How much equity do you need for a reverse mortgage?
Reverse mortgages can provide a much-needed lifeline to homeowners looking for financial relief. The financing option is especially valuable to seniors, enabling them to tap into the equity of their homes while still retaining ownership.
Despite its advantages, not everyone is eligible. A significant determinant of qualifying for a reverse mortgage is the amount of equity a homeowner has.
This article delves into the intricacies of reverse mortgages and home equity. Along the way, you’ll understand what the product is and the requirements for eligibility.
Be sure to read to the end to learn the factors lenders assess when determining loans and the often-overlooked costs associated with reverse mortgages.
What is a reverse mortgage?
A reverse mortgage is a loan available to homeowners aged 62 or older. It allows homeowners to convert a portion of their home’s equity into cash. This cash can then be received as a lump sum, monthly payments, or a line of credit.
Unlike a conventional mortgage, there are no monthly payments. Instead, over time, the loan balance rises.
A reverse mortgage loan amount is only due if the borrower dies, sells their home, or permanently moves out of it. As part of the agreement, the borrower must maintain the home and cover ongoing property taxes and homeowner’s insurance.
Types of reverse mortgages
- The Home Equity Conversion Mortgage (HECM), backed by the Federal Housing Administration (FHA), is the most common type of reverse mortgage available. It’s also the type most people refer to when discussing reverse mortgages generally.
- Some non-profit organizations and state and local government agencies offer single-purpose reverse mortgages. Funds from these loans must be used exclusively for a single purpose, like covering medical bills.
- The private reverse mortgage is offered by private lenders. Expect stricter qualifying requirements compared to the first two.
Borrower requirements for a reverse mortgage
To obtain a conventional HECM reverse mortgage, you must meet the following requirements:
- Be over the age of 62
- Own the property outright or have paid off a considerable amount of the principle
- Occupy the property as your principal residence
- Possess no outstanding federal debt
- Maintain the necessary resources to continue making timely payments of property taxes, insurance, and other fees
- Attend a consumer information session given by a Housing and Urban Development (HUD)-approved HECM counselor
Property requirements for a reverse mortgage
A variety of properties are eligible for a reverse mortgage, including:
- Single-family homes
- Two to four-unit homes where the borrower occupies one unit
- HUD-approved condominium projects
- Individual Condominium Units that meet Federal Housing Administration (FHA) Single Unit Approved requirements
- Manufactured homes that meet FHA requirements
Equity requirements for a reverse mortgage
Home equity is the value of a homeowner’s interest in their property. To calculate home equity, you deduct any outstanding mortgage balances from the property's current market value.
Because market prices fluctuate, equity values can change depending on when they are calculated.
Think of it this way: home equity reflects how much of the property you truly own. All else equal, the higher the equity, the more funding you can access through a reverse mortgage.
While no exact amount exists, says housing counselor and reverse mortgage specialist Cara Pierce of Money Management International, “There needs to be enough equity to pay off any current liens and mortgages, plus all the fees and costs associated with taking out the reverse mortgage.”
Moreover, Pierce claims, “Some lenders may also require that your future property taxes are set aside as part of the loan, which can also make a difference.”
As a general rule, assume you need a minimum of 50% equity to qualify for a reverse mortgage. To determine your equity, you simply deduct the amount you owe on the house from the current appraised value.
For example, imagine you owe the bank $100,000 on your mortgage. At the same time, your home is currently appraised at $350,000. Therefore, your equity is $250,000 ($350k less $100k). As a percentage of the property’s value, your equity represents 71% ($250k / $350k).
How much can you borrow?
According to the US Department of Housing and Urban Development, the amount you can borrow depends on several factors:
- The age of the youngest borrower or eligible non-borrowing spouse
- The current interest rate
- The lesser of the property’s appraised value, the property’s sales price (only applicable to HECM for Purchase where the homeowner intends to buy a new principal residence), or the HECM FHA mortgage limit (set at $1,089,300 in 2023)
- The existing mortgage balance: A reverse mortgage is first used to pay off your current mortgage balance before any funds can be tapped from your equity. The lower the existing balance, the more equity you can access.
For a HECM loan, you can usually borrow between 47.9% to 75% of your equity.
Take the same home discussed earlier as an example. Your equity component is currently valued at $250,000. Therefore, you can expect a lender to provide a loan ranging from $119,750 to $187,500.
Note, however, that the actual amount would be even lower after accounting for closing costs or fees.
Reverse mortgage costs
HECM loans will typically come with the following costs:
- Mortgage insurance premium: This is the cost to purchase FHA mortgage insurance. It guarantees that you’ll obtain the loan advances promised to you.
- Third-party charges: This might include costs for credit checks, appraisals, title searches and insurance, surveys, mortgage taxes, recording fees, inspections, and other fees.
- Origination fee: An origination fee is owed to the lender for processing your HECM loan. According to the US HUD, lenders can charge $2,500 or 2% of the first $200,000 of your home's value, whichever is greater, plus 1% of the amount over $200,000. Regardless, HECM origination fees are capped at $6,000.
- Servicing fee: These fees can cost up to $35 per month for the life of the loan. It covers items like sending you account statements, dispersing loan proceeds, and ensuring you meet loan requirements such as real estate taxes.
Reverse mortgages offer a financial cushion homeowners can leverage when in need. It’s particularly beneficial for seniors because they can tap into their home equity while maintaining ownership.
Reverse mortgage eligibility largely hinges on the amount of equity a homeowner possesses. The higher the equity ownership, the greater the loan value.
As with any significant financial decision, speaking to a financial advisor for assistance is prudent. An advisor can help determine whether a reverse mortgage makes sense for your current situation.