Consider a Reverse Mortgage, But Only as a Last Resort

By Benny L. Kass
Saturday, June 28, 2008

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 see as much of the world as possible. Several friends have suggested that we get a reverse mortgage. Can you explain how this works and whether it is something we should consider?

AReverse mortgages have become popular in recent years as many baby boomers have entered retirement without a lot of money saved. But you should explore other options first and take out a reverse mortgage only as your last resort.

Here's how a reverse mortgage works: If you are 62 or older and own a house that is paid off or has a relatively low mortgage balance, you can qualify. Unlike with a regular mortgage, on which 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 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 six months or one year -- the loan has to be repaid.

There are three ways you can take money from a reverse mortgage: a lump sum of cash; a monthly cash payment; or a line of credit, so that the money is available when it's needed.

There are a number of reverse-mortgage programs available. Perhaps the most popular is the home-equity conversion mortgage, which is insured by the Federal Housing Administration.

To be eligible for the HECM, all of the owners of a home must be at least 62, must use the home as their principal residence and cannot be delinquent on any debt to the Internal Revenue Service. The home must be either a single-family residence or a one- to four-unit building. Some condominium units that have received government 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 appraised value of the property. There's a handy calculator at http://www.rmaarp.com, a site run by AARP.

Another program available to homeowners is the Home Keeper, sponsored by Fannie Mae. There are some differences between this and a HECM. For example, 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 programs have loan limits. 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, http://www.reversemortgage.org, that has contact information for lenders active in each state. That site also has a lot of other information about these mortgages. AARP's reverse-mortgage site can also help you find lenders, though it will not endorse any.

That's a lot of information to review, but only you can decide whether you want a reverse mortgage. Recently, a lawyer friend suggested to me 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 that indicate that a high percentage of reverse-mortgage holders are satisfied, the fact remains that this is an area ripe for fraud and predators.

It sounds 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 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 about $200,000 for your enjoyment. In 10 years, assuming that your house appreciates at 4 percent a year, it will be worth about $740,000. But even if the interest rate is only 6 percent, at the end of 10 years, the loan amount will have increased to $537,000. This does not include lender fees and closing costs, which can be high.

If at the end of those 10 years, you want to downsize and buy a smaller home, or if you plan to leave your house to your children, the remaining equity -- about $200,000 in our example -- may not be 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 your home equity now?

· Do you have less costly options?

· Do you fully understand how these loans work?

What other options should you consider? You have no mortgage on your house. Why not look into a home-equity line of credit, which you should be able to obtain with little or no up-front closing costs? 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 could consider refinancing and pulling out some of that dead equity, though you would have to immediately start paying back that loan.

Additionally, instead of going to a commercial lender, you could ask your children if they can lend you money and set up a private reverse-mortgage situation. That way, the money that's eventually owed would be going to the people who are most likely to inherit the house anyway.

If you ultimately decide to obtain a reverse mortgage, there are some things that you should not do with the money:

· Do not buy stocks or bonds; there is no guarantee that they will appreciate significantly in value.

· Do not obtain an annuity, which will pay you a monthly sum. Your reverse mortgage can be that annuity at a much lower cost.

You should also 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 weight around your neck, causing you to sink rapidly. Educate yourself before you make any firm commitments.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036. Readers may also send questions to him at that address or contact him through his Web site, http://www.kmklawyers.com.