How Does a Reverse Mortgage Work

Written by Banks Editorial Team
4 min. read
Written by Banks Editorial Team
4 min. read

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A reverse mortgage is a loan product commonly used by senior homeowners with substantial home equity to supplement retirement income. These loans make it easy to access the equity they’ve built up over time to cover expenses. Plus, you’ll no longer have to make monthly mortgage payments. Even better, the borrowing costs are often lower than what you’ll find with many other loan products, and monthly loan payments aren’t required. 

This guide dives into how reverse mortgages work, who is eligible for these loans, the different loan types and how to decide if it’s right for you. 

What is a Reverse Mortgage?

When you take out a conventional mortgage, you’ll make monthly principal and interest payments to the lender over a period of 10, 15, 20 or 30 years. But a reverse works the opposite way – the lender will pay you either in a lump sum, through a line of credit or over time. Furthermore, your monthly mortgage payment will go away, and you can stay in your home. 

You’re not required to repay these funds, which are borrowed from your equity, unless you relocate. And if you pass away, your home will be sold to repay the loan unless your heirs opt to purchase it from the lender. If not, any of the proceeds remaining from the sale will go to the borrower’s estate. 

How a Reverse Mortgage Works

The process for taking out a reverse mortgage loan is similar to what you’ll find with traditional mortgages. If you have enough equity in your home – preferably 50 percent or more – you can apply for the reverse mortgage product that best suits your needs. 

After completing the loan application, the lender will review your financials, conduct a credit check, assess the property and ensure the title is clear. An appraisal is also required to confirm that you have enough equity to qualify for a reverse mortgage. 

Once the loan application is approved, you’ll receive the funds through your selected disbursement method. You can choose to be paid in a lump sum, in monthly installments for a set period or until the loan is no longer active (due to your death or relocation), or through a line of credit that grows over time. 

You’re free to use the funds as you see fit. However, some lenders implement spending restrictions, so it’s best to review the loan agreement carefully to ensure you comply with the terms and conditions. 

Can Anyone Take Out a Reverse Mortgage?

No. Reverse mortgages are reserved for homeowners who are at least 62 years old. 

How Do You Qualify for a Reverse Mortgage?

Before you can take out a reverse mortgage, you’ll need to meet the following eligibility criteria: 

  • Be at least 62 years of age
  • Live in a single-family home, multi-family home (no more than four units), manufactured home (constructed after June 1976), condo or townhome
  • Own your home outright or have at least 50 percent in equity 
  • Use your home as your primary residence
  • Complete a reverse mortgage counseling session (if you’re applying for a government-backed product) 
  • Not have any delinquent federal debt 
  • Have the means to afford payments for homeowners insurance, homeowners association fees and property taxes.

Be mindful that these requirements are general guidelines. Each lender has its own rules that could be more stringent than what’s listed here. 

What are the Types of Reverse Mortgages?

There are three types of reverse mortgage products to choose from: 

  • Home Equity Conversion Mortgage (HECM): HECMs are government-backed reverse mortgage products that can be used for several purposes. Your borrowing costs may be on the higher end, but you can choose how the funds are disbursed to you. 
  • Single-Purpose Reverse Mortgage: Offered through local and state governments or nonprofits, these loan products are the most affordable option. However, they’re only accessible in select areas and are designed to cover specific costs, like home renovations. 
  • Proprietary Reverse Mortgage: You can find these loans through private lenders. They’re generally easy to access and feature rapid funding times. Unfortunately, you’ll also find that scams are most prevalent with these types of mortgages as well. 

Other Things You Need to Consider When Taking Out a Reverse Mortgage

Before applying for a reverse mortgage, keep the following in mind: 

Fees and Other Costs

Compare the fees charged by the lenders you’re considering. They include loan origination fees, closing costs and servicing fees (if applicable). Also, be mindful of interest rates, as a slight increase of just one percent could add several thousand more to your loan balance. 

Your Loan Grows Over Time

Remember, the lender pays you with a reverse mortgage. So, the loan grows over time as interest and fees accrue and are added to the balance. 

Interest Rates May Change

If the reverse mortgage you select comes with a variable interest rate, it will likely change over time with market conditions. 

You’ll still be responsible for property tax and homeowners insurance payments when you take out a reverse mortgage. If you live in a deed-restricted community, HOA dues and other assessments are also your responsibility. Furthermore, you must maintain the home and make necessary repairs. Otherwise, the reverse mortgage could become payable. 

Your Heirs and Their Inheritance

If you want your heirs to inherit the home, they’ll have to repay the lender what’s owed on the reverse mortgage to keep it. Otherwise, the property will be sold, and any remaining proceeds from the transaction (if applicable) will go to your estate. But if the home sells for less than it’s worth, your heirs won’t be responsible for the difference. 

Mortgage Insurance Premiums 

Government-backed reverse mortgages require borrowers to pay mortgage insurance premiums. The upfront cost is 2 percent of the total loan amount. Plus, you’ll pay 0.5 percent annually in premiums. 

Is a Reverse Mortgage Right for You?

A reverse mortgage could be a good fit if:

  • You’re an older homeowner, and your costs in retirement are far more than you anticipated. 
  • Your home is paid off, or you have a significant amount of equity. 
  • You don’t plan to pass your home down to your heirs.
  • You have minimal cash reserves. 

However, it may not be ideal if: 

  • You don’t have much equity in your home. 
  • You have a sizable amount of money saved or life insurance policies with cash value. 
  • You have other relatives in your home that will stay if you pass away. 
  • You want your home to remain in the family. 

Where to Get a Reverse Mortgage

When you’re ready to maximize your home equity to live comfortably in retirement, consider a flexible reverse mortgage solution from AAG. Founded in 2004, it’s the leading provider of HECMs in the U.S. and holds an A+ rating from the Better Business Bureau. AAG also boasts a 90 percent customer satisfaction rate.

To learn more, complete the short questionnaire to be connected with a home equity specialist.

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