In recent years, home values have risen dramatically. In fact, between 2020 and 2021, home prices jumped over 13%. As a result, homeowners who are at least 62 years old can now tap into their home equity, a huge financial asset, to get cash through a reverse mortgage.

What is a reverse mortgage?

A reverse mortgage is a way for homeowners who are at least 62 years old to get cash from their home equity without having to sell their home and without having to make any mortgage payments.

A reverse mortgage is still a loan—it’s not free money—but under the right conditions, it can be a good choice to help you tap into the home equity you’ve spent so many years building.

What is home equity?

Home equity is the market value of your home minus anything you still owe on your mortgage. In other words, it’s the amount of money you’d get to keep after selling your home and paying off the mortgage.

It’s not uncommon for some applying for a reverse loan to have their mortgage already paid off. In that case, your home equity would be the entire market value of your home.

What’s the catch?

If the reverse mortgage is well structured, there isn’t really a catch, but the loan does need to be paid off eventually, plus any accrued interest, just like any other loan. What makes a reverse mortgage special is that you don’t have to make payments on the loan.

Instead, you’ll need to pay the loan off in a lump sum if you sell your home, or if you move away from it (whether or not you sell it).

If you live in the home for the rest of your life, your estate will pay off the loan after your death—but there are federal protections in place to help make sure your estate won’t owe more on that loan than the value of your home.

However, some reverse mortgages are structured to come due on a certain date. Be wary of this kind of agreement. If you can’t afford to pay off the loan when it comes due, you may be forced to either sell your home or take out a traditional mortgage to pay it off.

How does a reverse mortgage work?

You can apply for a reverse mortgage based on your home equity if you are at least 62 years old. If you receive the loan, the financial institution will provide funds in exchange for your agreement to pay back any money you borrow in a lump sum.

Most reverse mortgages are known as Home Equity Conversion Mortgages (HECM) and can pay out funds in any one of the following ways:

  • a lump sum, giving you all the cash at once
  • an ongoing annuity, giving you monthly payments
  • term payments, giving you regular payments for a limited time
  • a line of credit you can borrow from, up to a certain limit
  • monthly payments plus a line of credit
  • term payments plus a line of credit

You can keep living in your home, and you can use the cash however you like. Many retirees use a reverse mortgage to supplement their retirement income, for example, or to help pay for unexpected medical expenses.

Plus, because it’s a loan, the cash is not considered income by the Internal Revenue Service, so you won’t have to pay taxes on the funds you receive.

Although you don’t have to make payments, interest will still accrue over the life of the loan, meaning that you will owe more on the loan over time. In other words, you’ll eventually have to pay back more cash than you received.

There are federal regulations in place to make sure that your estate won’t end up owing more money than the value of the home, protecting your heirs in case the housing market drops, but beware of reverse mortgage scams that are not insured by the Federal Housing Authority.

Like any other home loan, a reverse mortgage will require you to keep paying your property taxes, maintain a home insurance policy, and keep up with maintenance on your home to protect its value.

What’s the downside of a reverse mortgage?

A reverse mortgage is a good financial choice for some homeowners, but it’s not right for everyone. And the right loan might depend on how it’s structured.

There are other costs involved, such as a mortgage insurance premium (both upfront and annually), the lender origination fee, and potential third-party fees. The interest rate could also be fixed or variable, depending on the loan’s structure, and there might or might not be a loan termination date.

Most importantly, if you plan on passing down your family home, remember that a reverse mortgage is a loan made against your home equity. Unless your family has a plan to pay that loan back without selling the house, there’s a very real chance that the home will have to be sold to meet the loan obligation.

How to use a reverse mortgage calculator

A reverse mortgage calculator is a tool to help you estimate the size of the loan for which you could potentially qualify.

Before starting, you’ll need the following information:

  • the age of the youngest borrower
  • the home’s value
  • the home’s location
  • your mortgage balance

A reverse mortgage calculator can give you an idea of how much you could potentially borrow and at what interest rate. However, remember that a calculator will only give you a vague estimate, at best, and that it will not include closing costs.

A reverse mortgage calculator also is not a guarantee that your application will be accepted, and it won’t lay out the terms of any reverse mortgage you might apply for.

You’ll need to talk with a reputable reverse mortgage lender to explore the variety of payment structures available and which plan best fits your needs.

Reverse mortgage alternatives

Keep in mind that you can only take out a reverse mortgage on your primary residence. If you don’t qualify for a reverse mortgage, don’t like the terms of a reverse mortgage, or want to take advantage of your equity in a second home or investment property, there are other alternatives to explore.

For example, home equity loans and home equity lines of credit (HELOC) also use your home equity to secure a loan.

A home equity loan lets you borrow cash and repay it with fixed monthly payments while a HELOC lets you draw a line of credit over a set period before you’re required to pay. Both options carry the risk of foreclosure if you miss payments, but there is no age limit.

Cash-out refinancing lets you take out a new mortgage on a property for more than you currently owe. This will probably either extend or raise your current monthly payments (or both), but that also depends on the structure of the two mortgages. If your original mortgage has a high interest rate, a cash-out refinance could be an advantageous choice.

Finally, remember that selling your home is another alternative. If you’re approaching retirement and plan on moving to a continuing care retirement community (CCRC), selling your home lets you keep all your equity, which can help pay any lump-sum entrance fee to your new community.

Reverse mortgage scams to avoid

Finally, there are a number of scams regarding reverse mortgages that you need to look out for.

  1. Contractors: If you’re thinking of building a retirement home, watch out for contractors who pitch you a project and recommend paying for it with a reverse mortgage. The harder someone is working to sell you on a reverse mortgage, the more likely it is to be a scam.
  2. Real estate agents: Agents who are quick to suggest using a reverse mortgage to buy a home with no down payment are more interested in making that commission than they are in looking out for your needs. Remember, real estate agents make money when they make a sale, even if the deal isn’t in your best interest.
  3. High-pressure situations: While not necessarily a scam, contractors, agents, or even lenders that use high-pressure sales tactics should send up a red flag. Be on the lookout for statements that are designed to make you act quickly.

FBI warnings about reverse mortgage scams

The FBI website on reverse mortgage scams recommends the following:

  • never respond to unsolicited advertisements
  • be suspicious of anyone trying to sell you a home with no down payment
  • never sign anything you don’t understand
  • do not accept payment for a home you didn’t purchase
  • seek out your own reverse mortgage counselor through channels you know and trust