Older adult homeowners who want access to cash for senior care expenses may be able to use a reverse mortgage. This type of loan offers options to homeowners who would benefit from the cash value of their homes. For instance, a homeowner who is over 61 years of age and has large home equity may be able to borrow against the value of their home. 

The loan has to be paid back once the homeowner sells the home, moves out, or passes away. In the meantime, the homeowner may be able to use those funds to cover a variety of expenses, such as senior care costs or long-term care insurance premiums.

If you or a loved one is considering a reverse mortgage to help finance living or medical expenses, here’s what you need to know about how it works, as well as the pros and cons of getting one. 

How do reverse mortgages work?

The lender makes payments to the homeowner instead of the other way around, as in a typical mortgage. Those payments are not taxable by the IRS even if a homeowner decides to use them as a form of income. The interest is included in the loan balance, which keeps the homeowner from having to pay anything upfront. 

As time goes on, the equity of the home — which the owner has borrowed against — goes down and their debt goes up. The home also acts as collateral for the loan itself. 

When do borrowers get the reverse mortgage funds

The ways that a borrower receives the funds may vary based on the type of mortgage they secure. The most common type is an HECM mortgage, which offers a number of methods for lenders to disburse money to the borrower. These methods include

  • Lump sum: With a lump sum payment, you receive the entire loan amount at once when your loan process is complete.
  • Equal monthly payments (annuity): For this option, the homeowner, or any listed borrower, can receive monthly payments as long as they live in the home. 
  • Term payments: The borrower receives monthly payments for a set period of time.  
  • Line of credit: The borrower can have access to all of the money at any time and will only be charged interest on money they actually borrow against the line of credit. For example, if the borrower never borrowed against the credit line, they would not have to pay any interest. 
  • Equal monthly payments plus a line of credit: This option combines both the monthly payments and the line of credit option. It ensures the borrower has steady monthly payments coming in, but also provides them with backup credit they can borrow against in case they need it. 
  • Term payments plus a line of credit: The borrower can combine term payments with a line of credit. Instead of indefinite monthly payments, they receive monthly payments within the term they set along with having the line of credit to access at any time. 

Types of reverse mortgages

Home Equity Conversion Mortgage (HECM)

The Consumer Financial Protection Bureau stated in 2022 that this is the most common type of reverse mortgage. HECMs are federally-insured mortgages that tend to cost more upfront; however, the funds can be used for any purpose. You can also choose any of the payment types with this kind of reverse mortgage. Only FHA-approved lenders can offer these kinds of loans.

Proprietary reverse mortgage

These are private loans that provide the option to get a larger loan advance. This is easier to obtain if your home is highly valued.

Single-purpose reverse mortgage

Borrowers can secure this type of loan through nonprofits as well as state and local government agencies. It’s also generally less expensive than an HECM or proprietary reverse mortgage. This is the most limited-use mortgage as it can only be used to cover one specific purpose, such as home repairs. The lender must approve of the purpose for the loan. 

Benefits and risks of getting a reverse mortgage

Reverse mortgages can be a source of cash, but they aren’t for everyone. There are benefits and drawbacks to reverse mortgages, so it’s important to consider each and decide if this type of loan works for your situation.

Benefits

  • Right to cancel within three days: This is the borrower’s right of rescission, which you can exercise without penalty. 
  • No need to make monthly payments toward the loan balance: This aspect of reverse mortgages offers the borrower peace of mind and flexibility in a time when an older homeowner likely has a limited income. 
  • In most cases, the use of funds is flexible: Most reverse mortgage options (not including a single-purpose reverse mortgage) allow the borrower to use the funds for a variety of expenses, including some of the most common expenses for older homeowners.  
  • Non-borrowing spouses can remain in the home after the borrower dies: This flexibility can be a comfort for borrowers who want to ensure their spouse is provided for even after they pass. 

Risks

  • Scams: Reverse mortgage scams can target older homeowners. For example, some lenders make claims that the Department of Veteran Affairs offers “no repayment” reverse mortgages. According to the Consumer Financial Protection Bureau, as of 2020, the VA does not offer no-payment reverse mortgages. Be wary of other fraudulent practices by talking with financial and real estate experts you trust.
  • Sales pitches: If you’re speaking with a private lender, their advice might not have your interest at heart — after all, it’s their job to sell you on a reverse mortgage. The Federal Trade Commission recommends speaking with an independent, government-approved housing counseling agency to make sure you receive impartial advice. 
  • Possibility of foreclosure: With a reverse mortgage, homeowners are still required to pay property taxes and home insurance. Although borrowers don’t have to make any payments, they must live in the home and care for it so it will stay at market value. 

If you think you could benefit from taking out a reverse mortgage on your home, reach out to ElderLife Financial to find out which option is the best for you.