Understanding the basics of reverse mortgages

Because many retirees are house-rich and cash-poor, financial gurus have developed a method for tapping into some of that bottled-up wealth: the reverse mortgage. As the name suggests, a reverse mortgage generates payments from a lender to a homeowner — the opposite of a standard mortgage. By providing access to home equity, reverse mortgages enable cash-strapped seniors to retain their property, subsidize their income, make home improvements, even cover unexpected medical expenses. Furthermore, money received from a reverse mortgage isn’t taxable and doesn’t negatively affect a retiree’s social security or Medicare benefits.

For several years the Federal Housing Administration (FHA) has offered a popular reverse mortgage called the Home Equity Conversion Mortgage or HECM. To qualify under that program, you must be at least 62 years of age and hold title to your home free and clear (or be able to pay off the mortgage balance with proceeds from the reverse mortgage). In addition, you must demonstrate the financial wherewithal to cover ongoing utility costs, maintenance, property taxes, and hazard insurance. You’ll be required to live in the home as a primary residence (although some types of reverse mortgages allow you to live in a nursing home or other medical facility for up to 12 consecutive months before the loan must be repaid). As with other types of mortgages, lenders charge origination and closing fees. Ongoing costs such as mortgage insurance premiums and servicing fees may be part of the bargain as well.

Before you sign on the dotted line, consider the following:

  • You’re taking out a loan. A reverse mortgage is an obligation that must be repaid when the borrower moves out permanently, the house is sold, or the borrower dies.
  • Read loan documents carefully. Payment amounts, interest rates (fixed or variable), loan length, line of credit availability, events that trigger foreclosure proceedings — all of these variables should be clearly delineated in the mortgage documents.
  • Expect your total debt to increase. Interest on a reverse mortgage is generally charged against and added to the outstanding loan balance on a monthly basis.

Although a reverse mortgage may provide a welcome source of cash, such a commitment shouldn’t be undertaken lightly. Shop around, and beware of pushy sales people who love to bundle additional products — risky investments, annuities, insurance — along with their reverse mortgage offerings.