Reverse Mortgages: How They Work and the Benefits They Offer

In today’s economy, retirees need innovative ways to leverage their assets to help fund their golden years. One option that has gained popularity is the reverse mortgage. This type of loan can provide financial flexibility and increase purchasing power. Like any financial product, it’s important to understand how it works and the potential benefits before diving in.

What is a Reverse Mortgage?

The Home Equity Conversion Mortgage (HECM), commonly known as a reverse mortgage, is insured by the Federal Housing Administration (FHA), and only available to homeowners aged 62 and older.  

Unlike a traditional mortgage where the homeowner makes monthly payments to the lender, a reverse mortgage works in the opposite way. The borrower converts a portion of the home’s equity to cash, and the lender makes payments to the homeowner. Over time, the loan balance increases as the homeowner receives payments, while the home equity decreases.

How Does It Work?

HECMs are only offered by federally-approved lenders (such as MiMutual Mortgage) and can be used to purchase a new primary residence or to tap into equity for cash. 

Here’s how they work:

Eligibility: To qualify for a reverse mortgage, you must be at least 62 years old, have significant equity in your home, and live in the home as your primary residence.

Loan Amount: The amount you can borrow is determined by a principal limit and the current lending limits. Principal limits are determined by factors such as your age, the value of your home, interest rates and the loan’s specific terms. Lending limits are set by the FHA each year and are based on a formula set in the National Housing Act. In general, the older you are and the more valuable your home, the more you can borrow.  

Payout Options: Homeowners can choose how they receive the loan proceeds:

• A lump sum: A single, large payment.
• Monthly payments: Either for a set number of years (term payments) or for as long as you live in the home (tenure payments).
• A line of credit: Withdraw money as needed, which offers flexibility.
• Combination: A mix of monthly payments and line of credit.

No Monthly Payments: One of the key features of a reverse mortgage is that the homeowner does not need to make monthly mortgage payments. The loan is repaid when the homeowner sells the home, no longer uses the home as a primary residence, or passes away. At that point, the home is typically sold, and the proceeds are used to pay off the loan balance. Any remaining equity goes to the homeowner or their heirs.

Interest Accrues: Since the homeowner isn’t making payments on the loan, the interest on the loan accrues over time and is added to the loan balance. This means that the amount owed grows, and the equity in the home decreases.

Why Consider a Reverse Mortgage?

One of the biggest challenges in retirement is having enough cash flow to not only meet the needs of daily living but to also have the funds for personal interests, travel and unforeseen emergencies, home repairs, or medical care. 

Utilizing a reverse mortgage can give retirees peace of mind knowing cash is available when needed. Benefits of a reverse mortgage include: 

Supplementing Retirement Income: For retirees who are “house rich but cash poor,” a reverse mortgage offers a way to tap into home equity to cover daily expenses, healthcare costs, or even leisure activities. It can provide financial flexibility without the need to sell the family home.

No Monthly Mortgage Payments: One of the most appealing aspects of a reverse mortgage is that it eliminates the requirement to make monthly payments. This can free up cash flow for homeowners who might otherwise struggle with mortgage payments in retirement.

Stay in Your Home: A reverse mortgage allows homeowners to remain in their homes while accessing the equity they’ve built up over the years. This is particularly beneficial for those who wish to age in place and avoid having to move.

Line of Credit Option: For those who opt for the line of credit option, the loan amount available increases over time, regardless of the home’s current market value. This is a powerful feature, especially in a rising interest rate environment, as it allows borrowers to maximize their borrowing potential in the future.

Non-Recourse Loan: Reverse mortgages are non-recourse loans, which offers a safeguard to borrowers that few other loans do. The United States Department of Housing and Urban Development (HUD) describes the non-recourse component as: “The HECM is a “non-recourse” loan. This means that the HECM borrower (or his or her estate) will never owe more than the loan balance or the value of the property, whichever is less; and no assets other than the home must be used to repay the debt.”  In other words, the homeowner or their heirs will never owe more than the home’s value when it’s time to repay the loan. 

Financial Flexibility: Homeowners can use reverse mortgage proceeds for any purpose, whether it’s supplementing retirement income, paying off medical bills, funding home renovations, or traveling. This flexibility allows retirees to create a financial plan that suits their unique needs.

Tax-Free Funds: Since funds received from reverse mortgages are considered a loan and not income, the payments are not subject to taxes.

Considerations Before Getting a Reverse Mortgage

While reverse mortgages offer several benefits, they aren’t for everyone. Here are a few things to consider:

• Decreasing Home Equity: Since reverse mortgages reduce the equity in a  home, there may be less available for the borrower’s heirs when the loan is due.
• Impact on Government Benefits: Although the payments from a reverse mortgage are not considered taxable income, they may affect a borrower’s eligibility for need-based government programs such as Medicaid or Supplemental Security Income (SSI). Homeowners should talk with a financial advisor, local Area Agency on Aging or their Loan Officer to learn more. 
• Requirement to Maintain the Home: Homeowners are still responsible for property taxes, homeowner’s insurance, and home maintenance. Failure to do so could result in the loan becoming due.

Is a Reverse Mortgage Right For You? 

A reverse mortgage can help unlock financial freedom during retirement. It can be an excellent tool for retirees seeking to benefit from home equity without selling their property. With its flexible payment options and elimination of monthly mortgage payments, it can provide a much-needed financial lifeline to older homeowners.

However, as with any type of home loan, it’s best to work with a Loan Officer from a trusted, established mortgage lender. MiMutual Mortgage can help borrowers understand the pros and cons of a reverse mortgage and develop a plan that meets your homeownership goals for retirement.