06/24/08: Reverse Mortgage: A Last Resort

Housing Counsel

By Benny L. Kass

Q. My husband and I are in our mid-70s, and have a modest fixed income from social security and pension plans. We own our house free and clear. While we are still in good health, we would like to travel and see as much of the world as possible. Several friends have suggested that we should get a reverse mortgage. Can you explain how this works and whether it is something we should consider?

A. A reverse mortgage has become popular in recent years, as the “baby boomers” – who have not saved a lot of money – are going into their retirement years.

In my opinion, such a mortgage should be your last resort – after exploring all other avenues first.

Here’s how the reverse mortgage works. If you are 62 years of age or older, and own your house that is fully paid for or has a relatively low mortgage, you can qualify. Unlike a regular (or forward) mortgage, where you have to make monthly mortgage payments, with a reverse mortgage you can borrow money, but do not have to repay the loan until you either sell the property or die.

At that point, the lender is repaid the principal and all of the accrued interest. The lender cannot foreclose on the property or in any way interfere with ownership, unless the owner is causing waste or damage.

Some loan documents also require that if you are out of the house for a period of time – typically 6 months to one year – the loan has to be repaid.

There are three ways you can take money from a reverse mortgage:

– A single lump sum of cash.
– A line of credit, so that the money is available as and when it’s needed.
– A monthly cash advance.

There are a number of reverse mortgage programs available. Perhaps the most popular is the Home Equity Conversion Mortgage (HECM), which is insured by the Federal Housing Administration. This is the only reverse mortgage that the federal government insures.

To be eligible for the HECM, all of owners of a home must be at least 62, must use the home as the principal residence, and cannot be delinquent on any debt to the IRS. The home must either be a single family residence, or a one to four unit building. Some condominium units that have received HUD approval are also eligible. Cooperative apartments and most mobile homes are not eligible.

How much money can homeowners take out? That depends on a number of factors, including Zip code, age and the current appraised value of the property. There’s a handy calculator on the Internet at www.rmaarp.com , a site run by AARP, the association representing senior citizens.

Another program available to homeowners is “The Home Keeper”, which is sponsored by Fannie Mae. Although similar to the HECM, there are some differences. For example, the loan limits for the HECM will vary depending on the location of the house; Home Keeper loans are limited only by the Fannie Mae guidelines. If a borrower opts to take the money as a line of credit, the unused portion of that line can increase over time with the HECM, but will remain fixed with the Home Keeper.

Both these reverse mortgages have loan limits, which are set annually by the various agencies. For example, Fannie Mae’s loan limit currently is $417,000, while HECM will lend up to $362,790.

If a homeowner wants more money, there are lenders who will make those larger loans, too. The National Reverse Mortgage Lenders Association has a Web site, www.reversemortgage.com , that has contact information for lenders active in each state. That site also has a lot of other information about these mortgages. The AARP’s reverse mortgage site can also help you find lenders, although they will not endorse any one.

Now that we have covered the basics, you – and only you – must make the decision as to whether to obtain a reverse mortgage. Recently, a lawyer friend suggested that “next to subprime mortgages, the next mortgage problem for older homeowners will be in the area of reverse mortgages.”

Why? Despite studies conducted by AARP which indicated a very high percentage of reverse mortgage holders were very satisfied, the fact remains that this is an area ripe for fraud and predators.

It sounds very attractive to be able to take a lot of money out of your house – tax free – and never to have to pay it back. But the upfront costs are high, and the interest on the loan accrues monthly. Let’s take this example: your house is currently worth $500,000, and you have a $100,000 mortgage. You obtain a $300,000 reverse mortgage, which pays off your existing loan, and provides you with approximately $200,000 for your enjoyment. In 10 years, assuming that your house will appreciate at 4 percent a year, it will be worth approximately $740,000. But if the interest rate is only 6 percent, at the end of 10 years, the loan amount will have increased to $537,000. And this does not include lender fees and closing costs which can be excessive.

If at the end of ten years, you want to downsize and buy a smaller home, or if you plan to leave your house to your children, the remaining equity (approximately $200,000 in our example) may not be acceptable or sufficient for your needs.

AARP suggests that before any homeowner obtains a reverse mortgage, there are five important questions to ask:

– do you really need a reverse mortgage?
– can you afford that kind of loan?
– can you afford to start using up your home equity now?
– do you have less costly options, and
– do you fully understand how these loans work?
(www.aarp.org/money/revmort)

What other options should you consider? You have no mortgage on your house. Why not look into a Home Equity Loan (HELOC) which you should be able to obtain with little or no up-front closing costs. This can be a line of credit, so that when you need some money, you just write a check out of that account. The value of such a loan is that you pay interest only on the money you actually have borrowed.

Interest rates are still relatively low. You should also consider refinancing, and pull out some of that dead equity. Additionally, instead of going to a commercial lender, ask your children if they can lend you money, and set up a “private” reverse mortgage situation.

If you ultimately decide – after a complete investigation of all options – to obtain a reverse mortgage, there are several things that you should not do with the money:

– do not buy stocks or bonds; there is no guarantee that they will appreciate in value;

– do not obtain an annuity, which will pay you a monthly sum of money. Your reverse mortgage can be that annuity, at a much lower cost;

– give serious thought before using your money to buy long-term care insurance – especially if it is being offered by the reverse mortgage lender.

A reverse mortgage can be your financial life ring, keeping you afloat in your senior years. But it can also be a noose around your neck, causing you to sink rapidly. Educate yourself before you make any firm commitments.