What is a Reverse Mortgage?

June 05, 2018 · 4 minute read

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What is a Reverse Mortgage?

Traditionally considered a last-ditch source of cash for homeowners, reverse mortgages are becoming more popular. Older Americans, particularly retiring baby boomers, have increasingly drawn on this financial tool to fund renovations, pay off debt or medical expenses, buy new real estate, or simply improve their lifestyles.

So what is a reverse mortgage? It’s a type of loan that allows homeowners to turn part of the value of their home into cash. Available to people 62 or older, a reverse mortgage can be paid as a lump sum, a monthly stipend, or a line of credit. Unlike a second mortgage or a home equity loan, the loan doesn’t have to be repaid until a borrower dies, sells the house, or moves out permanently.

Taking out a reverse mortgage can be a smart move for some homeowners, especially for older members of the workforce who need to draw on their home equity to pay for daily expenses as they move into retirement. It can also be used later in life to help fund long-term care.

Previously suspicious of the practice, a growing number of financial advisors have come to see a reverse mortgage as a viable part of retirement strategies. But reverse mortgages also come with drawbacks, and they aren’t for everyone. Depending on your goals, alternatives like personal loans or cash-out refinancing may be a better bet.

How do reverse mortgages work?

Reverse mortgages were created to help retirees who live in homes but have limited cash flow to cover living or medical expenses. To qualify for a reverse mortgage, all owners of the home must be at least 62. Reverse mortgages are only available to people who have paid off their home loan entirely or owe very little on their mortgage.

Borrowers must also use the home as their primary residence. The reverse mortgage amount you qualify for is determined based on an appraisal of your home’s value, the age of the youngest borrower, and going interest rates. Generally, the older you are and the more your home is worth, the higher your reverse mortgage will be. Borrowers, or their heirs, usually repay the reverse mortgage by eventually selling the house.

The most common type of reverse mortgage is a Home Equity Conversion Mortgage (HECM), which is insured by the Federal Housing Administration and offers certain consumer protections. These loans have a limit of $679,650 .

If you’re interested in taking out a reverse mortgage, apply through a member of the National Reverse Mortgage Lenders Association to avoid scams. You will also be required to meet with a HECM counselor.

Pros and Cons of Reverse Mortgages

If you’re nearing retirement, it’s easy to see why reverse mortgages are appealing. For one, unlike most loans, you don’t have to make any monthly payments. The loan can be used for anything, whether that’s debt, healthcare, daily expenses, or buying a vacation home.

How you get the money is also flexible: You can choose whether to get a lump sum, monthly disbursement, line of credit, or some combination of the three. You can start paying back the loan whenever you want, even if that means waiting until you’re ready to sell the house. Borrowers don’t have to pay back more than the home is worth, even if the loan balance ends up higher than the home value.

You can also use a reverse mortgage to purchase a primary residence if you have sufficient funds to pay the difference between the loan proceeds and the sales price plus closing costs for the property your are purchasing.

But reverse mortgages aren’t without their drawbacks. You are required to keep up with property taxes, homeowners’ insurance, and maintenance costs. If you don’t pay insurance or taxes, or if you let your home go into disrepair, you risk defaulting on the reverse mortgage. If you move out of your home, the loan becomes due.

Reverse mortgage interest rates can be fairly high compared to traditional mortgages and like most mortgage loans, there are origination and third party fees you will be responsible for paying. Finally, taking out a reverse mortgage means reducing the equity left in your home, which could mean leaving less for those who would inherit your house.

Alternatives to Reverse Mortgages

Depending on your financial needs and goals, a reverse mortgage may not be the best option for you. There are other ways to tap into cash that may offer lower fees and don’t have the same rigid requirements in terms of age, home value, and share of mortgage repaid.

If you don’t need monthly cash flow to support your basic needs, a personal loan could get you a lump sum of money without diminishing the equity in your home. A personal loan is a great choice if you need to pay off high-interest debt, fund home renovations, or make a big-ticket purchase.

SoFi offers personal loans ranging from $5,000 to $100,000 and unlike with a reverse mortgage, there are no origination fees or other hidden costs. If you aren’t sure home much your home renovation is going to cost, use this Home Improvement Cost Calculator to find out.

Another option is a cash-out refinance, which involves refinancing your mortgage for more than you owe and pocketing the difference in cash. This is a common way to pay for home improvements or even educational expenses. Cash-out refinances are a good option if you are eligible for a lower interest rate upon refinancing, if you have at least 20% equity in your home, and if your home’s value has been rising.

Need a boost to reach your financial dreams? Consider taking out a personal loan or refinancing your mortgage with SoFi.

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