Ask Stacy: How Do Reverse Mortgages Work?

Photo (cc) by pasa47

What do Henry Winkler, Robert Wagner and Fred Thompson have in common?

If you answered, “They’re all former stars of TV shows,” you’re right. But one other thing they have in common is they’ve all pitched reverse mortgages.

What’s a reverse mortgage and how do they work? I’m asked this question a lot. Examples:

Is a reverse mortgage something to look at? We have a 30 year mortgage on our house for $70,000 and thought it might be easier to let the house make the payments for us. The house is worth somewhere around $225,000.
– Roger

Can you give me a real, down to earth, honest to goodness explanation to the “reverse mortgage” currently being touted to seniors 62 and older. It almost seems like it’s “too good to be true” and you know what they say about those kinds of deals!
– Larry

What is your thoughts on Reverse Mortgages. I own my home, recently widowed and owe approximately $25,000.
– Mary

In case you somehow missed one of these commercials, Henry Winkler will whet your appetite with the following video: Check it out, then I’ll explain the nuts and bolts.

What’s a reverse mortgage?

A reverse mortgage gets its name from the fact that it’s a mortgage that pays you rather than requiring you to pay it.

Say you’re a senior and you own your home free and clear. Take out a reverse mortgage, and you won’t be making payments. Instead, you’ll be receiving money, either in a lump sum, monthly for a certain period of time, or even for life. So a reverse mortgage could be perfect for retirees with lots of home equity, but little income.

But to understand reverse mortgages, forget the “reverse” and focus on the “mortgage.” Because at the end of the day, that’s all it is — a mortgage.

How they work

As I mentioned, reverse mortgages allow you to convert your home equity into cash, without having to sell your home or make payments. As with any mortgage, you apply through a lender, although pretty much any homeowner meeting the age requirement will qualify.

You can repay the mortgage anytime, but it must be repaid when you die or when the home ceases to be your permanent residence. If you or your heirs can’t repay the loan, your home goes to the lender.

While there are different types of reverse mortgages, the most common are home equity conversion mortgages, backed by the U.S. Department of Housing and Urban Development. They’re available only to those 62 and older.

As with any money you borrow, reverse mortgages are tax-free. You can get the money in several ways:

  • Fixed monthly payments over a specific number of months.
  • Fixed monthly payments for life, or as long as you live in the home.
  • A line of credit you draw on as often as you want in whatever amounts you’d like.
  • A combination of monthly payments and line of credit.

You won’t give up the title to your home. You’ll still own it.

The amount of the loan and payments will vary based on your equity, along with the size and length of the payments and your age. To see how much you could be eligible for, use this calculator.

What’s the catch?

Catch No. 1: Something Mr. Winkler forgot to mention in the ad above is that reverse mortgages come with fees attached. Big ones.

When I did my first TV story on reverse mortgages many years ago, the homeowner I interviewed insisted he paid nothing for his reverse mortgage. He was right in the sense that he didn’t write a check to cover the fees, because they were rolled into the mortgage. But that doesn’t mean the mortgage was fee-free. In fact, reverse mortgages often have higher fees than regular mortgages. From the FTC’s reverse mortgage website:

Lenders generally charge an origination fee, a mortgage insurance premium (for federally insured HECMs), and other closing costs for a reverse mortgage. Lenders also may charge servicing fees during the term of the mortgage.

One fee example: Standard HECM mortgages include a 2 percent mortgage insurance premium, based not on how much you borrow, but the value of your home. So if your home is worth $500,000, that’s $10,000. Borrow only $100,000, and you’ve paid 10 percent in that fee alone.

There are lower-cost loans available. For example, the fee for the HECM Saver loan is only 0.01 percent of the home’s value, rather than 2 percent. But you can’t borrow as much with those loans and interest rates are typically higher.

As with any mortgage, you should shop and compare reverse mortgages and ask about fees. While some may be set by law, others could vary by lender.

Catch No. 2: Although you may be receiving checks in the mail, don’t lose sight of the fact that you’re paying interest, and unpaid interest is increasing the size of the loan. The longer the loan remains outstanding, the more interest will accrue.

Should you choose lifetime payments and stay in your home for decades, it’s likely you’ll have little, if any, equity to leave to your heirs, unless, of course, the home increases in value faster than the accumulated interest.

Catch No. 3 Since you still own the house, you remain responsible for property taxes, insurance and maintenance. This is one reason the FHA is considering new rules to make sure reverse mortgage applicants have the financial wherewithal to pay these expenses.

Catch No. 4: Do it wrong and you could be in trouble: for example, if one spouse is on the loan paperwork and the other isn’t. From a New York Times article:

Joan Serioux-Forde, 72, thought that she couldn’t feel more devastated after her husband, Christopher, died last year. Then, roughly a month after the funeral, she received a letter from Generation Mortgage, a reverse mortgage lender, informing her that unless she paid $293,000, she would lose her home in San Bernardino, Calif. Ms. Forde said she was never informed that if she wasn’t on the reverse mortgage deed, she would have virtually no right to stay in her home unless she bought it outright.

The bottom line

The benefits of tapping your home’s equity without selling your home or making payments are obvious. Whether a reverse mortgage makes sense for you, however, will depend on what other options you have.

If you have other resources, paying interest and fees is rarely your best bet. If you don’t, however, a reverse mortgage can be the difference between living and merely surviving. Just understand what you’re doing and shop carefully.

Before you’re allowed to take out a reverse mortgage, you’ll be required to receive counseling from an FHA-approved reverse mortgage counselor. So if you’re thinking of a reverse mortgage, call one in advance with questions. The vast majority are happy to help free of charge.

Got a money-related question you’d like answered?

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The questions I’m likeliest to answer are those that will interest other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer.

Got any words of wisdom you can offer for this week’s question? Share your knowledge and experiences on our Facebook page.

Got more money questions? Browse lots more Ask Stacy answers here.

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

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