Reverse mortgages can be great retirement tools, and it’s easy to see why. These loans turn home equity into cash without needing to make monthly mortgage payments. You just need to pay taxes, insurance, and maintain the home.
But did you know you could use a reverse mortgage to purchase a new home?
If you’re 62 or older and you’re ready to relocate in retirement, a reverse mortgage purchase loan may be right for you.
What's in this Article?
What is a Home Equity Conversion Mortgage (HECM) for Purchase?
There are several types of reverse mortgages, but the most common is the Home Equity Conversion Mortgage (HECM), and you would need a HECM for Purchase loan to buy a home.
HECM and HECM for Purchase loans are insured by the Federal Housing Administration (FHA), which is a division of the U.S. Department of Housing and Urban Development (HUD).
A standard reverse mortgage allows you to stay in your current home with an optional monthly payment. That means you don’t have to make any payments toward principal and interest until you move out of the home or pass away. But you must still pay taxes and insurance, and you must maintain the home.
When one of those events occurs, the balance of the loan comes due, and you or your heirs can sell the house to pay it off or refinance to a “forward” mortgage.
With a HECM for Purchase, you get the benefit of having an optional monthly payment but on a new home.
You may be wondering: If you don’t already own the home, how can you convert any equity? Where does the home equity come from?
In short, the equity comes from the hefty down payment — typically 30-50%. That’s why some HECM for Purchase borrowers sell their current homes and use part of the proceeds of the sale toward the down payment.
Who is an HECM for Purchase for?
Anyone 62 or older who meets the reverse mortgage requirements can get a reverse mortgage purchase loan. However, this product is especially good for retirement-age borrowers who want to rightsize into a new home, move closer to family, or who are going through a divorce and plan to move out of their current house.
Let’s say you’re 65, recently retired, and the owner of a 4-bedroom, 2.5 bath home worth $350,000 in the Upper Midwest.
Perhaps you love your home, but you’re ready to move somewhere warmer and into a home that requires less maintenance. You decide a two-bedroom condo costing $300,000 may do nicely.
- Sell your current $350,000 home and put $150,000 of the proceeds toward the condo. The $150,000 becomes your down payment, and you’ll make monthly payments on the new loan.
- Use a reverse mortgage purchase loan with $150,000 down. Then you get the benefits of a reverse mortgage for purchase — no monthly payment on a new home; just taxes, insurance, and home maintenance costs — and you have cash left over from the sale to cover healthcare, travel, and lifestyle expenses.
Of course, you could also pay the full $300,000 purchase price in cash. After all, you just sold your $350,000 home. Why not own the new property outright?
But that plan leaves you with very little cash, taking into consideration costs of selling a home and buying another (agent commissions, closing costs, etc.). With a HECM for Purchase loan, you’d keep $200,000 in cash, minus costs, which may allow you to delay withdrawals from retirement accounts.
And any funds received from the reverse mortgage, whether in the form of installments, a lump sum, or a line of credit, will not be considered taxable income. Relying on reverse mortgage funds before your IRA, 401k, or other investments could save you considerable money in taxes.
HECM for Purchase combines two transactions into one
Here’s another way to understand the benefits of reverse mortgage purchase loans: This loan can combine two common transactions into one, saving time and money.
If you paid cash for your new home’s full purchase price, you’d need to pay closing costs on the sale. Then, if you got a reverse mortgage on the same home next year, you’d pay some of those closing costs again.
Reverse mortgage purchase loans let you skip this in-between step. Jumping straight to the reverse mortgage means you’d pay closing costs only once and spend less time signing documents and working through the logistics.
HECM for Purchase requirements
Avoiding payments except for taxes, insurance, and maintaining the home. Saving money. Improving your monthly cash flow. Thinking the HECM for Purchase loan sounds too good to be true?
It’s not — but it’s also not for everyone.
To qualify for a HECM for Purchase loan you’ll need to:
- Be 62 or older: If you’re co-borrowing with a spouse, both applicants will need to be at least 62 years old
- Make a large down payment: Down payment requirements on a HECM for Purchase can range from 30-70% of the purchase price depending on your age. Older applicants can make a down payment on the lower end of the scale
- Meet property requirements: The home you plan to buy must be a single-family home, a multifamily home with no more than four units, or a HUD-approved condo or manufactured home
- Live in the home full-time: If you move out or spend significant portions of the year elsewhere, the lender can call the loan due
- Keep taxes and insurance current: As with any mortgage, you’re responsible for property taxes and homeowners insurance premiums, as well as any relevant homeowners association fees and home maintenance expenses. You’ll also need to pay FHA mortgage insurance premiums
- Complete a counseling course: HECM for purchase borrowers must complete HUD counseling to ensure that they understand the loan terms and obligations before they take out the mortgage
How is a reverse mortgage for purchase repaid?
Since you don’t make regular monthly payments (remember, you still owe taxes and insurance and must maintain the property) on a reverse mortgage purchase loan, what happens to the loan’s principal balance? What about the interest payments?
- Principal: Unless you choose to make payments, the principal balance stays the same until you or your heirs pay off the loan when you leave the home or pass away
- Interest: Interest will accrue on the loan, as it would with a forward mortgage. Any unpaid interest will come due when the last borrower leaves the home
Ideally, your new home’s value will increase over time. But appreciation isn’t a guarantee, and if property values in your area drop, your home’s could, too.
Fortunately, HECM reverse mortgages and HECM for Purchase loans are non-recourse loans. That means you can never owe more on the home than its fair market value. So if the balance of your loan is $350,000 but the home appraises at $275,000 when the mortgage comes due, you or your heirs do not have to pay the difference. The HUD/FHA mortgage insurance covers any loan amount above the home value.
Otherwise, the balance can be repaid by selling the home and using the proceeds to pay off the loan, by a cash payment, or by refinancing the loan to a forward mortgage. If your children inherit the home and do not qualify for a forward mortgage or otherwise cannot pay off the loan, they may choose a deed in lieu of foreclosure, in which they turn the deed to the property over to the lender.
|To learn more about your heirs options when inheriting a home with a reverse mortgage, see our guide here.|
What are the risks and rewards of a reverse mortgage purchase?
The greatest benefit of reverse mortgages is cash flow. Since you can keep more of your own money liquid, rather than putting it into a monthly mortgage payment, you may be able to extend the life of your investment savings and improve your overall quality of life. You will still owe the taxes and insurance, though, and you’ll need to stay on top of maintenance and repairs.
Keep in mind, only you and your professional retirement planner will understand the nuances of your unique financial situation. The following scenarios provide a snapshot of what can happen with a reverse mortgage for purchase. Your financial advisor will be able to go through the pros and cons in depth as they pertain to your finances and goals.
Best case scenario for a HECM for Purchase
Best case scenario, your reverse for purchase loan lets you keep more cash available while still buying a new home.
You can relocate or rightsize into a new house. Although you’ll need a large down payment, you won’t have to worry about monthly loan installments. As long as you live in the property full-time and keep the taxes, insurance, and maintenance current, you can live in the home without the monthly payment requirement.
With more cash on hand, you may be able to rely less on your retirement investments. That gives your portfolio more time to grow while also reducing your tax obligations since reverse mortgage funds are not taxable income.*
Worst case scenario for a HECM for Purchase
On the other hand, your HECM for Purchase loan could become a burden, especially if your home value decreases.
If the value of the home drops, you and your heirs will not owe more than it’s worth**, even if your loan balance is higher than the appraised value.
However, if you or they sell the home, you may make little to no money on the sale.
HECM for Purchase problems to watch out for
If you’re considering an HECM for Purchase, be sure to choose a reputable FHA-approved reverse mortgage lender.
Unfortunately, there are scammers who target retirement-age homeowners with promises of quick, lucrative sales and security and end up stealing their hard-earned money and equity.
A HECM is the only type of reverse mortgage that’s insured by the federal government. You can only get one through an FHA lender.
Always read the fine print and make sure you understand your new loan before closing day so you’ll know its costs and terms. Review the contract with your financial advisor, and an attorney if necessary.
Your HUD-required counseling session will also give you a chance to ask lots of questions.
Will the seller accept your offer if submitting with reverse financing?
Reverse mortgages require a large down payment. So even sellers who have never heard of a reverse-for-purchase loan will see you’re making a substantial down payment. And you can provide documentation from your lender showing that you have already been preapproved for the loan.
That can reassure sellers that you’re a qualified buyer with plenty of money to close on the home.
Reverse mortgage for purchase FAQs
A reverse mortgage purchase loan requires a substantial down payment, usually 30-70% of the loan depending on your credit score, the purchase price, and your age. Once you take out the loan, you will have an optional monthly payment — meaning that you can make a monthly mortgage payment but you’re not obligated to. You are obligated to pay taxes and insurance and maintain the home, though.
The full loan balance will come due when the last borrower on the loan leaves the house or passes away.
Yes, if you’re 62 or older, you can use a HECM for Purchase loan to buy a new house.
You should expect to put down 30-50% of the purchase price for a reverse mortgage for purchasing a home. The down payment can come from savings or from the sale of your current home. Your lender can advise you on acceptable fund sources and how much you’ll need upfront based on your credit score, age, and the price of the home you want to buy.
A new home and no monthly payments***
If you’re hoping to buy a new home in retirement, a reverse mortgage for purchase could enable you to get a great new place without feeling strapped for cash month to month.
*This advertisement does not constitute tax and/or financial advice. Please consult a tax and/or financial advisor regarding your specific situation. **There are some circumstances that will cause the loan to mature and the balance to become due and payable. Borrower is still responsible for paying property taxes and insurance and maintaining the home. Credit subject to age, property and some limited debt qualifications. Program rates, fees, terms and conditions are not available in all states and subject to change. ***Borrower must still pay taxes, insurance, and maintain the home.
Fairway is not affiliated with any government agencies. These materials are not from HUD or FHA and were not approved by HUD or a government agency. Reverse mortgage borrowers are required to obtain an eligibility certificate by receiving counseling sessions with a HUD-approved agency. The youngest borrower must be at least 62 years old. Monthly reverse mortgage advances may affect eligibility for some other programs. This is not an offer to enter into an agreement. Not all customers will qualify. Information, rates and programs are subject to change without notice. All products are subject to credit and property approval. Other restrictions and limitations may apply. Equal Housing Opportunity.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.