Reverse mortgages: Everything you need to know

Need some extra cash for retirement? A reverse mortgage may help. (iStock)

If you’re reaching retirement age with concerns that you won’t be able to cover all your living expenses, there’s an option that could provide additional monthly income: A reverse mortgage. A reverse mortgage allows borrowers to take money from the equity in their homes. The borrower does not have to repay the loan until they vacate the house.

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A reverse mortgage operates the opposite way a traditional mortgage does. Instead of the borrower paying the lender, the lender sends payments to the borrower. The lender pays from the equity the borrower has in the property. Once a borrower leaves the property or dies, the lender can collect on the debt. If you're considering a reverse mortgage, here's what you need to know.

Who is eligible for a reverse mortgage?

Individuals who own their home outright and are at least 62 years old may qualify for a reverse mortgage. Homeowners with a small balance on their loan may still be eligible for a reverse mortgage, but you must be able to pay off the remaining balance on the mortgage with funds from your reverse mortgage or your funds once you close on the loan.

In addition to age and homeownership requirements, you can only take out reverse mortgages on a primary residence. Further, your home should be in good repair, and you must be able to maintain property taxes.

When considering a reverse mortgage, make sure to check out an online mortgage broker like Credible to get personalized rates and preapproval letters without affecting your credit score.

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What are the three types of reverse mortgages?

There are three different types of reverse mortgages:

1. Home Equity Conversion Mortgage (HECM)

The Federal Housing Administration (FHA) offers reverse mortgages through the Home Equity Conversion Mortgage program. You can choose to receive your funds in a lump sum payment, a line of credit, or a combination of both. The property must be a single-family home (or 1-4 home unit with the owner occupying at least one unit), and the borrower may not owe any federal debt. Borrowers must complete a credit counseling course before receiving their loan.

2. Proprietary Reverse Mortgage

This type of reverse mortgage allows borrowers to access the equity in their home through a private lender, versus the FHA. These loans are not federally insured. Lenders typically charge higher rates and may offer lower lending options. There is no credit counseling course required to qualify for a proprietary reverse mortgage.

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3. Single Purpose Reverse Mortgage

Just like the name implies, a single-purpose reverse mortgage allows borrowers to use funds from the equity in their home for a specific purpose (medical bills, home repairs, etc.) The lender must approve the use of the funds.

No matter what type of reverse mortgage you’re considering, make sure to compare rates and lenders by visiting an online marketplace like Credible.

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Pros and cons of a reverse mortgage

There are significant benefits and a few potential drawbacks if you choose to use a reverse mortgage to finance your retirement.

  • Pro: Payments from a reverse mortgage are often tax-free. You won’t have to pay income tax on any payments from a reverse mortgage because the IRS considers the payments as loan proceeds, not income.
  • Con: You’ll have to pay loan fees. Like all loans, a reverse mortgage includes closing costs, loan origination fees, and processing fees. These fees could result in a lower payout.
  • Pro: You keep the title to your home. You don’t have to surrender your title to receive reverse mortgage payments. However, the loan must be repaid when the primary borrower leaves the property or dies.
  • Con: Surviving spouse may or may not be able to stay in the home. The reverse mortgage payments only apply to the primary borrower. If a spouse isn’t on the loan paperwork, they won’t collect additional loan payments, and they may have to fill out other paperwork to continue living in the home without repaying the loan.
  • Pro: Beneficiaries may retain ownership of the property if they can pay off the balance of the reverse mortgage.
  • Con: If the primary borrower moves out of the home for more than 12 consecutive months, the reverse mortgage will come due. Living away from the property includes moving to a care facility.

Unsure if a reverse mortgage is right for you? You can connect with an experienced loan officer on a marketplace like Credible. They can help answer any of your mortgage questions and concerns.

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What are alternatives to a reverse mortgage?

A reverse mortgage isn’t your only option. If you don’t want to undertake a reverse mortgage or you don’t qualify, here are a few other ways to use your home equity to help cover retirement expenses:

1. Sell your home

Consider selling your home and purchasing a smaller property. If you own your home outright, you could buy a smaller property and save the remaining money for other expenses.

2. Home equity line of credit (HELOC)

A home equity line of credit lets you tap into the money you’ve already paid towards your property. Unlike a traditional loan, a HELOC has a revolving line of credit. Once approved, you can borrow as much or as little of the total available. HELOCs have a limited withdrawal period. Once that period ends, your HELOC enters the repayment period, according to the Federal Trade Commission.

If you opt for a HELOC, the lender uses your home as collateral against the loan, and you could risk losing the property if you’re unable to repay the amount you borrowed. Head to Credible to see what kind of personal loans they offer and compare rates and lenders instantly.

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3. Consider a cash-out refinance

Alternatively, you could apply for a cash-out refinance. A cash-out refinance replaces your current mortgage loan with a larger loan. These loans may come with additional fees, but if timed correctly, it can result in lower monthly payments and extra cash.

4. Wait it out

If necessary, consider waiting to apply for a reverse mortgage until you have more equity in the home.

If you’re considering a cash-out refinance, visit an online marketplace like Credible to view the most current refinance rates and get quotes from multiple lenders.

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