Reverse mortgage explained: How it works and who qualifies

Mortgage professionals across the United States often deal with older homeowners who want more financial freedom in retirement. As more people look for ways to use the value of their homes, reverse mortgages are becoming a common option. If you’re working as a mortgage broker or aspiring to be one, knowing how a reverse mortgage works can help you serve clients better. 

In this article, Mortgage Professional America will talk about what a reverse mortgage is. We will discuss who this mortgage type is right for and how you can use it to support your clients. Want to learn more about how it works and when it makes sense? Keep reading below. 

What is a reverse mortgage? 

A reverse mortgage is a home loan that allows homeowners to convert part of their home equity into cash. Your clients can take out this mortgage while they still use the property as their primary residence. 

Who qualifies? 

This kind of property loan is different from other types of mortgages because only clients who are 62 or older can qualify for it. Unlike a traditional mortgage, your clients don’t have to make monthly mortgage payments. Instead, the home loan is repaid when your clients: 

• sell their home: The reverse mortgage becomes due once the property is sold, and the proceeds are used to repay the balance. 

• move out permanently: If your clients leave the property for more than 12 consecutive months or move into assisted living, the home loan must be repaid. However, there are a few exceptions: 

• If there’s an eligible non-borrowing spouse who will remain on the property, they may be allowed to stay in the home without triggering repayment. 
• Reverse mortgages can have co-borrowers. As such, if one borrower moves out but another listed borrower remains, the mortgage will stay active. 
• If the move into a care facility is short-term and less than 12 consecutive months, the home loan does not become due. 

• pass away: After the death of your clients, the reverse mortgage will be repaid by the heirs. This is usually done through the sale of the home. 

Watch this video to learn more about how reverse mortgages work in the US: 

Reverse mortgages shouldn’t be treated as your clients' last resort. Find out why in this article. 

What is the 95% rule on a reverse mortgage? 

When the loan is due for repayment, the usual route is to sell the home to cover the loan balance. If the loan amount is higher than the home’s value, that’s where the 95% rule comes in. 

With a reverse mortgage like the Home Equity Conversion Mortgage (HECM), your clients’ heirs won’t owe more than the home’s current market value. They won’t have to pay more than 95% of the home’s appraised value. The remaining balance will be covered by mortgage insurance. 

In other words, the 95% rule helps families avoid paying extra if the home’s value has gone down. 

Different types of reverse mortgages 

Here’s a quick look at three types of reverse mortgages for your clients: 

1. HECM 
2. Proprietary reverse mortgage 
3. Single-purpose reverse mortgage 

Let's take an in-depth look at each: 

1. HECM 

This is the most common form of reverse mortgage. An HECM is insured by the Federal Housing Administration (FHA) and often comes with higher up-front costs. On a positive note, the money that your clients will receive can be used for anything and they can decide how to withdraw the funds. For instance, it can be via: 

• a line of credit 
• fixed monthly payments 
• combination of both options 

While they are widely available, HECMs are offered solely through FHA-approved mortgage lenders. 

2. Proprietary reverse mortgage 

This type of reverse mortgage is not federally insured. If your clients’ property has high value, they can get a bigger loan advance from a proprietary reverse mortgage. 

3. Single-purpose reverse mortgage 

This type of reverse mortgage is less common than the previous two mentioned. It is offered by local and state government agencies and non-profit organizations. However, it is also the least expensive. 

The catch is that your clients can only use a single-purpose reverse mortgage to cover one specific expense. For instance, it can only be used for home renovation or repairs, property taxes, and other purposes specified by the mortgage lender. 

Whether your clients choose an HECM, a proprietary reverse mortgage, or a single-purpose reverse mortgage will depend on their financial situation.  

Help them understand both the advantages and disadvantages of these three options. If you wish to become as successful as those listed on our Best in Mortgage page, build good relationships with your clients. Discussing the pros and cons of reverse mortgages is a good place to start.  

What are the benefits of a reverse mortgage? 

Here are the main advantages for your clients who want to get a reverse mortgage: 

No monthly mortgage payments 

Your clients aren’t required to make monthly payments toward the home loan. This can help reduce financial stress, especially for those living on a fixed income. 

Tax-free loan proceeds 

The money that your clients will receive from a reverse mortgage is not considered taxable income, since it’s treated as a loan advance. This means they can use the funds freely without worrying about additional tax burdens. 

Non-recourse loan protection 

With a federally insured HECM, your clients and their heirs are protected if the loan balance ends up being more than the home’s market value. When the home is sold to repay the home loan, neither the borrower nor their heirs will have to pay the difference. The FHA insurance covers any shortfall, making it a safer option for families. 

What is the downside of getting a reverse mortgage?   

A reverse mortgage can be helpful for older homeowners, but it’s not the right choice for everyone. Before offering this option to your clients, it’s vital to understand the potential risks: 

The loan balance keeps growing 

Since your clients won’t make monthly mortgage payments, the interest and fees get added to the home loan every month. This means that the total amount owed becomes larger over time. 

It lowers the amount of home equity 

As the loan balance increases, the amount of equity left in your clients' home goes down. In turn, there may be less value left in the property for the homeowner’s children or heirs. 

If leaving the home to their family is a priority, this might be a concern. Make sure to inform your clients about this from the get-go. 

Borrowers must still pay ongoing costs 

Reverse mortgages don’t get rid of all home-related expenses. To avoid default, your clients will still be responsible for paying property taxes and keeping up with homeowners' insurance. 

They should also make sure that the house stays in good condition. If these responsibilities aren’t met, the mortgage lender can call the home loan due and possibly start foreclosure. 

Watch this video to understand why reverse mortgages might not always be the best option for your clients: 

Want to recommend other choices to your clients? Here are five alternatives to a reverse mortgage. 

Why is a reverse mortgage a good idea for seniors? 

A reverse mortgage can be a smart option for seniors who own their home and need extra income during retirement. It’s often used by homeowners to: 

• meet daily living costs 
• cover medical bills 
• make home improvements 
• pay for in-home care 
• other needs 

Your senior clients will also have the option to choose how they receive the money. This can be through: 

• a lump sum 
• a line of credit 
• monthly payments 
• combination of these options 

This will allow them to manage their finances in a way that fits their needs. As a mortgage broker, it’s important to remind your clients that a reverse mortgage is a big financial decision. Encourage them to get advice from a housing counselor through an HUD-approved agency. You can also ask them to consider what their family thinks before moving forward. 

Knowing how reverse mortgages work can improve your services 

If you want to help your clients who want to make the most of their home equity, start by building your knowledge of reverse mortgages. By understanding how it works along with the benefits and risks, you’ll be better equipped to guide your clients with confidence. You can also focus on this niche market by becoming a go-to mortgage broker for senior homeowners looking for flexible options. 

Already helping clients with reverse mortgages? What’s been working for you, or what do you wish you had known when you started? Feel free to share your insights in the comments below.