A reverse mortgage is a type of mortgage in which a homeowner can borrow money against the value of his or her home and receive funds in the form of a fixed monthly payment, line of credit, or a combination of these options. Instead of making monthly payments to a lender, a lender makes payments to you. The amount of payment is based on a percentage of the value in your home and the loan is repaid after the borrower moves out, sells the home, or dies. A reverse mortgage is structured so that the loan amount will not exceed the value of the home over the life of the loan.

Reverse mortgages are often a last-resort source of income. The decision to take this type of mortgage out may seem like an easy way out of a financial bind, but there are many financial pros and cons to be aware of to help you decide if this would make sense for you.

A reverse mortgage could benefit individuals who:

Do not plan to move.

Can afford the cost of maintaining their home.

Want to access the equity in their home to supplement their income or have money available for a rainy day.

Have an immediate need to pay off debt.

Have significant unexpected expenses such as health issues.

There are several different types of reverse mortgages, but by far, the most popular is the Home Equity Conversion Mortgage (HECM).

Borrower requirements under HECM are that you must:

Be at least 62 years old.

Own the home outright (or have a low mortgage balance).

Hold the title to the home and live in it as your principal residence.

Not be delinquent on any federal debt.

Be able to pay the home's insurance premiums, property taxes, homeowners association dues, and ongoing property costs.

Participate in a consumer information session from the U.S. Department of Housing and Urban Development (HUD)-approved HECM counselor.

To qualify for an HECM, the dwelling must be:

A single family home or a two-to-four unit home that the borrower occupies at least one of the units.

A HUD-approved condominium or townhouse.

A manufactured home that meets FHA requirements.

What happens after you open a reverse mortgage?

When you move, sell the home, or pass away, the heirs have several options. After lender fees are paid, any equity left in the home goes to you or your heirs. The heirs may:

Keep the property and pay off the remaining balance owed.

Sell the property and keep any proceeds once the reverse mortgage is paid off.

Do nothing and have the lender repossess the home.

If you receive more payments than your home is worth, you will never owe more than the value of the home, according to the Federal Trade Commission.

The big question: Can you afford a reverse mortgage?

The cost of a reverse mortgage will depend on the type of loan you choose, how much money you take out upfront, and the lender that you choose.

Reverse mortgages involve many upfront costs, including:

HECM counseling fee: This fee is typically around $125, according to the Consumer Financial Protection Bureau.

Appraisal fees: Professional home appraisals are a requirement for a HECM and cost on average $300-$500.

Third-party closing costs: Expect to pay more than typical mortgage fees for title searches and insurance, credit checks, inspections, surveys, loan recording, and mortgage taxes.

Mortgage Insurance Premium (MIP): Mortgage insurance, due at closing, guarantees that you will receive your loan advances if the company managing your account (the loan servicer) goes out of business.

Loan origination fee: Expect to pay 2% of the first $200,000 of your home’s value, plus up to 1% of any amount greater than that. HECM loan fees are capped at $6,000.

Servicing fees: Lenders can charge you a monthly servicing fee of $30 if the loan has an annually adjusting interest rate or $35 if the interest rate adjusts on a monthly basis. The fee covers things like sending your checks and account statements, plus any other customer service.

You might be able to roll these fees into the loan, but this added amount will accrue interest as part of the overall balance.

Risk of Foreclosure:

A reverse mortgage can become due if you fail to meet the obligations of the mortgage. You will be responsible for paying property taxes, insurance costs, and maintenance expenses of your home. If the home value drops below the amount borrowed for other reasons, like a decline in the housing market, you can't be foreclosed upon.

Other financial considerations:

The interest generated by the loan is not tax-deductible during its term. It can be deducted only when the loan is paid off in full.

The interest rate you pay is generally higher than that for a traditional mortgage.

Reverse mortgages can come with conditions that may require immediate repayment or foreclosure. If your contract does not allow the home to be unoccupied over a certain numbers of days, the lender may repossess the home. This unforeseen event could stem from health issues causing you to be in the hospital, rehabilitation center, or assisted living facility.

Before signing a contract, make sure the payments from a reverse mortgage will not impact other funds you receive, such as Medicaid.

If there is only one spouse’s name on the reverse mortgage, the house can be sold out from under the surviving spouse if the borrower passes away. If the spouse is unable to repay the mortgage, the house must be sold to repay the loan.

Reverse mortgages can be an important source of emergency funds for some seniors who would otherwise have to sell their homes to access their equity. It is a good idea to consider all other sources of income before tapping into your home equity. First consider whether to liquidate any existing investments and whether it is possible to reduce your living expenses. If you still do not have enough to fund living expenses, a reverse mortgage may make sense for you. There is a lot to consider, so proceed with caution and it is a good practice to involve an attorney to help you navigate the complexities of the reverse mortgage contract.

Carol Chaudet

(Last Update: 6/15/2017)