For older Americans who may find they need more money in retirement, using a reverse mortgage to convert some of their home’s equity into cash can be an intriguing idea.
Thanks to protections the U.S. Department of Housing and Urban Development (HUD) has put in place over the past few years, the risks once associated with these loans have been reduced.
And both the federal and state governments are cracking down on deceptive marketing practices that may downplay the complexity of reverse mortgage agreements. However, there still are some downsides to reverse mortgages that borrowers may not know about—including that it’s still possible for them to lose their home if they don’t comply with all the terms of their loan.
Related: What is mortgage amortization?
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Why Do People Choose a Reverse Mortgage?
A reverse mortgage allows qualifying homeowners age 62 and older to convert part of the equity they’ve built up in their primary residence and into money they can use to pay off their existing mortgage or for any other expenses that come up in retirement (from health-care costs to home repairs).
The big selling point for reverse mortgages is that the loan usually doesn’t have to be paid back until the last borrower, co-borrower, or eligible non-borrowing spouse dies, moves away, or sells the home. And when it is time to repay the loan, neither the borrower nor any of the borrower’s heirs will be expected to pay back more than the home is worth.
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Main Types of Reverse Mortgages
There are three basic types of reverse mortgages. The most common is a home equity conversion mortgage (HECM), which is the only reverse mortgage insured by the US government and is available only through an FHA-approved lender. An HECM can be used for anything, but there are limits on how much a homeowner can borrow.
There are also proprietary reverse mortgages, which are private loans that may have fewer restrictions than HECMs—including how much a homeowner can borrow.
And there are single purpose reverse mortgages, which are typically offered by nonprofit organizations or state or local government agencies that may limit how the funds can be used. Most of the time when someone refers to a reverse mortgage, though, they’re talking about an HECM.
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Reverse Mortgage Terms to Know
There are safeguards in the reverse mortgage process that protect borrowers, but there are also loan terms borrowers are required to uphold or risk defaulting and potentially triggering a foreclosure. They include:
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1. Staying Current With Ongoing Costs
Borrowers must stay up to date on property taxes, homeowners insurance, homeowners association fees, and other costs, or they could risk defaulting on the loan.
An assessment of a borrower’s ability to pay for those ongoing expenses is part of the reverse mortgage application process, and if it looks as though money might be tight, a lender may require a borrower to set up a reserve fund, called a “set-aside,” for those costs.
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2. Maintaining Full-Time Residency
Borrowers (and eligible non-borrowers) must use the home as their primary residence —the home they occupy for most of the year.
If they move out of the house or leave the home for more than six months, or receive care at a nursing home or assisted living facility for more than 12 consecutive months, it could result in the lender calling the loan due and payable.
The lender also may choose to accelerate the loan if the borrower sells the home or transfers the title to someone else, or if the borrower dies and the property isn’t the principal residence of a surviving borrower.
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3. Keeping the Home in Good Repair
Because the home is collateral and may have to be sold to repay the loan, lenders may require borrowers to do basic maintenance that will help the property keep its value (e.g., repairing a leaky roof or fixing a problem with the electrical system). If an inspector feels the home is not being properly maintained, the lender could take action.
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What Happens If a Reverse Mortgage Borrower Defaults?
If the homeowners default, the first thing that could happen is that future loan payments may be stopped.
And if the problem isn’t corrected within the lender’s stated timeline, the loan may become due and payable, which means the money the lender has distributed to the borrower, plus any interest and fees that have accrued, must be repaid. In that case, the borrower typically has four options:
- They can pay the balance in full and keep their home.
- They can sell the home for the lesser of the balance or 95% of the appraised value and use the proceeds to pay off the loan.
- They can sign the property back to the lender.
- They can allow the lender to begin foreclosure.
No matter what the homeowners decide to do, the process could take months to complete. HECM lenders may offer borrowers additional time to fix the problem that put them into default, or the borrowers may qualify for extensions or a repayment plan.
But in the meantime, there could be other implications—if the homeowners are no longer getting money they need to pay their bills or if the lender reports the default to credit monitoring agencies—that could affect the homeowners’ credit scores.
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A Few Alternatives to Consider
The advertisements some lenders use to sell their reverse mortgages can be convincing, and some seniors may see these loans as a convenient way to get some extra cash or as a much needed lifeline.
But, as with any financial decision, there are advantages and disadvantages—and alternatives—to be considered. There are other ways homeowners may be able to get help that could be less complicated and less limiting than a reverse mortgage.
Here are a few options:
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1. Tap Your Equity
Borrowers may wish to tap into their home’s equity with a traditional home equity loan or home equity line of credit.
They’ll have to make monthly payments, and their income and credit history will be considered when they apply, but the terms may be more flexible and the overall cost may be lower than a reverse mortgage. Because the home is used as collateral, there’s still a risk of foreclosure.
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1. Get a Personal Loan
A low rate personal loan might be another option for homeowners who qualify for a competitive interest rate based on their income and credit. Borrowers who don’t have much equity in their home may choose to look into this type of loan, which is unsecured and is paid out in a lump sum.
While foreclosure is not a worry with a personal loan, there still may be consequences to the borrower’s credit rating if they don’t uphold the loan terms.
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Borrowers who are struggling to keep up with their bills in retirement may find that refinancing a mortgage with a new, lower-cost mortgage might be an option to help them lower their monthly payments and stay on track with their budget.
Or if they need extra cash right away and can get a low enough interest rate, they may want to look into a “cash-out refinance,” which would involve taking out a new loan for a larger amount based on the equity they’ve built up during the years they’ve lived in the home.
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Unfortunately, no matter which type of loan homeowners might choose, there could be risks.
The government requires a counseling session for reverse mortgage borrowers for a reason: They’re complex, and it can be helpful to have someone cover all the rules and costs involved.
Homeowners also may want to talk to a financial advisor about what type of loan, if any, fits with their needs, goals, and where they are in their retirement.
Though reverse mortgages are available to homeowners starting at age 62, borrowers who expect to have a long retirement may choose to wait until they’re older to tap into their home equity, so they don’t risk running out of money in their later years.
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