The Reverse Mortgage, Revisited

By Farnoosh Torabi, MainStreet
Attention strapped seniors: The reverse mortgage, a financial instrument that acts as a lifeline for some financially struggling retirees, has become a bit more accommodating under Obama’s stimulus plan. An HECM, or home equity conversion mortgage, (the most popular reverse mortgage and only one issued by Uncle Sam) now carries a loan limit of $625,500, up from $417,000. This has more seniors looking into a reverse mortgage, especially as other types of home loan products become harder to attain.

A Reverse Refresher
A traditional reverse mortgage is basically a loan against the value of your home that doesn't have to be paid back until you sell the property, move out or pass away. A bank issues you credit, based on the value of your home, your age and current interest rates. For example, according to an AARP chart, if your home is worth $150,000, your age is 65 and the rate on the loan is 6%, your reverse mortgage loan amount should be roughly $74,000, or half the value of your home. Generally, the older you are, the more credit you can receive because you’ll likely be able to pay back the loan faster.

You can choose to receive the loan in a single lump sum, a credit line or fixed monthly payments. The debt you inherit is equal to the loan advance plus interest.

Qualifications
To be eligible you must own your home and be 62 or older. You also cannot be behind on any federal debt. The financial qualifications for a reverse mortgage are more lenient than a traditional home loan. Because you don’t owe money every month, like a normal mortgage (also known as a “forward” mortgage), banks won’t disqualify you if you don’t have savings or have no income.

Some Risks
Assuming your home value doesn’t skyrocket (and at this point I think that’s a safe assumption) your debt increases and your home equity decreases by taking on a reverse mortgage. This is the opposite of how a forward mortgage should work (in theory). One of the biggest risks is that if you take on a reverse mortgage accumulating interest for a long period of time, or if the value of your home falls, there may be hardly any equity left in your house. If that’s the case, you only have to pay the bank the value of the home. So, betting you are able to sell the house at market value, this will work in your favor.

Beware of the Costs
But reverse mortgages are not cheap. Origination fees, the costs related to preparing and processing your loan paperwork, can take a bite. With an HECM, fees can cost up to $2,500 for a home worth less than $125,000. If the house has a value beyond $125,000, the fee is capped at 2% of the first $200,000 of your home’s worth plus 1% of any amount beyond $200,000. The most origination fees will cost is $6,000. Third-party closing costs could be anywhere from $2,000 to $3,000. There are also appraisal costs to consider. There’s also an insurance premium, which can be tacked onto the loan. Total non-interest costs could easily tens of thousands of dollars. A good tip: Don’t take on more credit than you need. Just because the bank approves you for a certain amount of money, don’t assume you’ll need it. Consider borrowing less.

Case in Point
AARP uses a striking example on its web site of a 75-year-old homeowner who takes on a reverse mortgage for 12 years. The value of the home is $250,000. The loan amount is roughly $68,000, with a 7% interest rate. In 12 years this borrower would owe back the original $68,000 plus $111,000 in interest. Add to that the upfront costs ($12,000), the mortgage insurance ($7,900) and fees ($5,000), her total amount owed would be more than $200,000 in 12 years.

Alternatives
As my colleague Mike Woelflein outlines in his story about reverse mortgages, applicants should think long and hard before diving in. If you need cash, consider selling your home and downsizing, or renting out a room. Or what about a home equity line of credit, instead? And definitely check out low-cost loans from state and local governments to afford property taxes or significant home repairs.

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