If your budget in your retirement years feels a little tight, a reverse mortgage may be a viable option to add cash flow to your balance sheet. But are reverse mortgages available to everyone? Not necessarily. One of the most significant determining factors of your eligibility for a reverse mortgage is the amount of equity in your home. Do you have enough equity to borrow against?
- You must have equity to borrow against to secure a reverse mortgage.
- The U.S. Department of Housing and Urban Development (HUD) says that you must either own your home outright or have a “considerable amount” of the mortgage paid.
- Your age is a factor in how much you can borrow.
How a Reverse Mortgage Works
A reverse mortgage is a mortgage that allows homeowners over the age of 62 to borrow money by using the equity in their primary residences as collateral. Instead of paying money to the bank to slowly take complete ownership of the house, the lender pays you in monthly installments, a lump sum, or a line of credit. The reverse mortgage is paid when you sell the home or pass away and your heirs sell the house.
There are three different types of reverse mortgages:
- Home equity conversion mortgages (HECMs) are insured by the Federal Housing Administration (FHA) and require mortgage counseling.
- Proprietary reverse mortgages are offered by private lenders. They lack the regulation of an HECM but provide more options for those with high-value homes.
- Single-purpose reverse mortgages are typically offered by state and local governments or nonprofits to low-income homeowners who need to pay for home repairs or property taxes.
HECMs are the most common type of reverse mortgages, with the most definable standards. We’ll discuss how much equity you need for an HECM here.
Your equity is determined not only by how much you have paid on your current house but also by how much the house is worth. If you’re still paying on your mortgage but your house has appreciated with a strong housing market, your equity will be higher.
Finding Your Equity
Since reverse mortgages borrow against the equity that you’ve built in your home, you must know how much equity you have. Part of the application process for an HECM is an appraisal to find your home’s current worth.
Once the house’s market value is determined, it’s easier to see how much equity you have. This is an easy answer for homeowners who own their homes outright: They have 100% equity. If you’re still paying on a mortgage, it will be less than that.
Variable Equity Standards
Unfortunately, there is a little ambiguity around how much equity is required to qualify for an HECM. An oft-cited standard rule of thumb is that you need 50% equity in your home to qualify. However, the U.S. Department of Housing and Urban Development (HUD) is less clear in its requirements.
According to HUD, homeowners must own the home outright or have paid down a “considerable amount.” With that wiggle room, the amount of equity is only one portion of the qualifying stipulations for approval, with the borrower’s age and record of financial responsibility also weighing in.
While no easily accessible rubric for how these factors affect approval is available, FHA-approved lenders consider them all when determining the amount of money that you can access. Regardless of equity, HUD caps the amount of money that anyone can borrow at $970,800 for 2022.
How much can I borrow through a reverse mortgage?
The amount you can borrow is based on your age, interest rate, and either the appraised value of the house or the home equity conversion mortgage (HECM) limit set by the Federal Housing Administration (FHA), whichever is lower. This will vary for each person. Older people can typically borrow more money.
The lower the interest rate, the more money you can borrow. Since the interest will be paid when the home is sold to repay the reverse mortgage, this will avoid expending all the equity in the house before you move or pass away.
How do I determine my equity?
Equity is determined by the current appraised value of your home minus the amount that you owe on the house. Since home values vary based on market conditions, your equity can increase or decrease based on the appraised value of your home. In a period of high housing values, your equity will increase despite your payments staying the same. Conversely, in a housing crash, your equity may go down as your investment—your home—loses value.
What happens to leftover equity when my home is sold?
If you have a reverse mortgage on your home and don’t use all of the equity before you pass away or move out, then you or your heirs can keep the remaining equity after the home sale as profit. If you expend beyond all of the equity, that amount is paid by mortgage insurance premiums. You cannot owe more than the home is worth with an HECM.
The Bottom Line
Having equity in your home is a valuable asset in your retirement years, especially if you’re interested in a reverse mortgage. Since reverse mortgages are only available to seniors, there is an expectation of significant equity built up. If you purchased your home more recently and don’t have sufficient equity built up, other tools, such as a home equity line of credit (HELOC), might be better.