As retirement approaches for baby boomers, or as more and more of their parents are stuck in homes they can't or won't sell, a growing number of Americans are considering reverse mortgages as one way to supplement their income. Exactly what is a reverse mortgage? It's a payment that a homeowner receives from the holder of the mortgage, or a third party, in either a monthly or yearly amount or in a lump sum with the amount tied to whatever equity someone has in their home.
Sounds like a good deal, right? Many people seem to think so. In the past eight years, the number of reverse mortgages has grown from less than 8,000 a year to more than 100,000. While this is still a small percentage of the number of overall mortgages that are held in the United States today, it still represents a substantial increase in a type of mortgage that has drawn much criticism because of its high costs as well as the way they have been marketed and sold to aging homeowners.
In July, President Bush signed a rescue Housing Bill that was intended to help homeowners facing foreclosure, but also to raise the amount someone is able to borrow using federally backed reverse mortgages. The increases were from a maximum of $362,790 to $417,000, and even as much as $625,500 in some high cost areas. The bill, which will go into effect sometime in the next 60-90 days, also limits the relatively high cost of reverse mortgages by capping those costs at $6,000.
However, not only are reverse mortgages typically more expensive than regular mortgages, they are quite a bit more complicated. Add to that the current credit crisis and depressed housing market, reverse mortgages may not be the "golden goose" all those television infomercials would lead you to believe. While they resemble home-equity loans, you have to be over 62 years old to qualify for one and the amount you get will depend on your age, the value of your home, and interest rates.
On the plus side, the federal government guarantees more than 90% of all reverse mortgages through the Home Equity Conversion Mortgage (HECM) program. What that means is if the value of your home drops to the point where the price it sells for is less than the amount owed, the federal government will cover any short-fall. Otherwise, the mortgage holder will suffer a loss. Plus you don't have to make monthly payments or meet an income requirement to qualify.
In fact, you don't even have to repay the loan until you move out of your house, sell, or die. Whatever debt is left on your house is settled with the proceeds from the sale of the home. And if there's any money left over, if you are still alive, it goes to you and if you have died, it goes to your heirs.
As for costs, the basic rates for reverse mortgages are currently lower than those on home-equity loans -- somewhere around 4.3% for a reverse mortgage compared to 5.3% for home-equity lines of credit. This may seem like a good deal, but keep in mind that reverse mortgages are "rising debt" loans which means the interest you owe is added to the loan's balance and that could eventually become a large portion of your overall debt. Eventually you wind up owing interest on the interest, compounding the cost of the mortgage.
Plus, there are a number of upfront charges such as origination fees, the cost of the appraisal, and a title search. Add to that a 2% mortgage insurance premium required for all HECM loans. The housing rescue bill helps a little by limiting origination fees to 2% of the loan up to the first $200,000 and 1% of the rest, with a cap at $6,000. Still, $6,000 may be a fairly high price to pay to get access to equity in your home.
According to the AARP, high cost is the primary reason two out of three seniors who had been considering a reverse-mortgage shoppers decide against it. To be fair, not all lenders charge high fees. So do comparison shopping if you are considering a reverse mortgage; you may be able to negotiate for lower fees.
Historically, the way reverse mortgages were sold had something of a checkered past. Some mortgage brokers were accused of pressuring borrowers to buy something called deferred annuities with the money that they received from their loans. The new housing law prohibits lenders from requiring borrowers to buy investments or insurance products as a condition of getting the loan.
The new housing bill also prohibits requiring the purchase of annuities and other financial products. Still, you should question any financial product that someone tries to sell to you, including a reverse mortgage.
Keep in mind that even after taking out a reverse mortgage, you're still responsible for property taxes, insurance, utilities, fuel, maintenance, and other expenses related to your home. If you don't maintain homeowner's insurance, for example, you risk the loan becoming due and payable. Also, if you sell your home or no longer use it as your primary residence for 12 months in a row, you or your estate will have to repay the cash you received from the reverse mortgage, including interest and other fees to the lender.
So if you don't intend to live in your home until you die, you may want to reconsider getting a reverse mortgage. If you have to enter a nursing home for longer than 12 months, the loan will become due. Consider that if you can't remain in your home for several years, a reverse mortgage might not make much sense financially.
In fact, if you have equity in your home and you can qualify for a home-equity loan and you can make the monthly payments on that home equity loan, that may be a less expensive way to supplement your retirement than taking out a reverse mortgage. That way you get a lump sum of income from your home's equity as you continue to live there. (But you have to pay off the home equity loan when you sell your home.)
Another option to supplementing retirement income is to downsize. Sell your house and trade down by buying a less expensive home so that you will have the profits from the sale of your larger or more expensive home to invest or live on. You could also consider renting and investing the money from the sale of your home rather than immediately buying another home.
In either case, experts recommend that anyone who is thinking about a reverse mortgage should first talk to a loan counselor to weigh the pros and cons. You can find a loan counselor on a list approved by the U.S. Department of Housing and Urban Development (http://www.hud.gov/offices/hsg/sfh/hcc/hcs.cfm), or you can find a local housing counseling agency by calling (800) 569-4287.
Getting a Reverse Mortgage: Smart Move or Something to Avoid?...