How Does a Reverse Annuity Mortgage Work?

A reverse annuity mortgage allows homeowners to convert a portion of their home equity into accessible funds. This financial tool enables individuals, typically older adults, to utilize their home’s value without selling it or incurring new monthly mortgage payments. The lender provides payments to the homeowner, drawing against the home’s equity, which can help cover living expenses or other financial needs.

What is a Reverse Annuity Mortgage?

A reverse annuity mortgage, commonly known as a reverse mortgage, is a specialized loan product designed for homeowners to access their home equity. Unlike a traditional mortgage where the homeowner makes payments, with a reverse mortgage, the lender makes payments to the homeowner. This unique structure allows the loan balance to increase over time as funds are disbursed and interest accrues. The homeowner retains ownership of the property.

The primary purpose of a reverse mortgage is to provide financial liquidity to homeowners, typically those aged 62 or older, by converting home equity into cash. The loan becomes due and payable when specific events occur, such as the homeowner moving out permanently or passing away. This financial tool can provide a steady income stream or a lump sum without creating a new monthly mortgage obligation.

Eligibility and Property Requirements

To qualify for a reverse annuity mortgage, the homeowner must meet specific age and occupancy criteria. The youngest borrower must be at least 62 years old for the most common type, the Home Equity Conversion Mortgage (HECM), which is insured by the Federal Housing Administration (FHA). All borrowers must occupy the property as their primary residence.

The property itself must also meet certain requirements. Acceptable property types generally include single-family homes, one-to-four unit properties with one unit occupied by the borrower, and FHA-approved condominiums or townhouses. Manufactured homes are typically not eligible unless they meet specific FHA guidelines. The home must also have sufficient equity, as the loan amount is determined by its value, the age of the youngest borrower, and current interest rates.

How Funds are Disbursed

Borrowers have several options for receiving funds from a reverse annuity mortgage:
Single lump sum: The entire available loan amount, after mandatory payoffs and fees, is provided at closing. This option is often chosen by borrowers who need a significant amount of cash upfront, such as to pay off an existing mortgage or other large debts. However, the initial disbursement amount may be limited in the first 12 months for certain loan types.
Tenure payments: These provide equal monthly payments to the borrower for as long as at least one borrower lives in and occupies the home as their principal residence. This provides a consistent income stream.
Term payments: These provide equal monthly payments for a fixed period chosen by the borrower, such as 10 or 15 years. This option is suitable for those who need predictable income for a defined period.
Line of credit: This allows borrowers to access funds as needed, up to a maximum credit limit. Interest is only charged on the amount drawn, and the unused portion typically grows over time, increasing the available credit limit. This provides a flexible financial safety net, allowing homeowners to draw funds for unexpected expenses or as supplemental income.

Borrowers can also choose a combination of these disbursement methods, such as taking a partial lump sum at closing and establishing a line of credit for future needs, or combining monthly payments with a line of credit.

Ongoing Homeowner Responsibilities and Loan Repayment

While a reverse annuity mortgage eliminates monthly mortgage payments, homeowners retain important responsibilities regarding their property. Borrowers must continue paying property taxes, homeowner’s insurance premiums, and any homeowner association (HOA) fees. Failure to meet these obligations can result in the loan becoming due and payable, potentially leading to foreclosure. Homeowners must also maintain the home in good condition, performing necessary repairs and upkeep.

When the Loan Becomes Due

The reverse mortgage loan becomes due and payable when certain conditions are met, primarily when the last surviving borrower permanently leaves the home. This can occur if the borrower sells the property, moves into a nursing home or other primary residence for more than 12 consecutive months, or passes away. Upon such an event, the loan balance, including accrued interest and fees, must be repaid. The amount owed will never exceed the home’s value, even if the loan balance grows higher than the home’s market value.

Repayment Methods

Repayment of the reverse mortgage typically occurs through several methods. Most often, the home is sold, and the proceeds are used to satisfy the outstanding loan balance. Heirs of the borrower may choose to pay off the loan balance, often by refinancing the property into a traditional mortgage, to retain ownership of the home. They are given a period to decide on their course of action and can request extensions up to a year. If the home’s value is less than the loan balance, the FHA mortgage insurance covers the difference, ensuring heirs are not personally liable for the deficit.

Costs and Fees Associated with a Reverse Annuity Mortgage

Obtaining a reverse annuity mortgage involves several costs and fees that can impact the total loan amount and the equity available to the homeowner:
Origination fee: This fee is charged by the lender for processing the loan application. For FHA-insured Home Equity Conversion Mortgages (HECMs), this fee is capped at $6,000 or 2% of the first $200,000 of the home’s value plus 1% of the amount over $200,000, whichever is less. This fee can be financed into the loan balance.
Mortgage Insurance Premiums (MIP): These are a substantial cost, particularly for HECMs. There is an upfront MIP, which is 2% of the home’s appraised value or the HECM lending limit, whichever is less. This premium protects the lender and the borrower. An ongoing annual MIP of 0.5% of the outstanding loan balance is also charged, accruing over the life of the loan.
Other closing costs: These are similar to those found in traditional mortgage transactions. They can include appraisal fees, title insurance, recording fees, credit report fees, and document preparation fees. These costs can vary based on the loan amount and the specific services required.
Interest: Interest accrues on the outstanding loan balance, which includes disbursed funds, financed fees, and prior interest. This causes the loan balance to grow over time, reducing the remaining equity in the home.