With a reverse mortgage, older homeowners can use the equity in their home to get cash, but taking out this type of loan is often a bad idea. Reverse mortgages are complicated, come with extensive restrictions and requirements, and—under many different circumstances—can be foreclosed.
The Federal Housing Administration (FHA), which is a part of the U.S. Department of Housing and Urban Development (HUD), insures almost all reverse mortgages through its Home Equity Conversion Mortgage (HECM) program. This insurance protects the lender, not the borrower. It guarantees that the lender will be repaid in full.
Other types of reverse mortgages exist too—they're called proprietary reverse mortgages—which are private loans backed by the companies that develop them. Proprietary reverse mortgages are usually available only for very high-value homes.
Once a triggering event occurs, the reverse mortgage loan becomes due and payable. This means that the total amount of money the lender has disbursed to the borrower, plus interest and fees accrued during the life of the loan, must be repaid.
A HECM reverse mortgage loan becomes due and payable when one of the following circumstances occurs.
When this happens, the heirs have several options. They may choose to:
If you take out a HECM and have a nonborrowing spouse, your spouse might be able to remain in the home after you die, and the loan repayment deferred, so long as certain criteria is met. The rules are complex and different depending on whether you took the loan out before or after August 4, 2014. (Learn more in Reverse Mortgages: Foreclosure Protections for Nonborrowing Spouses.)
If the home is sold or title transferred, the loan becomes due and payable. Generally, if the property is sold, the escrow company will accept the purchaser's money and pay off the reverse mortgage along with any other liens on the property. If you transfer ownership of the home—for example to a relative—the loan becomes due and payable.
With a HECM, if the property ceases to be the principal residence of the borrower for reasons other than death and the property is not the principal residence of at least one other borrower, the loan becomes due and payable. To resolve the debt, you can correct the matter, pay the balance in full, sell the home for the lesser of the balance or 95% of the appraised value and put the proceeds toward paying off the loan, or complete a deed in lieu of foreclosure. Or else, the lender will foreclose.
With a HECM, the borrower can be away from the home—for example, in a nursing home facility—for up to 12 consecutive months due to physical or mental illness; however, if the absence is longer, and the property is not the principal residence of at least one other borrower, then the loan becomes due and payable. Again, to resolve the debt, you can correct the matter, pay the balance in full, sell the home for the lesser of the balance or 95% of the appraised value and put the proceeds toward paying off the loan, or complete a deed in lieu of foreclosure. Otherwise, the lender will foreclose.
The terms of the mortgage will require the borrower to pay the property taxes, maintain adequate homeowners' insurance, and keep the property in good condition. (In some cases, the lender might create a set-aside account for taxes and insurance.) If the borrower doesn't pay the property taxes or homeowners' insurance, or if the property is in disrepair, this constitutes a violation of the mortgage and the lender can call the loan due. The lender must usually allow the borrower to cure the default to prevent or stop a foreclosure.
When a lender forecloses, the total debt that the borrower owes to the lender sometimes exceeds the foreclosure sale price. The difference between the sale price and the total debt is called a "deficiency."
Example. Say the total debt owed is $200,000, but the home sells for $150,000 at the foreclosure sale. The deficiency is $50,000.
In some states, the lender can seek a personal judgment against the borrower—or the borrower's estate—to recover the deficiency after a foreclosure. But deficiency judgments are not allowed with HECMs.
Before getting a reverse mortgage, you should understand how they work, and learn the risks and requirements associated with them. A good place to start is www.aarp.org/revmort. You also need to watch out for reverse mortgage scams.
Reverse mortgages are complex and, even after attending a required counseling session before getting a HECM, many borrowers still don't completely understand all the terms and requirements of this kind of loan. It's also highly recommended that you consider talking to a financial planner, an estate planning attorney, or a consumer protection lawyer before taking out a reverse mortgage.
If you need help avoiding a foreclosure, consider talking to a foreclosure attorney.