How Does a Reverse Mortgage Work?

Many seniors who purchased homes early in life own the full equity of their homes. A reverse mortgage allows them to tap into the equity to pay for other expenses, such as medical bills or living expenses.  

This is a huge financial help for seniors especially in tough economic times or periods of high inflation.

If you have questions about the program, visit our Lender411 reverse mortgage FAQ, which answers the most common questions regarding reverse mortgages. 

Reverse Mortgage Financing 

A traditional mortgage involves making a down payment and gradually building equity in a property. A reverse mortgage essentially extracts this home equity in exchange for a sum of money.  Unless the homeowner decides to relocate or is confined to a care facility for 12 months, he or she does not have to repay anything, and all funds generated through the loan are considered tax free.

Additionally, all funds acquired through a reverse home mortgage loan may be applied to any expense, even other debts, loans, and mortgages. 

Most often, seniors use the funds as a source of income to supplement other residual forms of income.

Disbursement of Reverse Mortgage Funds 

Lenders provide reverse mortgage payment in one of four ways, depending on the needs and desires of the consumer:

• Monthly payments provided on the 1st of each month
• As a credit line, available as needed.
• As a lump sum for the full benefit amount
• Any combination or variation of the above options.

Equity and Ownership 

As the bank provides money to the homeowner for the loan, the bank gains the right of ownership over the depleted equity. Once the equity has been exhausted, and the reverse home mortgage has ended, the funding provided is treated as a mortgage against the property and must be repaid either by the homeowner or the homeowner’s estate. 

Typically, borrowers achieve this through a sale of the home, the proceeds of which are paid to the bank for the amount owed. Borrowers may also choose to refinance the home mortgage to retain ownership of the home.

For a full explanation of all parts of the reverse mortgage program, see the HUD’s helpful summary.

Reverse Mortgage Costs 

Here is a list of the fees and expenses which you will be required to pay when acquiring a reverse mortgage:

• Origination Fee: This charge is paid to the lender for his or her services originating the loan
• Closing Costs: Title search, appraisals, taxes, and other similar fees involved in closing the loan are all considered closing costs.
• Mortgage Insurance: All reverse mortgages are overseen by the HUD and require a minimal degree of mortgage insurance to insure the funds.
• Interest Rate: You’ll be charged interest on the equity provided to you.  The lower the interest rate, the more cash you will receive the lower the monthly interest.

Reverse Mortgage Programs 

Reverse mortgages can be secured through one of the following programs:

Home Equity Conversion Mortgage (HECM)

Home Equity Conversion Mortgages are federally insured, and government backed, sponsored by the Department of Housing and Urban Development (HUD). Senior homeowners considering a Home Equity Conversion Mortgage must consult a professional reverse mortgage loan counselor who has been approved by HUD before being approved. 

During this informative session, homeowners will be briefed on the advantages and disadvantages of the program to ensure they understand how Reverse Mortgages work.

Borrowers who move to a nursing home or need other medical care will not be responsible for the loan until a year after the borrower moves from the property. Furthermore, with federal insurance, borrowers are protected against lender default and will still receive payment under these circumstances.

Home Equity Conversion Mortgages currently comprise the most popular reverse mortgage program. According to data, over 99% of all new reverse mortgage originations involve this loan program.

HECM for Purchase

A reverse mortgage can also be used as a streamlined tool for homeowners to purchase a new home without the hassle of a standard home loan application. 

This option best suits seniors who wish to downsize or relocate closer to friends and family and don't want a monthly mortgage payment.

To perform this transaction, seniors must receive the reverse mortgage funds in a lump sum, rather than in monthly installments. With all of the money received at once, the senior can make an adequate down payment on the new home. The down payment amount is deducted from the full amount of cash paid out to the senior.

HECM Saver

Designed by the HUD, the HECM Saver program is an alternative to the Standard HECM loan. One of the advantages of the HECM Saver is that it features a cheaper Mortgage Insurance Premium than the HECM Standard loan, at .01% of the loan amount compared to 2.0% MIP for the standard variant.

The defining characteristic of the HECM Saver is the amount of equity that a borrower has access to. With a significantly smaller initial loan balance, the HECM Saver program will leave more equity intact within your home to be left to the estate when the loan balance is due. 

If the estate chooses to sell the home, the estate will be able to access this equity directly, and if the estate chooses to keep the home, the remaining equity will not need to be repaid when assuming the mortgage.

Proprietary Reverse Mortgages

These reverse mortgages can be secured through private lending companies and frequently involve loans which exceed the maximum limits imposed by the HUD. 

Following the economic downturn and housing market crisis, proprietary reverse mortgages have been replaced by HECM reverse mortgages, which subsequently exploded in popularity.

Reverse Mortgage Application Process

Application for a reverse mortgage has much the same steps involved in any other mortgage application. As mentioned above, there are no credit score requirements for a borrower to qualify. If a homeowner meets the qualifications, he or she can apply.

Visit Lender411's Checklist for Reverse Mortgages and see what steps you need to take to complete a reverse mortgage loan.
Here is a list of the steps required to secure a reverse mortgage:

• Set financial goals and develop a plan for the future.
• Meet with a reverse mortgage counselor.
• Compare rates and fees provided by multiple lenders and select a lender to work with.
Progress through the application process.
• If purchasing a home, identify the new home you wish to move into.
• Fill out the necessary closing paperwork once you’ve been approved.
• Receive your money and apply it to your lifestyle by your financial plan.

Reverse Mortgage Counseling

One unique step in the reverse mortgage application process is the mandatory attendance of professional reverse mortgage counseling. Due to the specialized nature of the reverse mortgage program and its unusual characteristics, the HUD requires all individuals who wish to pursue a reverse mortgage attend a session with a qualified and approved counselor. 

During the meeting, you will be familiarized with the ins-and-outs of the reverse mortgage program, including the application process, the advantages and disadvantages of reverse mortgages, and alternatives to this program.

Essentially, the counselor will thoroughly explain how reverse mortgages work and how your reverse mortgage will affect your estate and your financial situation.  

For a more thorough overview, visit our reverse mortgage counseling page.

To obtain a reverse mortgage, you must work with a federally recognized and qualified reverse mortgage counselor. The HUD offers some helpful advice on finding a legitimate counselor:

• Agencies with access to grant money must provide counseling without charge to persons who demonstrate they cannot afford the fees
• Agencies must inform clients of the fee structure in advance of providing services
• The fee may not exceed $125

A reverse mortgage can allow you to continue living in your home for the remainder of your lifetime and give you the money you need to live well during the best years of your life. Get started on your reverse home mortgage loan today.

Closing the Reverse Mortgage Loan

Following approval for a reverse loan application, a title agent or attorney (depending on the state) will schedule the loan closing. At this time, the lender will confirm the selected payment plan that the borrower will receive in addition to any requested cash to be given in a lump sum at the funding. 

At closing, all documents and final costs will be prepared. Typically, closing costs are included within the loan balance; however, the homeowner may choose to pay the costs up-front.

Paying Off an Old Mortgage

When acquiring a reverse mortgage, it must be the sole lien on the property. All existing mortgages on the property must be settled and paid off, though borrowers may use the funds from a reverse mortgage to pay off the mortgage.

Closing Timeframe of a Reverse Mortgage

Ideally, closing a reverse mortgage takes a few business days to authorize all fees and payoffs, arrange an end date, organize the necessary documents, and communicate to all of the involved parties.

After Closing a Reverse Mortgage

Once the reverse mortgage has been closed, the borrower will be assigned to a service company which will manage his or her account. This servicer will be the party responsible for distributing monthly payments to borrowers that have selected this option. 

Also, servicers will collect any voluntary payments toward the balance and send loan statements monthly.

Furthermore, servicers are responsible for supervising a borrower’s taxes and homeowners insurance to ensure that real estate taxes are paid up to date. 

Borrowers in debt on taxes and insurance may go into default, causing the reverse mortgage to become due. Accordingly, borrowers should be tremendously cautious not to fall behind on these two payments.

Paying Off the Loan

When the homeowner moves from the home or passes away, the loan amount comes due. The estate may sell the house to pay off the debt and keep the proceeds, or refinance the Reverse Mortgage and retain ownership of the home.

If the home value continues to appreciate even after the homeowner has taken advantage of a reverse mortgage, he or she owns the new equity. This equity may be accessed by refinancing the reverse mortgage with another reverse mortgage.

Reverse mortgage loans are known as non-recourse loans, meaning the homeowners or their estate are not responsible for the debt once the mortgage is due. If the home decreases in value such that the amount owed exceeds the expected proceeds from the home sale, the estate is not held responsible for paying back the additional costs beyond the sale amount.

Find a Reverse Mortgage Lender

When securing any loan, you should always take the time to compare rates and shop around. For a reverse mortgage especially, borrowers should look for the best rates with the fairest terms. When looking for a reverse mortgage home loan, persistence and patience pay off noticeably.

If you are seeking a reverse mortgage, speak with a qualified lender today and make the first step toward a smart, educated mortgage decision. 

To start your Reverse Mortgage Loan today, fill out our form at the top of the page by clicking Request a Quote.

Gretchen Wegrich

Gretchen Wegrich is an editor at Lender411. She specializes in mortgage basics, personal finance and green living. She graduated with a bachelor's degree in writing from University of California, San Diego and previously worked at the Santa Cruz Sentinel. Contact her at gretchen@lender411com.