Can you use a reverse mortgage to buy a home if you have bad credit?

By Gina Pogol
Mortgage Credit Problems Columnist

Dear Gina, I have bad credit and want to buy a new house. I read that FHA has a reverse mortgage that you can use to buy a home and that reverse mortgages don't need a credit check. Is that true? How would it work? - Darlene, Lebanon, Tenn.

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All of those things are true about reverse mortgages -- you don't have to have good credit and you can use them to buy a house. But the loan's usefulness is probably pretty limited. Here's why: First, you need to be over 62 years old. Second, you need a sizable down payment.

If you meet the criteria, though, you can purchase your next home with no mortgage payments and live in it for the rest of your life, payment-free. Here's how it works.

Why take out a reverse mortgage to buy a home

Reverse mortgages make sense for eligible existing homeowners who want to sell their home and move to a smaller home or a cheaper area.

For example, suppose that you're able to sell the family home for $750,000 and get $500,000 in proceeds from the sale. You want to buy a cheaper house for $400,000. You could just buy it outright, but then you'd use up all of your cash except for $100,000. You'd like to finance the purchase, but you can't get a regular mortgage because your bad credit scares mortgage lenders away.

What you could do is buy your new home with a reverse mortgage called a Home Equity Conversion Mortgage, or HECM, which is a type of FHA loan. In this scenario, you could put down $200,000 and keep the other $300,000. So you'd have your new home, most of the proceeds from your property sale as cash and no mortgage payments.

Borrowing limits

That depends on a few variables -- the age of the youngest borrower (the older you are, the more you can borrow), the value of the home and current interest rates (the lower they are, the more you can borrow).

HECM mortgages are not cheap -- the fees are regulated by the federal government, but the mortgage insurance that's required upfront is pretty expensive. AARP has a reverse mortgage calculator that can give you an idea of what kind of funding might be available.

Does the lender own your home?

Borrowing with a reverse mortgage does not give ownership of your home to the lender. Like any loan, the balance of your mortgage is subtracted from the value of your house, and the difference is your home equity. You continue to own your home, and its equity reverts to you if you sell your home or to your heirs when you die.

Before you're allowed to take out any HECM mortgage, you have to talk to a U.S. Department of Housing and Urban Development- (HUD-) approved reverse mortgage counselor. This person is trained to help you decide if a reverse mortgage is a good option in your situation.

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