Using a Reverse Mortgage to Purchase Your Next Home

Read Time: 6 minutes

Are you retired or near retirement and dreaming of downsizing or relocating from your current home? A reverse mortgage can be a great choice that can help you pivot comfortably to a new property.

This form of financing for homeowners 62 years and older enables you to convert part of your home’s equity into cash and use the proceeds to help pay for your next residence.

However, several requirements and restrictions apply, which is why it’s smart to learn more about the basics of a reverse mortgage and how it can be used to fund a home purchase before pulling the trigger.

Reverse mortgages explained

When you think “mortgage,” you typically imagine borrowing funds to buy or refinance a house and then making monthly payments to the lender over a fixed period, commonly ranging from 15 to 30 years. But a reverse mortgage works in opposite fashion.

Here, the lender pays you, the homeowner, with funds earned by cashing in a predetermined portion of your home’s accumulated equity. If you still have a primary mortgage loan, your reverse mortgage loan will pay this off and you will receive the remainder as tax-free funds in the form of a lump sum, a line of credit, or as monthly payments made by the lender.

With a reverse mortgage, such as the commonly known federally insured Home Equity Conversion Mortgage (HECM), interest and fees are accrued monthly, causing the loan balance to grow over time—unlike a traditional mortgage where the balance decreases with payments. Consequently, as the loan balance increases, your equity in the property decreases. 

Despite retaining ownership of the home, you must fulfill obligations such as paying property taxes, homeowners insurance, and maintaining the property. To qualify for a HECM, you must be at least 62 years old and undergo a financial assessment to confirm your capability to meet the loan’s financial obligations.

Additionally, attending a counseling session is obligatory to ensure comprehension of the loan terms and the eventual repayment responsibility. Homes eligible for a reverse mortgage include single-family residences, two-to-four-unit properties where you reside in one of the units, condominiums, townhouses, and certain manufactured homes.

Repayment of the borrowed amount is not required until you permanently vacate the property, sell it, or die. In the event of your demise, your heirs or beneficiaries are responsible for settling the reverse mortgage debt.

This usually occurs upon the sale of the property. Alternatively, they can refinance with a traditional mortgage, use personal funds to settle the debt, or transfer the property title to the lender and terminate the loan.

Purchase a next home with a reverse mortgage

Eager to buy another home? You can opt for a HECM for purchase loan that will cover up to half of the total sale price of a new property.

Instead of the conventional process of purchasing a new home, incurring closing costs, and subsequently obtaining a reverse mortgage on the newly acquired property along with additional fees, the HECM for reverse purchase consolidates these steps into a single transaction.

You’ll need to make a substantial down payment on the home, typically around 50%, with the remaining home price balance financed via the reverse mortgage. After that balance is paid, you can pocket any remaining funds from the home equity you choose to liquidate, providing you extra cash if you need it.

Note, however, that the home you are purchasing must be your principal residence. That means you’ll have to sell your existing home used as your principal residence to qualify.

It also means that second/vacation homes and investment properties aren’t eligible for a HECM for purchase reverse mortgage.

Instead of pursuing a HECM for purchase loan, another way to accomplish your goal of buying a house is to secure a traditional mortgage loan, use it to purchase a residence, and then repay that mortgage after you move in with a reverse mortgage. A third option is to buy a home 100% with cash and then utilize a HECM to replenish your funds.

Most of the same rules above that apply to a traditional reverse mortgage remain also apply to a HECM for purchase. But what’s different here is that neither you nor your heirs will ever be liable for an amount exceeding the home’s value; also, there are no penalties for loan prepayment.

Exploring the benefits

A HECM for purchase loan can make the process of acquiring a new home easier, the pros concur.

“Imagine you sell your current home for $300,000 and want to buy a new one for $250,000,” explains personal finance expert Shawn Plummer, CEO of The Annuity Expert. “If so, you can use a HECM for purchase reverse mortgage for part of the new home’s purchase. For instance, say your total proceeds are $150,000 after selling your $300,000 home and paying off your remaining mortgage on that home. You could use that $150,000, coupled with $100,000 borrowed via a reverse mortgage, to cover the new home’s $250,000 cost. Plus you wouldn’t have any monthly mortgage payment to worry about.”

Remember, too, that in this hypothetical example you only have one set of closing costs because the reverse mortgage covered the home purchase. If you chose to tap even more equity on your $250,000 new home and borrow more—say $125,000 instead of $100,000—you could pocket the remaining $25,000 at closing and have extra cash for other expenses or financial goals.

Examining the disadvantages

Of course, a reverse mortgage can have its downsides, too.

“The drawbacks include the accumulation of interest, the necessity to keep up with property taxes, homeowners insurance, and maintenance, and having less home equity,” says Plummer.

Also, keep in mind that your accumulated debt on a reverse mortgage gets inherited by your heirs, “which minimizes your possible contribution to your children or other beneficiaries,” cautions Noah Gomez, a consumer credit specialist and founder of ThickCredit.

Furthermore, you’ll need to carefully consider how long you expect to remain in your new home.

“If you aren’t planning to stay in the property for an extended period, a reverse mortgage may not be the best loan option for you. It’s intended for older homeowners who plan to age in place,” Neil Christiansen, branch manager and certified mortgage advisor with Churchill Mortgage, says.

Also, you’ll have to pay closing costs, including origination and servicing fees, which will be higher than those charged by other types of reverse mortgage loans, according to the Consumer Financial Protection Bureau.

Consider other avenues

Before diving into a HECM for purchase reverse mortgage, it’s essential to conduct thorough research and explore alternative options that can help you purchase a new home, including a traditional mortgage loan, paying fully in cash, or taking a part-time job to earn extra money.

“Always consider reverse mortgages as part of a broader financial strategy,” recommends Plummer. “It’s essential to explore all options and understand the long-term implications thoroughly, including your impact on heirs, possible life changes in the future, and the consequences of increasing your debt over time.”

Gomez says there are two key questions to ask yourself before committing to a reverse mortgage.

“Are you comfortable lowering equity for your inheritors? And after doing the math on offers from multiple lenders, is the amount you can borrow worth the hassle and closing costs?”

David Mully

David Mully is president and CEO of Lender Insider, a mortgage consulting firm. With 26 years in the mortgage industry, he has worked as both a mortgage loan officer and in the business-to-business sector of the industry. He is the former author of the weekly “Mortgage Search” column for Observer and Eccentric Newspapers. You can read his blog at http://www.lenderinsider.com/blog.

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