How to Use a Reverse Mortgage To Tap Your Home for Dollars

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How to Use a Reverse Mortgage
To Tap Your Home for Dollars

By Aleksandra Todorova
From Smart Money

Home values have surged in recent years, but so have health expenses and local taxes, leaving some seniors feeling both house-rich and cash-poor. In response, some are turning to so-called reverse mortgages to tap their home equity for cash.

Reverse mortgages have been around for more than a decade but became popular only in recent years. Retirees took out a record 43,131 federally insured reverse mortgages in the year ended Sept. 30, up from 37,829 in the same period a year earlier and a mere 6,640 in 2000, according to the National Reverse Mortgage Lenders Association, a trade group based in Washington, D.C.

People naturally are intrigued at the thought of a product that puts cash in their pockets and, in contrast to a home-equity loan, doesn't require them to start making payments at once. But reverse mortgages aren't for everyone. They are complex, costly and final. "Make sure you understand all the costs and alternatives," says Ken Scholen, director of the AARP Foundation's reverse-mortgage education project.

Here is a guide to help you:

1. Nuts and Bolts

Instead of using income to build home equity as in regular mortgages, you use home equity to get income. You remain the title owner and don't make payments on the loan as long as you live there. The loan, plus interest, is due when you -- and any other owner such as a spouse -- move or die.

To qualify, you and any other owners must be at least 62. You must own the home outright or be able to pay off any balance with reverse-mortgage money. To avoid default, you must keep up the house and pay taxes and insurance.

Loan amounts vary. The older you are and the lower interest rates are when you seek the loan, the more equity you can borrow.

All reverse mortgages accrue interest, even though the interest isn't paid off until the loan becomes due. The interest rate adjusts annually or monthly, at the borrower's choice. (Annual rates tend to be higher -- and less popular.) To see how your age, home's value and interest rates will affect the amount you can borrow, plug your numbers into the National Reverse Mortgage Lenders Association's reverse mortgage calculator (www.reversemortgage.org).

Contrary to popular perception, the lender doesn't take your house automatically when the loan comes due, says Peter Bell, director of the National Reverse Mortgage Lenders Association.

True, heirs may sell the home in order to pay off the balance if you die. But they could decide to keep the house by coming up with cash to repay the loan. If the house is worth less than the amount due, you or your heirs will owe to the lender only what the house can sell for. If it's worth more, you or your heirs get to keep the difference.

2. Types of Products

There are three types. Most common is the so-called home equity conversion mortgage, or HECM, insured by the Federal Housing Administration, or FHA. These make up 90% of all reverse mortgages in the country, according to the National Reverse Mortgage Lenders Association.

The remaining 10% is made up of Fannie Mae's reverse mortgage product, called "HomeKeeper," and a "Cash Account" jumbo reverse mortgage offered by Irvine, Calif.-based Financial Freedom Senior Funding Corp.

The FHA puts limits on the home values that can be mortgaged, which vary by county -- from $172,632 in rural areas to $312,895 in metro areas this year. If you live in an area with a $300,000 limit but your home's worth $500,000, you can take a reverse mortgage based on $300,000 of home equity. (HomeKeeper and Cash Account mortgages generally make a lower percentage of your home equity available than do HECMs, but can make more sense for borrowers whose homes exceed the FHA limits in their county.) HECMs are available through roughly 500 lenders around the country, according to Mr. Bell, from small local companies to big lenders like Wells Fargo and Bank of New York. Unlike regular mortgage terms, which vary by lender, reverse-mortgage terms are set by the Department of Housing and Urban Development. The only variable is the origination fees charged by the lender.

3. Picking a Payout Schedule

Payouts take three forms. You can get a one-time lump sum, establish a credit line and draw on it as needed or set up an annuity-like payment schedule. Or you can combine the three. At any point, you can switch between options for a small fee of around $25, Mr. Bell says. In either case, payouts from a reverse mortgage are tax-free.

All three options have pluses and minuses. A lump sum will put a lot of money in your hands, but you'll accrue more interest since you'll have a larger loan for longer. And it might affect your Medicaid eligibility if you don't spend the money right away, Mr. Bell explains. Yet it may be a smart strategy for retirees who still owe money on their regular mortgages, suggests the AARP's Mr. Scholen. Taking a lump-sum reverse mortgage payout to pay off their balances will eliminate their monthly mortgage payments.

The best option for most retirees is the credit line: Draw on the money when you need it and accrue interest only on the balance.

4. The Costs

Reverse mortgages are expensive. Expect to pay 6% to 8% of your home's value at the time of loan origination (or the FHA limit, if lower). Of that, 2% goes to HUD for insuring the mortgage, another 2% (or less, in a competitive market) goes to the lender and the rest toward title and appraisal fees and other costs. "If you intend to stay in your home for only a short period...ask yourself if the fees are worth it," says Mr. Scholen.

Retirees must go through special counseling before taking a reverse mortgage. For a list of approved agencies near you, call HUD at 800-569-4287.

Email your comments to rjeditor@dowjones.com.

-- November 22, 2005