Your Home as a Retirement Fund
Reverse mortgages are finally catching on. But are they for you?
Reverse mortgages have long been regarded with a skeptical eye. Critics say they're costly, complicated products, financial-planning tools of last resort. Lately, congressional hearings have raised concerns about predatory lending. And the reverse-mortgage market is attracting bad apples from the subprime market in pursuit of high commissions from sales of inappropriate investments bundled with reverse loans.
Since federally backed home equity conversion mortgages were introduced in 1989, only 1% of eligible seniors have gotten on board. (HECMs account for the vast majority of the market.) But despite negative publicity, reverse mortgages seem to be catching on with seniors who are house-rich but nervous about their cash flow.
Two-thirds of the nearly 350,000 reverse mortgages made to date were taken out within the past three years, and one-third were issued in 2007 alone. Structured properly, a reverse mortgage can be a life-saver for a cash-strapped senior.
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No nasty surprises. One reason for the lack of interest in reverse mortgages until now is the misconception that the bank can take your house, leaving you and your heirs in the lurch. But a reverse mortgage comes due and is payable only when you sell the house, when you die (or the last surviving borrower dies), or when you reside elsewhere for a year or longer. Then you or your heirs must repay the lender from the proceeds of the home's sale.
If the proceeds exceed what you owe, you walk away with the remaining equity. But the lender can't come after you or your heirs if the home sells for less than you owe or if your lifetime payments exceed the initial loan limit.
Because there are no loan payments to potentially fall behind on, you can never lose the home to foreclosure. And because HECMs are federally backed, if the lender fails, the federal government takes over the loan and continues to fund it. The lender does have the right to call the loan if you fail to pay your property taxes or homeowners insurance, or if you don't maintain the property.
How they work. To take a reverse mortgage, you must be at least 62 years old, your house must be your primary residence, and your mortgage must be paid off or have a small balance. The older you are and the higher the appraised value of your home, and the lower the initial interest rate, the higher the initial loan limit for which you'll qualify.
With an HECM, you can get a lump sum upfront, a line of credit, a monthly payment for a fixed period of time (term) or for the life of the loan (tenure), or some combination of these. You can change your selection at any time for a $20 fee. Interest is typically a variable rate, but lenders have also begun to introduce reverse mortgages with a slightly higher, fixed rate. The fixed rate works best for borrowers who will take a large lump sum right off the bat.
With an HECM loan, the appraised value is capped at your county's median home value, up to a maximum of $200,160 in most non-metro areas and $362,790 in many urban areas. Fannie Mae's Home Keeper program caps the allowable property value at its conforming loan limit, which until recently was $417,000.
If your home appraises above the caps, you can borrow up to the allowable limit.Lenders have begun to introduce jumbo loans for more-expensive homes, but the credit crunch has thinned out the number of lenders. Jumbo loans aren't backed by the federal government and don't enjoy the same protection against loss, so such loans tend to be more expensive than HECMs and offer lower initial limits.
Experts recommend that you take as much as possible in the form of monthly payments or a line of credit to tap as needed. If you take a lump sum that you don't need, you'll run up unnecessary interest charges, says Meg Burns, director of the FHA's Office of Single-Family Program Development at HUD. Plus, the line of credit on an HECM will grow over time (that's not the case with a Fannie Mae Home Keeper loan or jumbo products).
AARP gives this example of how the math works: Say you set aside $100,000 of your initial loan limit in a credit line and you withdraw $20,000, on which the interest accrues at a rate of 6% annually. Your available credit (now $80,000) will grow by the same rate, so that a year later you can borrow up to $84,800 (6% x $80,000 = $4,800).
Should you take one? A recent AARP study on reverse mortgages shows that a 74-year-old borrower living in a $300,000 house could expect to pay about $15,000 in upfront costs on an HECM, including the origination fee, mortgage-insurance premium and closing costs, plus another $15,000 in monthly insurance premiums and servicing fees over the life of the loan.
Because of the upfront costs, it doesn't make sense to take a reverse mortgage if you don't expect to keep your home for at least five years. If you have substantial income and assets, it's almost always less expensive to tap them than to take a reverse mortgage, says Don Redfoot, of AARP.
If you need a relatively small amount of money -- say, $30,000 for home modifications -- it's almost certainly cheaper to take out a home equity line of credit. Or your state or municipality may offer a lower-cost reverse mortgage specifically for home improvement (visit www.hecmresources.org and click on "Alternatives").
Just like any other loan, the longer the term, the higher the costs (see the box). But the interest you pay isn't tax-deductible until the loan is paid off. That bolsters the case made by many financial planners that a reverse mortgage should be a last resort.
Still, says Joe Downs, a financial planner in Sarasota, Fla., such a mortgage can be useful. "If it improves your life for 10 to 15 years, then it can be a good product," says Downs. "I'm a firm believer in that bumper sticker "I'm spending my children's inheritance.'"
Federal law requires you to consult with a HUD-approved counselor, in person or over the phone, before you can apply for a federally insured loan. If a counselor pushes you to work with a particular lender, or vice versa, look elsewhere for advice and service. Also, a recent AARP survey showed that 9% of all prospective borrowers were invited to buy other financial products with their payout money. That's never a good idea, most experts agree, because you'll get hit with upfront costs twice.
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