What Is a Reverse Mortgage and How It Works
Many older adults find it difficult to manage their monthly expenses, even though they may have built significant equity in their homes over the years. In many cases, their mortgage payments continue to strain their limited income, creating additional financial pressure.
If you or your parents have substantial home equity but limited cash available, a reverse mortgage may help ease financial stress by improving monthly cash flow. However, this option is not ideal for everyone. It’s important to understand both the benefits and potential drawbacks before deciding whether a reverse mortgage is the right choice.
What Is a Reverse Mortgage Loan?
A reverse mortgage is a special type of loan designed for older homeowners. It allows them to access some of the equity they’ve built in their home without making monthly mortgage payments. Instead of paying the lender each month, the homeowner receives money from the lender.
How It Works
Reverse mortgages are created to support retirees who may have a valuable home but limited monthly income. By using this loan, seniors can convert part of their home equity into usable cash—without the burden of monthly payments.
Borrowers can choose how they want to receive the funds:
- A single lump-sum payment
- Monthly payments from the lender
- A flexible line of credit, similar to a HELOC
- Or a mix of these options
Just like any other loan, the money you receive is not considered taxable income.
The lender places a lien on the home. When the homeowner sells the property, moves out permanently, or passes away, the loan must be repaid. In many cases, the lender may take ownership of the property to settle the loan. However, reverse mortgages are non-recourse loans, meaning neither the homeowner nor their heirs will owe additional money if the home sells for less than the loan balance. Heirs can also choose to pay off the loan themselves and keep the house.
A major benefit is that you can stay in your home for the rest of your life as long as you follow the loan terms—and you never have to make monthly payments.
Of course, lenders still charge interest and fees. Interest accrues over time and is added to the loan balance instead of being paid monthly. Borrowers also typically pay an upfront origination fee (often called “points”). If the mortgage pays out monthly or as a credit line, the interest rate is usually variable.
Reverse Mortgage Example
Let’s say your home is valued at $300,000, and you still owe $100,000 on your current mortgage.
A lender approves you for a $150,000 reverse mortgage. You use part of this amount to pay off your existing $100,000 mortgage. This leaves you with $50,000 in available funds.
You can then choose how to access those remaining funds:
- Lump sum: Take all $50,000 at once at closing and use it however you like, with no tax consequences.
- Monthly payments: Receive smaller monthly instalments until the full $50,000 has been paid out. Your loan balance increases with each payment.
- Line of credit: Access the $50,000 only when you need it and pay interest only on what you use.
- Combination: Mix lump sum, monthly payments, and credit line.
Throughout the loan, you never have to make principal or interest payments, unless you choose to repay the loan voluntarily.
How Reverse Mortgages Differ From Traditional Mortgages
Reverse mortgages can seem unusual because they work in the opposite way of a standard home loan. Here are the key differences to understand before deciding whether they’re right for you.
Credit History Isn’t a Major Factor
Unlike traditional mortgages, reverse mortgage lenders generally don’t rely on your credit score or financial background to determine your eligibility or interest rate.
Since you’re not required to make monthly payments, your credit profile carries far less weight during approval.
Repayment Happens at the End of the Loan
With a reverse mortgage, the lender is paid back only when a major event occurs—when you move out permanently, sell the home, or pass away.
As long as the property remains your primary residence, you are allowed to live in the home for the rest of your life without making monthly payments.
You Cannot Turn the Home Into a Rental
Some retirees consider turning their home into a rental property after taking out a reverse mortgage—thinking they can pull equity, eliminate the mortgage payment, and earn rental income.
However, reverse mortgage rules do not allow this.
If you move out and the home is no longer your principal residence, you violate the loan terms. The lender can then call the loan, requiring full repayment immediately.
By contrast, traditional mortgages typically allow you to move out after living in the home for one year, without needing to pay off the loan.
Reverse Mortgages Come With Lower LTV Ratios
Traditional mortgage loans follow an amortization schedule, giving lenders confidence in how and when they will be repaid. Because of this, some conventional loans offer high loan-to-value (LTV) ratios—sometimes even up to 100%.
Reverse mortgage lenders face more uncertainty. They do not know exactly when the loan will be repaid, so they offer lower LTVs, usually between 50% and 65%.
Older Borrowers Can Access More Equity
The loan amount partly depends on the age of the youngest borrower. Lenders use life expectancy tables to estimate the possible length of the loan.
- If the borrower passes away sooner than expected, the loan becomes due at that time.
- If the borrower lives longer than predicted, the loan continues until they leave the home or die.
As a result, the older the youngest borrower is, the higher the potential LTV and the more equity they may be able to access.
Reverse Mortgage Loan Programs and Eligibility
Compared to standard home loans, reverse mortgage options are more limited. Most homeowners who choose a reverse mortgage do so through the Federal Housing Administration (FHA). However, new programs are slowly emerging, and the industry may offer more choices in the future.
FHA’s Home Equity Conversion Mortgage (HECM)
The Home Equity Conversion Mortgage (HECM) is the most widely used reverse mortgage program in the U.S. It is backed by the FHA and comes with specific rules and eligibility requirements.
Eligibility Requirements
To qualify for a HECM loan, borrowers must meet the following criteria:
- You must be 62 years of age or older.
- The home must be your primary residence.
- The property must be a single-family home, 2–4 unit property, or an FHA-approved condo.
- Borrowers must complete a HUD-approved counseling session to fully understand the financial responsibilities and legal terms of the loan.
- You must show the ability to pay ongoing costs such as property taxes, homeowners insurance, and home maintenance.
- The maximum loan amount under the HECM program is $822,375 (as of 2021).
Since this is an FHA-backed mortgage, it includes mandatory mortgage insurance. Borrowers pay:
- An upfront mortgage insurance premium (MIP) equal to 2% of the loan amount (that’s $2,000 per $100,000 borrowed).
- An annual MIP of 0.5% of the original loan balance, added to the loan monthly.
Because not every traditional lender is approved to offer HECM loans, borrowers often need to compare lenders or work with brokers who specialize in reverse mortgages.
Finance of America Reverse’s EquityAvail Program
Another option gaining attention is EquityAvail, a hybrid reverse mortgage program offered by Finance of America Reverse.
This program blends features of a traditional mortgage with a reverse mortgage:
- Borrowers receive an upfront lump sum.
- For the first 10 years, they make reduced monthly payments to the lender.
- After the 10-year period ends, payments stop completely, and the borrower can stay in the home without monthly mortgage payments until they move out, sell, or pass away.
Benefits of EquityAvail
- No mortgage insurance requirement.
- Allows younger borrowers, starting at age 60, since the program involves 10 years of payments.
- Helps homeowners ease into retirement while still accessing part of their home equity.
Hybrid reverse mortgages like EquityAvail may become more common as the demand for retirement financing grows among aging baby boomers.
Advantages of Reverse Mortgages
Reverse mortgages offer several benefits that can make retirement more comfortable and financially secure. Here are the key pros to consider:
No Monthly Mortgage Payments
One of the biggest advantages is that you don’t have to make monthly mortgage payments as long as the home remains your primary residence. This can significantly reduce your monthly expenses and free up cash flow.
Stay in Your Home for Life
Reverse mortgages do not come with a set repayment term. The loan only becomes due when you move out permanently, sell the property, or pass away. This allows you to live in your home for as long as you choose.
Non-Recourse Protection
These loans are non-recourse, meaning you or your heirs will never owe more than the home’s value. If the property sells for less than the loan balance, the lender absorbs the loss—your estate is protected from deficiency judgments.
Option to Repay Anytime
Borrowers or their heirs can repay the loan at any point if they want to keep the property. Ownership does not automatically transfer to the lender upon the homeowner’s death.
Credit Score Not a Barrier
Reverse mortgage eligibility does not depend on your credit score. Even with past credit issues or bankruptcy, you may still qualify as long as you meet the program’s other guidelines.
Flexible Payout Options
Borrowers can choose how they receive their funds:
- A lump-sum payment
- Monthly income-style payments
- A line of credit
- Or a combination of these options
This flexibility makes it easier for retirees to tailor the loan to their specific financial needs.
Disadvantages of Reverse Mortgages
While reverse mortgages can be helpful for retirees who need additional cash flow, they also come with several drawbacks. It’s important to understand these potential risks before choosing this type of loan.
You Must Live in the Home
A reverse mortgage requires the home to remain your primary residence. You cannot:
- Move out and turn the property into a rental
- Move permanently into a nursing home
- Vacate the property for an extended period
If you do, the loan becomes due immediately.
Low Loan-to-Value (LTV) Ratios
Reverse mortgages typically allow borrowers to access only 50%–65% of their home’s value. Because these loans are non-recourse, lenders reduce their risk by offering much lower LTVs compared to traditional mortgages.
Age Restrictions
To qualify for an FHA-insured HECM reverse mortgage, the youngest borrower must be 62 or older. Younger homeowners cannot access this loan type.
Limited Tax Benefits
Interest on a reverse mortgage cannot be deducted until the loan is fully repaid — which for many happens only after death. With standard deductions now significantly higher, even fewer retirees benefit from interest deductions.
Mortgage Insurance Costs
HECM loans require borrowers to pay:
- A 2% upfront mortgage insurance premium (MIP)
- An ongoing 0.5% annual MIP
These expenses can reduce the overall benefit of the loan.
Mandatory Counseling
All applicants must undergo a HUD-approved counseling session, which adds an extra step and sometimes an additional cost to the process.
Limited Lender Options
Reverse mortgages are not offered by all financial institutions. Fewer lenders and fewer loan programs mean limited competition and potentially higher borrowing costs.
Risk of Scams and Fraud
Unfortunately, seniors are frequent targets of financial scams. Examples include:
- Family members or caregivers misusing power of attorney to take out a reverse mortgage and steal proceeds
- Financial advisors pushing unnecessary or harmful products (such as annuities) that can only be purchased using a reverse mortgage
- Illegal kickbacks between unethical advisors and lenders
These risks make it essential to work with trusted professionals and involve family members you trust.
When Reverse Mortgage Lenders Can Foreclose
Even though most reverse mortgage borrowers do not make monthly payments, missed payments are not the only reason a lender may initiate foreclosure.
Borrowers are required to stay current on property taxes and homeowners insurance. If these obligations are not met, it is considered a violation of the mortgage agreement. In many cases, the lender will step in and pay these charges on the borrower’s behalf, then add the amount to the loan balance. However, if the borrower cannot repay these advanced costs, the lender may proceed with foreclosure.
Leaving the home without paying off the reverse mortgage balance also breaks the terms of the loan. Even if the borrower plans to stay in the home long-term, health issues may require moving into a nursing facility or assisted living. Once the borrower no longer occupies the home as their primary residence, the reverse mortgage becomes due, which can lead to foreclosure if it is not repaid.
Borrowers must also maintain the property in good condition. Neglecting necessary repairs or allowing the home to fall into disrepair violates the loan requirements and may result in foreclosure as well.
Conclusion
Reverse mortgages can offer much-needed financial relief for older adults who are “house-rich” but cash-poor. However, they come with responsibilities that borrowers must carefully manage. Staying current on property taxes and homeowners insurance, maintaining the home, and continuing to live in the property are essential to keeping the loan in good standing. Failing to meet these obligations can result in foreclosure, even though monthly mortgage payments are not required.
Before choosing a reverse mortgage, it’s crucial to weigh the benefits against the risks and understand all terms clearly. With the right planning and awareness, a reverse mortgage can be a helpful tool — but only when it aligns with your financial situation and long-term living goals.
