You’ve saved up a nice little nest egg to fund your retirement, but despite all of your hard work scrimping and saving, you’re worried you might need some extra income to fully enjoy your golden years. A reverse mortgage can be a great way to access additional funds by tapping into the equity you’ve built up in your home. A steady influx of extra cash each month can help you stay on top of everyday expenses and keep your standard of living up to your expectations.

Reverse mortgage rates may vary compared with other types of home loans. Whenever a reverse mortgage offer lands in your lap, take a moment to see how it stacks up against current rates before agreeing to anything.

If you’re confused about how reverse mortgages work, don’t worry, you’re not alone. Let’s clear the air about this often-misunderstood — and sometimes unfairly maligned — financial tool.

What is a reverse mortgage?

A reverse mortgage is a loan using the equity you’ve established in your home. As the name implies, a reverse mortgage flips the roles of the lender and the borrower. In this case, the lender pays money to the borrower based on that equity. Keep in mind that while the lender will make monthly payments to the borrower, you are still responsible for any applicable taxes, insurance premiums and association fees.

With a traditional mortgage, every payment builds equity in your home. Eventually, you’ll own a larger share of your house than the bank does, and one day, you’ll pay off that loan in full. In many cases, that equity isn’t available to homeowners until they sell their property or take out a home equity loan. With a reverse mortgage, however, you can extract some of that equity to pay for other needs, like groceries, clothing or medication, long after you’ve stopped earning a steady paycheck. If you’re worried about making ends meet during your retirement, and you have a lot of equity in your home, a reverse mortgage can help pay the bills and cover your living expenses.

This type of loan is also useful if you’re looking to downsize — say, from a single family home to a townhouse. After using the proceeds from the sale of your current home as a down payment, you can then take out a reverse mortgage on that equity to open up a line of credit. You don’t owe any mortgage payments on your new home, and you can access additional funds whenever you need them. Or simply leave that line of credit alone to accrue interest.

How do you qualify?

Reverse mortgages are highly specialized financial tools created with the express purpose to give retirees and seniors extra money to draw from in the event their life savings and supplemental income aren’t enough to cover their bills. There are several criteria you have to meet to qualify for this type of loan:

• Be at least 62 years old.
• Own 50 percent or more of your home’s equity, in most cases.
• Home needs to be your primary residence and an FHA-approved residence.

How much money can you access?

The payout depends on your age, the market value of your home, how much equity you have built up, how up to date you are with other financial obligations like property taxes, the purpose of the loan and the type of reverse mortgage you’re using, and the current interest rates.

In general, borrowers who are older and have more equity in their home will receive more favorable loan conditions. Keep in mind, it’s unlikely your lender will offer a reverse mortgage loan that’s equivalent to the value of your home or the amount of equity you have in the property. Best-case scenario: You might get 75% of your home’s market value, but you should expect closer to 40 or 50 percent.

Know the different types of reverse mortgages.

Lenders usually offer three types–single-purpose, home equity conversion, and proprietary.

Single-purpose reverse mortgages are often the least expensive option available, but as the name suggests, you’re pretty limited as far as how you use your loan proceeds. Your lender will need to sign off on the purpose of the loan, whether that’s to pay outstanding property taxes, cover insurance premiums, or repair a leaky roof. Given all of that, it’s not surprising that single-purpose reverse mortgages generally cover much smaller dollar figures compared with other available options.

Home equity conversion mortgages (HECM), on the other hand, offer far more flexibility to the borrower. You can basically use the loan proceeds any way you like. There are a few caveats, though. For one, only lenders approved by the Federal Housing Administration (FHA) can offer these types of loans, so it’s possible your preferred financial institution won’t even support them. And as noted earlier, there’s a limit on the amount you can receive with any government-backed reverse mortgage. HECMs are also typically more expensive on the front end due to the extra costs borrowers have to cover. For instance, the FHA requires borrowers to pay a mortgage premium equivalent to 2 percent of your home’s market value. That’s a lot of money to put down, especially for cost-conscious retirees.

Proprietary reverse mortgages, also referred to as jumbo reverses, aren’t backed by the FHA. While that may seem like a negative, it also means they aren’t beholden to the maximum limits imposed on HECMs. As such, these types of reverse mortgages make the most sense for people who want to trade off of their high-value homes to get the largest payout possible.

Who owns the property?

People often worry about their status as a homeowner when using a reverse mortgage. We’re here to tell you that there’s really nothing to be concerned about. Your home’s title will stay in your name and can be passed on to your heirs just like any other piece of property.

In the meantime, you retain all the rights that come with your title, including the ability to make renovations and sell the property, if you so choose. Keep in mind, you’ll still be expected to stay current on financial obligations like paying your property taxes and homeowners insurance. If you fall behind on those payments, your lender has the option to demand the loan be paid back in full.

What time limits are on a reverse mortgage?

One of the most common concerns people have about reverse mortgages is how much time their family and loved ones have to sell the property after they’ve passed away. Reverse mortgages are beholden to the same estate guidelines as any other asset. The IRS requires the estate to file a final estate tax return within 9 months of the individual’s death.

Another question that frequently comes up is what happens if the borrower needs to leave the home for an extended period of time — say, to move into a nursing home or receive extensive treatment for a health condition. In those cases, the mortgage lender will wait a year before recommending that the property be sold to pay off the reverse mortgage loan.

What are the downsides?

Given all of the advantages discussed here, why do some people view reverse mortgages in a negative light? The truth is there are some downsides:

Origination fees, interest rates, extra fees, and loss of equity.

• Origination fees. Usually a little higher than the closing fee on a conventional mortgage, due to upfront FHA mortgage insurance costs. That being said, all other closing costs, such as title fees and appraisal fees, are pretty comparable across both conventional and reverse mortgages.
• Interest rates. Often higher than traditional mortgages, so you may wind up paying more in interest than if you had kept paying off your original mortgage.
• Extra fees. Your mortgage insurance will cover any deficits when it comes time to settle your debt. That insurance isn’t free, though, and your lender will require you to foot the bill for your coverage
• Loss of equity. Retirees need to consider how much equity they’re comfortable giving up to enjoy the benefits of a reverse mortgage.

 

Jeff Keleher wrote this article for Guaranteed Rate (rate.com), a mortgage lender.