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Reverse Mortgages Aren't for Everyone

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You can scarcely turn on the TV without seeing ads for reverse mortgages. They're touted as a great tool for cash-strapped seniors to tap their home equity to pay off bills while remaining in their homes with no monthly mortgage payments. Although that may be true for some people, these complicated and costly loans aren't right for everyone, so it pays to do your homework.

Here's a primer on reverse mortgages and precautions you need to take:

Reverse mortgages let homeowners age 62 or older borrow against their home equity without having to make monthly payments (as with refinance loans). The reverse mortgage needn't be repaid until you move out permanently, sell the property or die. Any money left after the sale goes to you or your estate.

In addition, seniors wishing to downsize or relocate may make a large down payment on a new home and then use a reverse mortgage to finance the rest, thereby avoiding the minimum income and credit score requirements of traditional mortgages and eliminating the need for paying two sets of closing costs.

These loans are the "reverse" of traditional mortgages because instead of you paying the lender each month, it pays you through advances against your home equity. The vast majority of these mortgages are made through the Federal Housing Administration's Home Equity Conversion Mortgage (HECM) program. Common features include:
  • All parties on the loan must be at least age 62.
  • The home (current or future) must be your principal residence.
  • You must own the home outright or be able to pay it off with proceeds from the loan.
  • The allowable loan amount is based on your home's appraised value, your age, interest rate and type (fixed or variable), mortgage insurance and applicable fees. Generally, the older you are and the more valuable your home, the greater the available loan.
  • The repayment amount never exceeds the home's final sale value, so you (or your heirs) are never liable for more than you originally borrowed.
  • You can take the money as a lump sum, a line of credit, fixed monthly payments or any combination.
  • The money isn't considered taxable income so regular Social Security and Medicare benefits usually aren't impacted, although your ability to qualify for certain needs-based assistance like Medicaid or Social Security SSI could be affected.
Reverse mortgages can be very expensive. Lenders may charge a loan origination fee of up to $6,000. In addition, you must pay upfront and then ongoing mortgage insurance premiums (MIPs).
  • With the Home Equity Conversion Mortgage Standard loan, the upfront mortgage insurance premium is 2 percent of the home's value.
  • The relatively new HECM Saver loan has a far lower 0.01 percent upfront MIP (although the allowable loan amount may be up to 18 percent less).

Both versions also charge an additional 1.25 percent MIP of the outstanding balance annually, as well as a loan origination fee of up to $6,000 and various other charges. Typically, these fees are deducted from your loan amount, so they accrue interest over time.

A few other potential downsides with reverse mortgages:
  • You are responsible for homeowner's fees, property taxes, insurance and repairs for the life of the loan. If you don't pay them, you risk cancellation or foreclosure.
  • They aren't cost-effective if you plan to move in a few years.
  • Some couples put only the older spouse on the loan in order to secure a higher balance, but this can backfire: If that person dies first, the survivor could be bound to pay off the loan -- a real problem if the home's value is "underwater."
  • Because interest accrues, the longer you carry a reverse mortgage, the more your home equity -- and thus, your estate -- will decrease. However, weigh that and living in your own home against the expense and possible inconvenience of an assisted living facility.

Because reverse mortgages are so complicated, potential borrowers are required to consult a Department of Housing and Urban Development (HUD)-approved counselor before being allowed to apply. Before you even get to that stage, do your research. Helpful sites include those sponsored by HUD, the Federal Housing Administration and AARP, which has a Reverse Mortgage Calculator to help you estimate how much you could qualify for under the two types of HECM loans.

A few last tips:
  • Get a second opinion from an accountant, a financial planner or a lawyer specializing in elder law to make sure a reverse mortgage is right for you.
  • Consider other options like refinancing, downsizing, tapping other assets, loans from family members, etc.
  • If you do decide to pursue a reverse mortgage, shop around. Interest rates, fees and other costs vary widely by lender.
  • Only use the money for essential living expenses, not for investments -- you don't want to gamble with your biggest asset.

This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.