the home’s ultimate value and the U.S. Department of Housing and Urban Development’s (HUD) lending limit –whichever is lower. Other factors that can impact the total amount that can be borrowed in a reverse mortgage include the existence of any liens or other mortgages on the property, which must first be completely paid off.

As with traditional mortgages, reverse mortgages also have closing costs. These are taken out of the total amount a borrower is able to obtain from their home. Similarly, just as mortgage borrowers must maintain homeowners insurance and pay property taxes on their home while they are repaying a mortgage, so, too, must reverse mortgage borrowers.

The idea behind reverse mortgages is to provide people who have a dearth of cash, yet significant equity tied up in their homes, a way to access the cash they need to meet their living requirements in their retirement years.