Into Reverse, with Caution: Details About Reverse Mortgages

by Dianne Molvig

For many years, you dutifully handed over a monthly payment to your mortgage lender. Now there's a mortgage product, aptly named, that reverses the payment process.

A reverse mortgage is a loan with a different twist. The lender pays you an amount of money that depends on your age, your home's value, and the loan's interest rate. To qualify for a reverse mortgage, you must be at least 62 years old, have equity in your home, and your home must be your principal residence. If more than one person owns the home, the youngest owner must be at least 62.

Under this plan, you make no monthly loan payments as long as you continue to live in your home. Ultimately, the loan--including the amount you borrowed, plus interest and any loan fees you rolled into the loan--will be paid off whenever you or your heirs sell your house. When that day comes, the amount owed will be limited by what your home is worth at the time.

Who could benefit?

Strong interest among members is spurring Rogue Federal Credit Union, Medford, Ore., to add reverse mortgages to its loan product line in early 2005, according to Therese Strohmer, mortgage loan manager. "People are clamoring for this," she says. "We get inquiries on a weekly basis, if not daily."

Borrowers perhaps best suited to a reverse mortgage are those "who are looking for a way to attain some kind of financial security," Strohmer explains. "They have plenty of money in their house, but they can't afford a home equity loan because they'd have to make monthly payments. They're on a fixed income."

Being house-rich and cash-poor, these borrowers often face difficulties in meeting ordinary living expenses, medical bills, home repair costs, and property taxes. Selling their home--their major, perhaps only, substantial asset--seems the only way to make ends meet. A reverse mortgage offers another option.

"I think the best part about this," Strohmer says, "is the ability to stay in your own home and the dignity that comes with that. That's a huge benefit you can't measure with money."

Still, along with the benefits, there are tradeoffs and pitfalls. Opting for a reverse mortgage is a complex, often difficult decision.

Dealing with emotions and unknowns

Your house may be the biggest asset you have to pass on to your heirs. But in a reverse mortgage, the payments you receive from the lender come from your home's equity. That brings up one of the leading drawbacks of reverse mortgages in many people's minds. Your heirs will get less, perhaps a lot less, depending on how much you end up borrowing against your home equity.

On the other hand, you may have no children or, if you do, perhaps they won't need your inheritance. Only you--along with your family members, if you choose to discuss this with them--can decide how important this issue is.

Keep in mind, too, that reverse mortgages come with sizable fees that may be as much as 5% to 6% of the home's value. You can roll these fees into the loan. Still, that increases the amount you'll borrow and adds to the amount of interest you'll pay.

Because of the high fees, reverse mortgages aren't a good option if you think you'll be moving out and selling your home in the next couple of years, advises Bronwyn Belling, reverse mortgage specialist with AARP, Washington, D.C. "You want to be sure you're going to stay in the house," she says, "so you can amortize those fees over a longer period of time. Then the effective cost to you is less ... If longevity runs in your family, you may be a better candidate for staying in your home a long time."

Also, "It's better to look at a reverse mortgage," Belling adds, "when you're older, rather than younger." You get to borrow a larger percentage of your home's value based on your age, or the age of the youngest borrower among the home's owners. AARP has a calculator to help you figure how much money you'd be able to borrow.

Still, many factors affect how well this loan will work for you. Typically, reverse mortgages are adjustable-rate loans, with a life-time cap. Interest rates can climb. Your home's value can change, as can your health and your ability to continue living in your home. All of these, Belling points out, "ultimately drive what the real costs of a reverse mortgage are to you in the end."

At the same time, many of these factors are difficult or impossible to predict. "That's why the education part is so important," Strohmer emphasizes. "You have to know what you're getting into."

Much to learn

The issues we've raised so far touch on only a few of the factors you must weigh to decide if a reverse mortgage is right for your situation. You'll also need to find out whether receiving this money will affect your Medicaid or Supplemental Security Income benefits.

There may be other local programs that are better suited to you. "These might meet your financial needs," Belling advises, "and allow you to stay in your house, without having to take out a fairly expensive mortgage."

If you believe a reverse mortgage may be your best option, you face more decisions. Which type of reverse mortgage is right for you? The Home Equity Conversion Mortgage (HECM), which is federally insured, is by far the most common. More than 95% of reverse mortgages are HECMs, according to Belling. Another type is Fannie Mae's Home Keeper^®.

Check with the people at your credit union to see if it offers reverse mortgages, or if they can advise you.

Other key decisions include: Do you want your money in a lump sum, as monthly payments, as a credit line to draw on as needed, or some combination of these? Do you want the loan's adjustable rate to change monthly or annually (a choice available only with HECMs)?

All prospective borrowers who wish to apply for a HECM must talk to an independent, objective housing counselor who works for an agency (some charge a fee) approved by the U.S. Department of Housing and Urban Development (HUD). Also, the AARP Foundation's Reverse Mortgage Education Project HECM Counseling Network includes counselors at HUD-approved agencies who have scored high on a special counselor exam and met other specifications. These counselors' services are free.

Certainly, you've learned enough already about reverse mortgages to see why counseling is critical. Reverse mortgages bring up a lot to think about.

"The worst thing we see," Belling reports, "is people just jumping in and not taking their time ... You have to go in with your eyes open. For some people, a reverse mortgage is not a good idea. For others, it's a godsend."

February 28, 2005