How Do Reverse Mortgages Work? And What Is It?

Reverse mortgages are often misunderstood, but they could be a helpful financial solution for homeowners entering retirement. If you’re over 62 and looking for ways to tap into your home equity without selling your home, this guide will explain what a reverse mortgage is, how it works, and what you need to consider before moving forward.

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What is a reverse mortgage?

A reverse mortgage is a type of home loan designed specifically for homeowners aged 62 and older. Unlike a traditional mortgage where you make monthly payments to a lender, a reverse mortgage allows you to convert part of your home equity into cash while still living in your home. Instead of paying the lender, the lender pays you – either as a lump sum, a line of credit, or monthly installments.

This loan doesn’t require repayment until the borrower moves out, sells the home, or passes away. A reverse mortgage could offer a financial cushion for retirees who want to supplement their income, pay off existing debts, or cover health care costs.

How do reverse mortgages work?

Reverse mortgages work by allowing eligible homeowners to borrow against the equity they’ve built in their home. The most common type is a Home Equity Conversion Mortgage (HECM), which is federally insured by the FHA. Here’s a simplified breakdown with more detail:

To qualify, the homeowner must continue to live in the home as their primary residence. This means they must physically occupy the home for the majority of the year. If the homeowner leaves the property for more than 12 consecutive months—due to health care needs or other reasons—the loan may become due and payable.

Even though monthly mortgage payments are not required, the homeowner is still responsible for paying property taxes, homeowners’ insurance, and keeping the home in good condition. Failing to meet these responsibilities could result in loan default and foreclosure.

Unlike traditional mortgages where the loan balance decreases with each payment, a reverse mortgage loan balance increases over time. This is because no monthly payments are made to reduce the principal. Instead, each disbursement you receive adds to your loan balance, and interest is charged on the total amount borrowed.

Interest on a reverse mortgage accrues over time and is added to the loan balance. Repayment is deferred until a triggering event occurs, such as the borrower selling the home, permanently moving out, or passing away. At that time, the full loan balance—including interest and fees—must be repaid, usually through the sale of the home.

Reverse Mortgage Example

Let’s say your home is worth $400,000, and you’ve either paid it off completely or have a very small remaining mortgage balance. Depending on your age, current interest rates, and other eligibility factors, you might qualify to receive between 40% and 60% of your home’s appraised value; that could translate into $160,000 to $240,000 in available funds.

How you choose to receive that money can vary based on your needs and preferences. Some homeowners opt for a lump sum payment, which provides all the funds at once—ideal for handling major expenses or paying off existing debt. Others prefer monthly payments, which offer a steady stream of income that can help supplement retirement funds. Another popular option is a line of credit, which gives you access to funds as needed and may even grow over time if unused. Finally, you can choose a combination of these methods, such as taking a portion upfront and the remainder as monthly disbursements or as a line of credit, allowing for flexibility tailored to your financial situation.

It’s important to remember that while this money is tax-free, it is not free. Interest and fees accrue over time, and the total loan balance must be repaid when you no longer live in the home—typically through a home sale.

Types of Reverse Mortgages 

Reverse mortgages aren’t one-size-fits-all. There are several types, each tailored to different financial situations and homeowner needs. Understanding the differences can help you determine which option—if any—is right for you. 

The most common and widely used type of reverse mortgage is the Home Equity Conversion Mortgage (HECM). These loans are federally insured by the Federal Housing Administration (FHA) and are available through FHA-approved lenders. HECMs offer flexible options for receiving funds—whether in a lump sum, monthly payments, a line of credit, or a combination of methods. Available to homeowners aged 62 and older, HECMs include mandatory counseling to ensure borrowers fully understand the loan terms. 

Proprietary reverse mortgages are private loans offered by individual companies. These loans are often geared toward homeowners with higher-value properties that exceed the FHA’s HECM lending limits. Because proprietary reverse mortgages are not federally insured, they may have different terms, protections, and costs—but they can provide larger loan amounts compared to HECMs. 

Single-purpose reverse mortgages are usually offered by local or state government agencies and nonprofit organizations. As the name implies, these loans can only be used for specific purposes such as home repairs, accessibility improvements, or paying property taxes. While they generally carry lower upfront costs, they are more limited in both availability and usage than HECMs or proprietary options. 

Connecting with a knowledgeable loan officer at Direct Mortgage Loans will allow you to better understand which program you should choose and how to move forward. 

Reverse Mortgage Eligibility 

To qualify for a reverse mortgage, several criteria must be met to ensure the borrower is financially and physically situated to manage the loan over time: 

• You must be at least 62 years old. Reverse mortgages are designed for older homeowners, and the older you are, the more money you’re typically eligible to receive due to your life expectancy. 
• You need to either own your home outright or have a low remaining mortgage balance. If there’s an existing mortgage, it must be paid off either before or at the time of closing using proceeds from the reverse mortgage. 
• You must live in the home as your primary residence. Reverse mortgages are only for homes you occupy the majority of the year. You cannot use this type of loan on rental properties or vacation homes. 
• You must remain current on property taxes, homeowners’ insurance, and necessary maintenance. These are ongoing responsibilities and failure to meet them can result in default. 
• You are also required to complete a HUD-approved counseling session. This step ensures that you fully understand how the loan works and its potential impact on your finances and estate. 

Reverse Mortgage Application Process 

Applying for a reverse mortgage involves several key steps designed to ensure homeowners are informed, protected, and financially qualified. First, borrowers are required to complete a counseling session with a HUD-approved housing counselor. This session is mandatory and provides an overview of the reverse mortgage process, the costs of a reverse mortgage, and the reverse mortgage impact on your finances and heirs. Once the counseling is complete, borrowers can move forward by submitting an application through an FHA-approved lender. The application will request personal information, details about the property, and documentation confirming age, residency, and financial standing. 

After the application is submitted, the next step is the home appraisal. A licensed appraiser evaluates the home to determine its market value, which directly affects how much can be borrowed. The loan then moves into underwriting, where the lender thoroughly reviews the application, appraisal, and financial qualifications to confirm eligibility. If approved, the loan proceeds to closing, where borrowers sign the final paperwork and choose how they would like to receive their funds—either as a lump sum, monthly disbursement, line of credit, or a combination. 

Once the reverse mortgage is finalized, funds are disbursed according to the borrower’s chosen method, and no monthly mortgage payments are required as long as the loan terms are followed. This structured process ensures the homeowner understands every aspect of the loan before proceeding and provides peace of mind throughout the transaction. 

Reverse Mortgage Cost and Fees 

Reverse mortgages come with several costs which could impact the amount of money received and the total loan balance over time. Understanding these expenses upfront could help you make an informed decision. 

The origination fee is charged by the lender to cover the processing of your loan. For HECM loans, this fee is regulated and typically ranges from $2,500 to $6,000 depending on your home’s value. It includes administrative tasks such as application review, documentation, and underwriting. 

Mortgage Insurance Premiums (MIP) are required for HECM loans to protect both the borrower and the lender. This includes an upfront premium, usually equal to 2% of the appraised value of your home, and an annual premium of 0.5% of the outstanding loan balance. These insurance payments ensure the lender is repaid even if your loan balance exceeds the value of your home when it’s time to repay. 

Closing costs for reverse mortgages are like those of traditional mortgages and may include appraisal fees, title insurance, credit reports, inspections, and recording fees. These costs can vary by location and lender but are often financed into the loan to minimize out-of-pocket expenses. 

Some lenders may also charge a monthly servicing fee to manage the loan, provide statements, and ensure compliance with FHA requirements. This fee is capped and also added to the loan balance. 

Finally, interest is charged on the amount you borrow and compounds over time. Depending on the loan terms, your interest rate may be fixed or adjustable. Because you’re not making monthly payments, interest adds to your loan balance every month. 

All of these fees are typically rolled into the loan itself, which reduces the amount of equity available to you and increases the balance that will eventually need to be repaid. Being aware of these costs can help you determine whether a reverse mortgage aligns with your financial goals. Speaking with a trusted loan officer will allow you to understand these costs on a deeper level and make an informed decision. 

Reverse Mortgage Pros and Cons 

Every financial product has advantages and disadvantages, and reverse mortgages are no exception. Before deciding whether this loan type aligns with your goals, it’s important to weigh both sides carefully. Here’s a look at the key benefits and potential drawbacks to consider. 

Reverse Mortgage Pros 

One of the most appealing features of a reverse mortgage is that it eliminates the need for monthly mortgage payments. This can significantly reduce financial strain for retirees who rely on a fixed income. Additionally, the funds received from a reverse mortgage are typically tax-free and could be used however the borrower sees fit, all while they continue living in their home. This allows homeowners to tap into their home equity without selling or relocating. 

Another advantage is the flexibility in how funds are disbursed. Borrowers could choose a lump sum, monthly installments, a line of credit, or a combination of options to meet their financial needs. Plus, Home Equity Conversion Mortgages (HECMs)—the most common type of reverse mortgage—are federally insured. This insurance offers protections such as guaranteed access to funds and non-recourse terms, meaning borrowers or their heirs will never owe more than the home value when the loan is repaid.  

Reverse Mortgage Cons 

While reverse mortgages offer financial flexibility, they also come with notable downsides. First, because you’re not making monthly payments, the interest on the loan accrues and is added to the loan balance. This means the amount you owe increases over time, potentially leaving less equity for your heirs. 

When the borrower passes away or permanently moves out, the loan becomes due. In most cases, heirs must repay the balance to keep the home—often by selling the property or refinancing the loan. This can create pressure or financial difficulty if the home’s value has declined or if the estate lacks liquid assets. 

Additionally, reverse mortgages come with a range of fees and interest charges. These ongoing costs can significantly reduce the remaining home equity over time, limiting future options for both the borrower and their families. 

Finally, receiving reverse mortgage funds could impact eligibility for certain government benefits. Programs like Medicaid or Supplemental Security Income (SSI) have income and asset thresholds, and how you use or save the reverse mortgage funds could potentially affect your qualification for these types of support. 

Alternatives to Reverse Mortgages 

A reverse mortgage may not be the right fit for everyone, especially if you’re concerned about preserving home equity for heirs or minimizing long-term borrowing costs. Fortunately, there are other financial strategies that may better align with your goals and needs. 

Home Equity Loans (HELOC) allow you to borrow against the equity in your home while maintaining full ownership. With a home equity loan, you receive a lump sum and repay it over time with fixed monthly payments. A Home Equity Line of Credit (HELOC) offers more flexibility, acting like a credit card secured by your home. However, both require monthly payments and credit qualification. 

If you’re still paying on a traditional mortgage, refinancing into a new loan with a lower interest rate or extended term can reduce your monthly payment. This could free up cash flow without tapping directly into your home equity the way a reverse mortgage does. 

Selling your current home and downsizing into a smaller, less expensive property could unlock your home’s equity and reduce ongoing expenses. This could be a smart option for retirees looking to simplify their lifestyle and finances. 

Many state and local governments offer special programs for older adults, including grants or low-interest loans for home repairs, property tax relief, or utility subsidies. These programs could provide financial support without requiring you to borrow against your home equity. 

Each alternative comes with its own set of pros and cons, so it’s wise to consult with a trusted financial advisor or loan officer to evaluate which solution best supports your long-term financial well-being. 

Is a reverse mortgage a good idea? 

Whether a reverse mortgage is a good idea depends on your financial goals, age, home equity, and long-term plans. A reverse mortgage could be a valuable tool for older homeowners who want to age in place and need extra income. However, it’s essential to understand the long-term impact on your estate and to discuss options with a trusted loan officer or financial advisor. 

FAQ’s About How Reverse Mortgages Work 

Who owns the house in a reverse mortgage? 

You still retain full ownership and title of your home when you take out a reverse mortgage. However, the lender holds a lien on the property as collateral. This means the loan must be repaid—typically by selling the home—before ownership can be transferred or passed to heirs free of debt. 

Is reverse mortgage interest deductible? 

Reverse mortgage interest is not deductible on your taxes each year like it is with a traditional mortgage. Instead, the interest accumulates and can only be deducted in the year it is actually paid—which is generally when the loan is settled through repayment or the sale of the home. 

What is the 95% rule on a reverse mortgage? 

If a borrower passes away or permanently moves out and the reverse mortgage becomes due, the heirs have the option to keep the home by repaying the loan. Under FHA guidelines, they can do so by paying the lesser of the loan balance or 95% of the home’s appraised value at that time. This helps ensure heirs aren’t burdened with paying more than the home is worth. 

How much money do you actually get from a reverse mortgage? 

The amount available depends on a variety of factors including your age, the appraised value of your home, current interest rates, and how much you still owe on your mortgage. Older borrowers typically qualify for more because they’re expected to have a shorter loan term. On average, borrowers receive between 40% and 60% of their home’s value. 

Who benefits the most from a reverse mortgage? 

Homeowners aged 62 and older who have built up substantial equity and want to stay in their home long-term may benefit most. It’s especially helpful for retirees with limited monthly income who need to cover expenses like medical bills, home improvements, or daily living costs without having to sell their home or make monthly loan payments.