How Does a Reverse Mortgage Work

A reverse mortgage, like a traditional mortgage, is a loan made by a lender to a homeowner using the home as security or collateral.

With a traditional mortgage, the bank may lend up to 90% of the property’s value to the homeowner and the bank expects the homeowner will use their income to pay down the debt over time. The way a reverse mortgage works is the lender loans less and expects the reverse mortgage loan balance will grow over time because the homeowner is not making monthly mortgage payments.

A reverse mortgage loan generally does not require repayment until the last homeowner has passed away or moved out of the property. Consequently, life expectancy is a huge part of the lender’s calculation of how much to lend. A 62 year old homeowner can borrow a substantially lower percentage of their property’s value than a 80 year old homeowner.

Example of How a Reverse Mortgage Works

John and Anne are a retired couple, aged 72 and 68, who want to stay in their home but need to boost their monthly income to pay living expenses. They would like to take a belated honeymoon. They have heard about reverse mortgage loans, but didn’t know the details. They decide to contact a reverse mortgage advisor to discuss their current needs and future goals.

John and Anne meet with an FHA appraiser, who determines that their home’s value is $300,000. They currently owe $35,000 on their mortgage, which gives them $168,000 in equity. John and Anne can access $124,127 of their equity from the reverse mortgage loan. Below is an illustration of how John and Anne spend their loan proceeds.

Reverse Mortgage Chart