Reverse mortgage basics

BY STAFF WRITER —
If you've purchased a home before, you probably know most of the ins and outs of common mortgage products. However, the reverse mortgage, designed to help more people stay in their homes as they age, may be a new concept to you, one that is significantly more complex in its long term financial implications.

So complex, in fact, you must by law (24 CFR 206) meet or speak by phone with a qualified reverse mortgage counselor before completing an application for a Home Equity Conversion Mortgage ("HECM") loan, the most popular program, which is insured by the Federal Housing Authority. (Call HUD's Housing Counseling Clearing house at 800-569-4287 to locate a local counselor or go to http://www.hud.gov to find a list of approved counselors.) Fannie Mae sponsors the proprietary "Home Keeper" loan, which has some similar provisions as the HUD program, but higher interest costs.

It's also a good idea, before you take any action on signing up for a reverse mortgage, to speak with a trusted financial advisor who has specific expertise in this area. And, because of the future implications of reverse mortgages on your estate, all family members and heirs should be brought into the process.

How does a reverse mortgage work?

When you purchased your home, you probably took out a mortgage loan that sent the proceeds to the seller in exchange for your title. You agreed to make regular payments of principal and interest to the holder of the mortgage until the loan was settled and to pay any balance remaining upon sale of the property.

With a reverse mortgage, you receive the proceeds (in the form of a lump sum, monthly payment, line of credit, or a combination of any of the three) in exchange for an agreement with the lender that it will receive payment when the loan comes due, either because you decide to move to another home or on the death of the last surviving owner. This payment is the amount of your loan plus any accrued interest (and any closing costs you financed as part of the loan).

Your responsibilities as a home owner

You continue to own the home as long as you (or your spouse) live in it as your principal residence. You are responsible for maintenance, insurance and taxes on the property. The mortgage company will never "repossess" your home; however, if you fail to pay the taxes or maintain and insure the home, the loan can be called. If you declare bankruptcy, the loan will also become due. So, before accepting a reverse mortgage, be sure you will have adequate resources to cover the expenses of home ownership. Once you take out a reverse mortgage, you will not be allowed to rent all or part of your home or add a new owner to the title, so don't count on any of these as a source of outside income.

Non-recourse loan

One of the most attractive features of reverse mortgages is that they are "non-recourse" loans. You can never owe more than the value of your home at the time of its sale. If you sell your home fo a lower amount than what is due on the loan, the lender accepts the balance of the sale, without recourse for more payment from you or your heirs. However, if the sale of the home realizes more than the loan balance after selling expenses, you (or your heirs) keep the remainder of the proceeds.

In general, you have one year from the time the loan becomes due to sell the home or pay off the balance. This provides time to market the home or can provide your heirs the opportunity to purchase it by paying off the loan balance. However, if your objective is to pass the home along to your heirs, a reverse mortgage is probably not a good option, because the value of the property will be reduced by the amount of your reverse mortgage obligation, along with fees and interest charges.

You do not need to make any monthly payments on your reverse mortgage. However, the amount you owe at the end of the loan will increase over time. And so, the cash you receive from the final sale of your home will be less (or could be none at all) if you do not make any payments.

Having to move out of your home for more than 12 months (for example, due to illness requiring an extended stay in a nursing home) can also trigger the repayment, since it is no longer your "principal residence." This is an important factor to consider before applying for a reverse mortgage.

Money received from a reverse mortgage is tax-free. It does not affect the benefits you receive from Social Security or Medicare. It may, however, count as an asset in determining your eligibility for Medicaid, SSI and other government assistance programs, so discuss this with your counselor before you apply.

You do not receive a mortgage interest tax deduction (assuming you itemize deductions on your tax return) until the loan is settled, unless you are making payments during the life of the loan. If you have a complicated tax situation, you'll want to discuss this with a tax advisor.

You are not restricted in how you use the money from any of the most popular reverse mortgage programs. You can use it to fund long-term care insurance, make repairs or additions that make your home more "aging-friendly," or anything from general living expenses to a trip around the world. It's your decision. However, since it affects your financial future, you should make this decision only after careful consideration and discussion with a knowledgeable advisor. (See "Be careful how you use the proceeds of that reverse mortgage.")

For example, some unscrupulous marketers of financial products have been pushing reverse mortgages as a way to fund investment vehicles, like annuities. This is not a good idea. If you want monthly income like an annuity, you can arrange to get monthly payments of your proceeds from a reverse mortgage, so taking on the added expense of buying an annuity doesn't make much sense.

And, because a reverse mortgage has high interest rates and fees, you will probably not realize more in an investment without taking on high risk, so this is not a good reason to take out a reverse mortgage. Remember, when you take out a reverse mortgage, you're giving away some or all of the home equity you've built up over the years. For many people, this is their most valuable financial asset, and once it's gone ... it's gone.

Am I qualified?

To qualify for a reverse mortgage, you must meet these requirements:

• You must be at least 62 years old; if more than one owner is on the title, they must each be at least 62 years old.
  

• You must have at least some equity in your home. You can qualify even if you have an outstanding mortgage, but you must completely pay off your balance. You can do this from the proceeds of your reverse mortgage loan.
  

• The home must be your principal residence. Single-family homes and many condominiums, townhouses and manufactured homes are eligible; mobile homes and co-ops generally are not.

Unlike the more common type of "forward" mortgage you're probably familiar with, there are no credit requirements for obtaining a reverse mortgage. The loan is based on the value of your home, not your ability to pay it back from other assets or income. You may, however, be required to make repairs and upgrades to your home to bring it up to code before you can get a reverse mortgage. If these repairs are too costly, you might want to reconsider applying for the loan.

How big a loan can I get?

The amount you can borrow will be less than the market value of your home. The size of the loan you will qualify for depends on several factors — the equity you have in your home, its market value and the area you live in, prevailing interest rates and your age at the time you take out the loan. (The younger you are when you take out the loan, the less money you will be able to borrow and the more interest you will have to pay over the life of the loan. So, don't enter into one of these loans until you really need the money.)

You can get a rough estimate of the amount you'd qualify for by using the National Reverse Mortgage Lenders Association online calculator at http:// www.revmort.com/nrmla/index.asp.

There are three types of government loans that are widely offered, and each has somewhat different interest rates and amounts you can borrow. Your counselor should be able to explain the details. In addition, there are also private lending programs, which generally have lower upfront costs but are more expensive in the long run, due to higher interest rates. You'll probably want to check out the federally insured programs offered through HUD and Fannie Mae before considering a private loan option. Private mortgage companies and banks offer the federally insured loans.

Some states and localities offer reverse mortgage loan programs. These typically are restricted to use for home maintenance or property tax payment. These are generally the lowest-cost reverse mortgages available. They usually have very low (or no) fees and the interest rates are often quite low. If your needs fit with the provisions of these programs, they may be a good option to consider.

A costly loan program

When you close on a reverse mortgage, you pay some of the same fees you would pay on a regular mortgage, including loan origination fees, appraisal, mortgage registration tax, premium mortgage insurance, etc.. However, these fees and the interest rates on the loan are generally higher than those of other mortgages. (Fees can add about 7% of a loan's value, according to a study by AARP.)

If you don't want to pay these expenses out of pocket, you can finance them as part of the loan. However, they will increase the ultimate payment when the loan comes due.

For this reason, reverse mortgages are very expensive in the early years of the loan. A bill introduced in the previous U.S. Congress session (H.R. 1852: "Expanding American Homeownership Act of 2007") could, in the future, result in lowering some of the up-front fees as well as increasing the number of eligible loans under the HUD-insured program.

As things stand now, you should not consider a reverse mortgage if you are planning on selling your home in the near future, because you will have paid a lot of loan expenses up front. In that situation, you'll be better off financially if you sell your home without having a reverse mortgage on it.

Interest rates are based on different benchmarks, depending on which loan program you are considering. Interest rates adjust, either monthly or annually, so that can significantly affect the amount due at the end of your loan. Over the course of several years, fees and interest can actually exceed the amount of the loan proceeds.

Other options, like a home equity line of credit (HELOC), might provide the funds you need. So, be sure to discuss this option with your financial advisor when you are considering a reverse mortgage. Reverse mortgages will likely continue to grow in Minnesota, because home appreciation has been relatively high and property taxes have increased, sometimes beyond some people's ability to pay them.

(POSTED: March 2, 2008)