Reverse Mortgage: How It Works

A reverse mortgage is a loan that lets homeowners aged 62 and older tap their home equity without selling and move out. The lender pays the borrower cash now; the loan balance grows over time and comes due when the home is sold, the borrower moves, or the borrower passes away. It’s a way to unlock wealth that might otherwise sit dormant, though fees, interest, and insurance costs matter.

The HECM structure

The Home Equity Conversion Mortgage, or HECM, is the most common reverse mortgage product in the United States. The Federal Housing Administration insures it, meaning the FHA covers the lender’s loss if the home sells for less than the outstanding loan balance—a feature that protects both borrower and lender.

To qualify, a borrower must own the home outright or have a small outstanding mortgage balance. The lender appraises the home and calculates a lending limit based on the borrower’s age, interest rates, and local market value. Older borrowers can access more equity. The amount a borrower can draw is capped at the lesser of the home’s appraised value or the FHA lending limit for the county.

The borrower receives funds in one or more forms: a lump sum, a monthly payment, a credit line (used as needed), or a combination. Monthly payments don’t come due—the borrower never makes principal or interest payments to the lender while living in the home.

How loan balance grows over time

This is the critical mechanic. Because the borrower makes no payments, the loan balance rises each month. The lender adds three things to the outstanding balance: interest (charged at a variable or fixed rate), mortgage insurance premiums, and servicing fees. Over 10, 15, or 20 years, compound interest can roughly double the original loan amount.

A simple example: a 70-year-old borrows $200,000 against a $400,000 home using a variable-rate HECM at 5% annual interest. One year later, before any draw of additional funds, the balance grows to roughly $210,000 (assuming insurance and servicing are rolled in). After 10 years, the balance might approach $325,000 if no additional draws occur. The home’s value may rise or stay flat; either way, the loan eats into the borrower’s equity each quarter.

This is why timing matters. A borrower who exits early—by selling, moving to assisted living, or passing away—may still owe less. One who stays 20+ years and leaves the home to heirs may find little or no equity left.

When repayment is triggered

The reverse mortgage is due and payable when any of three events occur:

Sale of the home. If the borrower sells, the lender is paid from sale proceeds. If the home sells for more than the loan balance, the borrower (or heirs) keeps the difference. If it sells for less, the FHA insurance absorbs the gap—the borrower is not responsible.

Permanent move. If the borrower moves into a nursing home, assisted living facility, or another primary residence for 12 consecutive months (or 12 of 24 months for some plans), the loan becomes due. The borrower must repay it, typically by refinancing or selling.

Death of the borrower. When the borrower dies, heirs have a grace period (usually 30 days to several months, depending on the lender) to arrange repayment. They may sell the home, refinance into a traditional mortgage in their own name, or let the lender foreclose. If heirs sell and the proceeds exceed the loan balance, they receive the difference.

Impact on the borrower’s estate

This is where the math becomes emotional. A borrower who draws $200,000 and lives another 15 years may leave heirs a home with $300,000 remaining balance owed—eating half the home’s value. If the heirs want to keep the home, they must refinance or pay the balance themselves.

However, FHA non-recourse rules matter: the lender can never pursue the heirs for more than the home’s sale price. If a $400,000 home becomes worth $350,000 and the balance is $380,000, heirs can walk away, and the FHA insurance pays the shortfall. This caps downside risk, though it forecloses on the inheritance.

Some borrowers use a reverse mortgage strategically—drawing a line of credit but not using it, preserving flexibility. Others take the payments to fund retirement and accept the trade-off: lower home equity in exchange for cash today. The decision hinges on life expectancy, future home value expectations, and whether heirs care about inheriting the property.

Fees and costs matter

Reverse mortgages are expensive. Origination fees, appraisal fees, title insurance, and an FHA mortgage insurance premium (upfront and annual) can total 2–5% of the loan amount. A $250,000 HECM might cost $10,000–$12,000 in fees before a dime is drawn.

These costs are often rolled into the loan balance, meaning they accrue interest over time. A borrower who plans to move within five years likely won’t break even on fees alone. The crossover point is typically 7–10 years of occupancy, depending on interest rates and personal spending patterns.

Interest rates on HECMs are typically variable, tied to an index like SOFR or the prime rate, plus a lender margin. This adds rate risk: if rates rise sharply, the balance grows faster. Some lenders offer fixed-rate options, but they cap the draw amount lower.

Alternatives and trade-offs

A home equity line of credit (HELOC) or home equity loan requires the borrower to qualify and make payments, but has lower fees and no age requirement. A traditional mortgage refinance can pull cash but restarts the amortization schedule.

Selling and downsizing gives the borrower direct access to equity with no ongoing debt. Moving into assisted living eliminates the home entirely but may not appeal to every borrower.

A reverse mortgage is neither inherently good nor bad—it’s a tool for a specific situation: an older homeowner who needs current income, has substantial home equity, plans to stay in the home, and values simplicity over leaving the largest possible estate.

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