Reverse Mortgage 101: The Risks and Rewards


For seniors, the idea of a reverse mortgage seems appealing: Turn your home equity into a steady stream of income, and stay in your home as you age.

Especially given the stock market's free fall and the onerous mortgages some folks are looking to escape, these loans may sound better than ever.

What's more, HUD last month instituted new rules for Home Equity Conversion Mortgages, or HECMs, the federally insured loans that make up virtually all reverse mortgages. The new law may make reverse mortgages more attractive by raising the limit on qualifying home values, capping origination fees and, starting in 2009, allowing seniors to use a reverse mortgage to buy a new home in a single closing.

Still, these loans remain expensive, and can be risky. Here's what you need to know:

Reverse mortgages 101: Reverse mortgages allow homeowners age 62 or older to borrow money based on their home equity, with the principal and interest repaid when they die or move out for a year or more. Cash is available in a lump sum, monthly payments, a line of credit (which typically grows 5% to 5.5% annually) or a combination. These loans are available from major financial institutions, including Wells Fargo, Bank of America (which acquired Countrywide), M&T Bank, MetLife and Genworth.

When the loan comes due, the senior (or his or her heirs) can sell the home or buy the equity back. The good news: If the house is worth less than the total amount due, they pay only the value of the home.

Loan amounts and interest rates vary with a home's value and the homeowner's age. The older you are, the more you can typically borrow. A 70-year-old homeowner can generally finance about 62% of home equity, or about $260,000 at the new $417,000 maximum home value.

The bottom line: These are complex loans in which your debt rises as time goes by -- the opposite of a typical loan. As a result, HUD requires that HECM applicants receive counseling from an approved provider.

High costs, and some risks: Reverse mortgages include a number of fees: origination fees, closing costs, mortgage insurance (required for HECMs, typically 2% upfront and a 0.5% addition to your interest rate) and servicing fees (typically $30 to $35 per month). They can total 10% of the loan amount over time, even with the new rules.

In 2007, AARP determined that a 74-year-old with an HECM for $181,000 on a $300,000 home could pay more than $30,000 in fees over 12 years. That figure should be lower under the new laws, but critics say it's still more expensive than a conventional mortgage.

Peter Bell, president of the National Reverse Mortgage Lenders Association, an industry advocacy group, admits these loans are "complex," and advises candidates to speak "openly and candidly" to counselors before taking the plunge. But he doesn't think reverse mortgages are expensive.

"Compared to what?" he says. "We're saying, 'I'll give you a loan for an unidentifiable amount of money, you can have it for an unknown amount of time and you may pay me back less than I gave you.' There's no other loan like that. With a forward mortgage, you pay interest and fees every month. We have to collect that money upfront."

Still, Bell acknowledges that the ultimate reverse mortgage nightmare -- no home equity and no more loan income -- is a possibility. Remember, lenders can call for full payment if the homeowner vacates the house for a year or fails to pay property taxes, insurance or maintenance. So, for example, if you ran through much of your equity and then went into a nursing home for a year, your loan payments could stop just when you'd need them most.

Reverse mortgages also can eat up your home equity fast: Borrowing $150,000 at 6% means losing $272,000 of home equity over 10 years. And they can impact your ability to qualify for federal entitlement programs such as Medicaid.

What's more, some unscrupulous advisers use reverse mortgages to take advantage of seniors, using hard-sell tactics and deception to push loans or tie them to inflexible annuities.

The ideal applicant: Be sure to investigate all your options before pursuing a reverse mortgage. If you need cash, consider selling your home and downsizing or renting. (Doing so may be difficult in today's market -- one reason Bell and others expect HECMs to grow more popular.) A home equity loan may make sense. And many state and local governments offer low-cost loans to help pay property taxes or make critical repairs.

Otherwise, homeowners age 70 or older who have dwindling assets or medical/long-term care costs beyond their means are the best candidates for reverse mortgages. Because most fees are front-loaded, and paid with loan proceeds, these loans also may make sense for people planning to stay in their home for several years. If you're thinking about a reverse mortgage, consult the guides offered by AARP and HUD.

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