By Jack Guttentag
Saturday, October 4, 2008

Because some fees on a reverse mortgage are fixed, small reverse mortgages are quite costly. Nonetheless, they may be the best option available in some circumstances. Here is an example:

Q. My grandfather is 96 and in poor health, but he wants to stay in his house. However, he requires constant care, which the family cannot afford. We need to find about $1,000 a month. His townhouse is worth only $52,000 and it has a mortgage balance of $12,000. Would a reverse mortgage on his house be an answer for us? Would we have to pay off the reverse mortgage when he dies?

A. On reading this letter, I was skeptical that a reverse mortgage would be an answer, but after crunching the numbers and considering the alternatives, I changed my mind.

On a house worth $52,000, someone your grandfather's age can get a reverse mortgage of about $46,000, from which about $6,000 in upfront fees must be deducted, leaving $40,000 that can be drawn on. However, the $12,000 outstanding loan balance on your grandfather's house must be repaid out of this. That leaves only about $28,000 available as a credit line to be drawn on as needed. Nonetheless, the reverse mortgage will provide $1,000 a month for at least 28 months, which is exactly what the family needs.

There is no repayment obligation on a reverse mortgage. If the borrower dies within the 28-month period, the lender will sell the house, repay the balance of the reverse mortgage, and remit anything left over to the borrower's estate. If the borrower is still alive when the credit line has been exhausted, he can continue to live in the house, but the family will have to find another way to pay for his care.

Q. I am 72. My mortgage is paid off. I intend to live with my children in a year or two, at which point I will sell my house. In the meantime, I have some repairs to make and some credit card balances I would like to pay off. I am thinking of taking out a reverse mortgage, then paying it off when I sell. Good idea or not?

A. This is a bad idea. A reverse mortgage is not suitable for raising funds for a short period because the upfront cost is so high. The appropriate instrument for your purpose is a home-equity line of credit, on which the upfront cost is low -- sometimes zero if you shop carefully.

The difference between your case and that of the first reader's grandfather is that the grandfather will remain in the house, and there is no other fund source that will permit this. In your case, you intend to pay off the loan when you sell in just a few years. That makes the home-equity line a feasible option -- and a less expensive one.

Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site, http://www.mtgprofessor.com.

Copyright 2008, Jack Guttentag

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