General knowledge says that borrowers need “substantial equity” in their homes to take a reverse mortgage. Obviously, if you own your home outright, that counts as substantial equity. But how much equity will be sufficient for borrowers with an existing mortgage? Here’s a look at equity in reverse mortgages.
What is home equity?
Equity is the financial stake a homeowner has in their home. For a person who owns a home free and clear, their equity is equal to the market value of the home. Equity for borrowers with mortgages is the value of the home minus the amount owed on the mortgage. As the borrower makes payments toward the principal and interest, they reduce the loan amount and increase their equity in the home. Equity can increase if the home value appreciates because of market fluctuations. If you decide to renovate your home, you can also increase the equity in your home.
What are the home equity requirements for a reverse mortgage loan?
The U.S. Department of Housing and Urban Development (HUD) does not have a specific guideline on the amount of equity a homeowner needs to be potentially eligible for a reverse mortgage. Generally speaking, homeowners need at least 50% equity in their homes to qualify for a reverse mortgage. Individual lenders make specific determinations about required equity depending on individual borrower circumstances and the current interest rates.
Why does the amount of equity matter in a reverse mortgage loan?
In addition to determining whether you can obtain the loan or not, your equity directly impacts how much money you could receive in proceeds. If you own your home outright, you will receive the maximum amount of proceeds from your reverse mortgage. However, if there is a balance, the proceeds from the reverse mortgage will be used to pay off that outstanding amount as a requirement of the loan, and then you could receive the remaining amount subject to any set-aside requirements imposed by your lender and the HUD’s limitations on the disbursement.
What if you don’t have enough equity for a reverse mortgage loan?
Some borrowers may need more equity, especially if they just purchased their home or have large mortgages. There are some options if a borrower doesn’t have enough equity. They are as follows:
- Wait. Borrowers can wait until the market value rises. This will take patience, but borrowers can capitalize on a higher market value with increased equity.
- Make additional mortgage payments. Borrowers can choose to make extra mortgage payments. It may take longer to build equity this way, but borrowers could have a better chance to be eligible for a HECM.
- Make home improvements. A borrower can make home improvements. They can potentially increase the appraisal value and the equity in the home.
- Consider a HECM for purchase. A home equity conversion mortgage (HECM) for purchase could offer an alternative for borrowers who’d like to downsize and roll the proceeds from the sale of their home into the purchase of a new home. Because a HECM for purchase is a reverse mortgage used to purchase a new home, there is no equity requirement to qualify. The borrower does need to make a large down payment, and the reverse mortgage covers the remaining purchase price of the home. Aside from being used to purchase a new home, a HECM for purchase works exactly like a regular HECM, offering borrowers the same advantage of no required monthly mortgage payments. Borrowers are still responsible for paying property taxes and homeowner’s insurance and are required to maintain the home. For a HECM for purchase loan, you’ll need cash to pay the difference between the HECM proceeds and the sales price, plus any closing costs.
