As you pay off your mortgage, you’ll build equity in your home. Equity can be an extremely valuable financial resource, particularly as you grow older. That’s because if you need funds, you have the option to tap your equity, meaning borrow against it.  

You’ve probably heard of home equity loans before, but they’re not the only vehicle for accessing your equity—a reverse mortgage is another option that may provide a reliable stream of money. Let’s examine what exactly a reverse mortgage is and help you evaluate whether getting one might be a good idea for your financial situation.

What is a reverse mortgage? 

A reverse mortgage is a type of loan that lets homeowners borrow against their home equity. It allows you to access a portion of your home’s value without selling it first. A lender allows you to borrow cash or against a line of credit, and you’ll pay back what you owe when you sell the house. 

But, it’s crucial to note a reverse mortgage comes with certain risks and may not be right for everyone. First, you secure the loan with your home, meaning you could lose it if you don’t meet your obligations. In addition, if you wish to leave the home to your heirs as an inheritance after your death, know that a reverse mortgage can impact whether they can keep it or must sell it off to pay off the debt. 

There are multiple types of reverse mortgages, each with unique eligibility requirements, insurance, borrowing limits, etc. We’ll dive further into the details of different types in just a moment to help you decide which might be best for your situation. 

How do reverse mortgages work? 

With a traditional mortgage, you borrow money to buy the home and pay your lender in monthly installments. But with a reverse mortgage, the lender pays you. 

You’ll no longer make monthly payments on your home; rather the financial institution will lend you enough money to pay off your mortgage and even give you some extra money that you can use as you please. You can choose to receive a lump sum, a monthly payment, or a line of credit. 

Note that you are still responsible for paying property taxes and your homeowners insurance bill. 

Similar to a common home equity loan or home equity line of credit (HELOC), the money you borrow with a reverse mortgage is considered a “secured” loan, as you’re using your home as collateral. 

But there are big differences. First, a home equity loan or HELOC doesn’t go toward paying off your mortgage. Second, reverse mortgages don’t require repayment until: 

• You sell the home. If you decide to move and sell your property, the lender will require its loan to be paid off with a portion of your proceeds from the sale. 
• You no longer use the home as your primary residence. If you keep the house but move somewhere else, you’ll have to pay back the loan. 
• The last surviving homeowner dies. For example, if the house is under both your and your spouse’s name, the lender will require repayment once you’ve both passed away. 

All to say, you’re not on a fixed repayment schedule. You can repay the money ahead of time at your discretion or know the debt will be called due if one of the above situations occurs. 

When you take out a reverse mortgage, the interest and fees associated with the loan are added to your loan balance each month—meaning the loan balance will increase month after month. Naturally, your home equity decreases as you borrow. 

Again, when the time comes to make the lender whole, either you or the property’s inheritor can sell the house or make a cash payment. 

Beware of default events 

In addition to the aforementioned maturity events, such as moving or selling your home, a handful of negative events will force you to repay your reverse mortgage or risk losing the property. This includes: 

• Failing to pay property taxes. 
• Neglecting to maintain homeowners insurance. 
• Inadequate property upkeep. 

Different types of reverse mortgages 

There are three main types of reverse mortgage options. Before you apply for a reverse mortgage, it’s worth knowing the differences between them. 

Home equity conversion mortgages (HECM)  

The most common reverse mortgage is called a home equity conversion mortgage (HECM). They’re available only through lenders that have been approved by the Federal Housing Administration. Only homeowners aged 62 and above are eligible to secure an HECM. 

The only reverse mortgage insured by the federal government, HECMs are backed by the U.S. Department of Housing and Urban Development, protecting lenders in case a borrower fails to meet their obligations.  

For borrowers, note that HECMs are recourse loans, which ensures that you or your heirs will never owe more than your house is worth when it’s time to pay back your loan. 

An HECM provides options when it comes to receiving funds. You can take a lump sum, a fixed monthly payment, a line of credit, or a combination of both. You can use the money for essentially whatever you like, similar to a personal loan.

Lenders calculate what they’re willing to let you borrow via an HECM based on factors such as your age, the value of your home, and your HECM’s interest rate. This number is called the “principal.” There are a couple caps to be aware of, however: 

• The maximum you may be allowed to borrow is $1,209,750. 
• You can typically only borrow up to 60% of your principal amount during the first year. 

There’s an exception to that second bullet. If you still owe more than 50% of your principal limit on your home, you may borrow enough to pay off your mortgage and make other required payments—plus an additional 10% of your initial principal. 

As an example, let’s say the lender approves you for a $300,000 principal limit: 

• If you owe less than $150,000 on your home, you can request up to $180,000 during the first year. 
• If you owe, say, $190,000 on your home, you can request up to $190,000 (enough to pay off your mortgage) plus an additional $18,000 (10% of your initial principal amount). That’s a total loan amount of $208,000. 

Proprietary reverse mortgages 

Proprietary reverse mortgages are backed by the individual lender instead of the government. Unlike HECMs, these loans typically do not require borrowers to be 62 years of age or older. It’s possible to open a proprietary reverse mortgage as early as age 55. 

In addition, proprietary reverse mortgages are known for offering higher loan amounts than HECMs. That means if you own a home worth $1.5 million or $2 million or more, you’d likely be able to access more of the equity through a proprietary reverse mortgage than via an HECM. 

Single-purpose reverse mortgages 

Perhaps the least common (and potentially least expensive) option, single-purpose reverse mortgages are offered by select state and local government agencies. In some cases, nonprofits also offer these mortgages. 

This reverse mortgage type is relatively self-explanatory: a sum of money specifically for a lender-approved purchase or expense, such as home maintenance. They’re not available in every state, so whether you’re able to apply for this type of loan will depend on where you live. 

These types of reverse mortgages typically provide access to a more limited amount of home equity, meaning the loans are smaller. Single-purpose reverse mortgages may also be a good option for homeowners with low to moderate income. 

Similar to an HECM, only those ages 62 and up may apply. 

Reverse mortgage requirements 

While the qualification requirements for a reverse mortgage may vary slightly between these three loan options (and by which specific lender you apply with) criteria will generally include: 

• Age requirements. Again, HECM and single-purpose borrowers must be at least 62 years old to qualify. For proprietary reverse mortgages, the age minimums may vary but can be as low as 55. 
• Residency requirements. The home must be your primary residence. This means you must live there for the majority of the calendar year. 
• Housing counseling requirements. HECM applicants are required to meet with an independent housing counselor to discuss their finances and the implications of a reverse mortgage. Proprietary reverse mortgages will sometimes require counseling, as well. 
• Mortgage balance. Most reverse mortgages require that applicants have at least paid off a substantial portion of the mortgage. 
• Debt. Most lenders require that applicants not have any federal debt (think unpaid federal income taxes). 
• Condition of the home. Typically, the home must be in good shape to qualify for a reverse mortgage. If not, the lender may require repairs before proceeding with the loan. 

Benefits and downsides of a reverse mortgage  

There are pros and cons to reverse mortgages that should be weighed carefully before you commit. They’re not the right solution for everyone’s situation. Here are some factors to consider. 

Pros 

Reliable flow of funds 

Whether you choose ongoing payments or a line of credit from your reverse mortgage, these loans can provide a steady source of funds, which can be particularly important for those on a fixed income. 

Eliminating mortgage payments 

When you take out a reverse mortgage, the lender pays you and you cease making mortgage payments, though you’re still responsible for property taxes and homeowners insurance. The lack of a monthly mortgage payment can be a key benefit that’s helpful for individuals who have a limited income as they age—or for individuals who simply want to have additional money available. 

Avoid using other retirement accounts 

Using a reverse mortgage can make it possible for borrowers to avoid tapping retirement investment accounts. This may be especially helpful during market downtowns that impact retirement savings accounts. 

Reverse mortgages aren’t taxed 

The money generated by a reverse mortgage is not taxable. The IRS considers that money a loan advance. 

Cons 

You eat away at the equity in your home 

As your reverse loan balance increases, the equity in your home decreases. If your goal is to transfer the home with equity to your heirs, you should carefully consider this ramification before proceeding. And, know that if your heirs do not have the money available to pay off the reverse mortgage upon your passing, they may have to sell the home to cover the debt.  

You’ll pay fees and interest 

Like any loan, there will be interest charges and fees on a reverse mortgage. Many lenders charge an origination fee or closing costs—or both. There may also be servicing fees during the course of the loan. And depending on whether you open a HECM or a proprietary reverse mortgage, there may also be insurance premiums that are added to your loan balance each month. Reverse mortgages are also known for typically charging higher rates than some alternatives, such as a home equity loan or HELOC. 

You must still pay taxes and insurance 

The reverse mortgage arrangement requires that borrowers still pay property taxes on the home out of their own pocket and homeowners insurance. Be sure you understand what you’re responsible for. 

When does a reverse mortgage make sense? 

Reverse mortgages aren’t exactly a no-brainer. As previously outlined, there are expenses and requirements involved with maintaining this type of loan—the most immediate of which is that borrowers must have the means to continue paying property taxes and home insurance out of their own funds. 

Still, for the right person, in the right circumstances, a reverse mortgage may provide a helpful source of funds. If you desire to stay in your home but predict that it may eventually be unaffordable on a fixed income, you might decide to deploy a reverse mortgage to lower your out-of-pocket (though your home will eventually be worth less to whomever you leave it to). 

A reverse mortgage can sometimes also be a good choice for those who want to modify their homes as they age without having to take a typical personal loan that would require making principal and interest payments. 

Finally, this loan type may be worth considering for individuals who want to avoid drawing from retirement accounts. 

Frequently asked questions