Pulling the equity out of your house through a reverse mortgage seems to fly in the face of the American dream of proudly living in a fully paid-up home.
That, combined with the sketchy reputation reverse mortgages have sometimes had, is why most people are wary of pursuing these loans.
But over the past decade, the US Department of Housing and Urban Development strengthened regulations to protect consumers.
“Like any financial product, reverse mortgages can be a great tool,” says Jennifer Fraser, with GreenPath Financial Wellness, a nonprofit financial counseling service. “They work well for some people and are not a great fit for others.”
A reverse mortgage is a loan, with the interest on it compounding. But unlike a traditional mortgage, you or your estate repays the principal and interest at the end of the loan.
Home Equity Conversion Mortgages (HECMs) are the only federally insured reverse mortgages and have strict requirements.
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You must be age 62 or older and, as of 2022, the loan can’t be based on a home value greater than $970,800, even if the house is worth more.
Typically, you must have at least 50% equity in the home, which must be your principal residence. (Besides HECMs, a small number of private reverse mortgages are available in some states through specific lenders. Typically, private reverse mortgages are more appropriate for someone younger than 62 who has a high-dollar-value house.)
The lender takes over a house when the borrower dies or moves out for more than a year, but heirs are entitled to any leftover home equity and can even use it to pay off the reverse mortgage and reclaim the house. With a reverse mortgage, you or your heirs can’t owe more than the home’s fair-market value.
Borrowers must receive counseling at HUD-approved sites before closing on an HECM. Still, some people don’t know what a reverse mortgage is, says Cora Hume, a lawyer with the Consumer Financial Protection Bureau. “If people are taking out a product and don’t understand it, that’s a problem.”
About 40% of potential applicants who go through counseling to take out the loans decide not to proceed, says Steve Irwin, president of the National Reverse Mortgage Lenders Association. Expense is a factor. Reverse mortgage fees, which are usually rolled into the loan, can be high.
The reverse mortgages themselves can be paid out in four different ways: a lump sum when the loan is taken out; equal monthly payments as long as at least one borrower continues to use the home as a main residence; equal monthly payments over a fixed period; or a line of credit that can be used until the money is gone.
Only the lump sum option qualifies for a fixed interest rate. Everything else has a variable rate.
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