A reverse mortgage, also known as the home equity conversion mortgage (HECM) in the United States, is a financial product for homeowners 62 or older who have accumulated home equity and want to use this to supplement retirement income. Unlike a conventional forward mortgage, there are no monthly mortgage payments to make. Borrowers are still responsible for paying taxes and insurance on the property and must continue to use the property as a primary residence for the life of the loan.
These loan products can be a challenge to explain or understand, even for people who have plenty of financial experience. We’ve put together this introductory article in hopes of better explaining the basics. In general, it’s easiest to explain these loans by beginning with a comparison to a better known financial product, the home equity loan. At its core, the reverse mortgage is a home equity loan that’s designed to help seniors tap into the equity in their homes. This loan is only available to homeowners who are 62 or older and have built up substantial home equity.
The other unique features of a reverse mortgage are best explained by a comparison to traditional forward mortgages. In a forward mortgage, the borrower makes monthly payments to the lender, gradually reducing the loan balance and building equity. With a reverse mortgage, the borrower receives payments from the lender and does not need to make payments back to the lender so long as he or she lives in the home and continues to fulfill his or her basic responsibilities, such as payment of taxes and insurance. The loan balance grows over time as the borrower receives payments and interest accrues on the loan; home equity declines over time. Essentially, the mortgage works in the reverse direction of a forward mortgage, which is where the term “reverse” comes from.
All loans must eventually be repaid, and this one is no different. The loan is due once the borrower sells the home or passes away. Of course, the borrower may also choose to pay off the loan at any time. In most instances, a reverse mortgage is paid off when the mortgaged home is sold. It is important to note that reverse mortgages are designed so that the amount owed cannot exceed the value of the home. If, for example, a reverse mortgage balance is $150,000, and the house is sold for $125,000, the borrower does not owe the difference. If the house can be sold for more than the value of the reverse mortgage, that equity belongs to the borrower or the borrower’s estate.
Today, almost all reverse mortgages that are originated are Home Equity Conversion Mortgages (HECM). The HECM is a program of the Federal Housing Administration (FHA), and these loans are guaranteed by the federal government. This means that you do not need to worry about your reverse mortgage lender failing to make payments to you. We’ll cover what this really means later, but it’s important to note that the rest of the information here applies to HECM reverse mortgages unless explicitly noted.