Know the Facts Before Jumping into a Reverse Mortgage

December 14, 2012

Most people understand the basic premise behind a reverse mortgage: It allows you to convert part of the equity in your home into cash without having to sell your home or pay monthly mortgage payments.

You can see how a reverse mortgage might be beneficial to cash-strapped retirees who are trying to remain in their home.

But that doesn’t answer the question the former stars ask in the television commercials: “Is a reverse mortgage right for you?”

Reverse mortgages generally are available to homeowners age 62 or older. In a reverse mortgage, you receive money from the lender and usually don’t have to repay it as long as you live in your home.

The loan must be repaid upon one of the following events:

• When you die
• When you sell your home
• When your home is no longer your primary residence

There are three types of reverse mortgages:

1. Single-purpose, offered by some state and local government agencies and nonprofit organizations

2. Federally insured, known as Home Equity Conversion Mortgages (HECMs) and backed by the U.S. Department of Housing and Urban Development

3. Proprietary, offered as private loans backed by the companies that develop them

Single-purpose reverse mortgages are the least expensive option. But they are not available everywhere and can be used for only one purpose, which is specified by the government or nonprofit lender. Most homeowners with low or moderate income can qualify for these loans.

HECMs and proprietary reverse mortgages may be more expensive than traditional home loans. In particular, upfront costs can be significantly higher.

HECM loans are widely available and have no income or medical requirements. The proceeds can be used for any purpose. But using the proceeds from a reverse mortgage for investment purposes is generally not recommended because the investment would have to earn more than the cost of the loan.

The amount you can borrow depends on several factors, including your age, the type of reverse mortgage you select, the appraised value of your home and current interest rates.

The Home Equity Conversion Mortgage lets you choose among several payment options:

• Term – Fixed monthly cash advances for a specific time
• Tenure – Fixed monthly cash advances for as long as you live in your home
• Line of credit – An option that lets you draw down the loan proceeds at any time in amounts you choose until you have used up the line of credit
• Combination – An option that combines monthly payments and a line of credit

For a small fee, you can change your payment option.

HECMs generally offer a lower total cost compared with proprietary loans. But if you own a higher-valued home, you may get a larger loan advance from a proprietary reverse mortgage.

Reverse mortgage loan advances are not taxable, and they do not affect your Social Security or Medicare benefits. You retain the title to your home, and you do not have to make any monthly repayments.

Remember: The loan must be repaid when the last surviving borrower dies, sells the home or no longer lives in the home as a principal residence. In the HECM program, a borrower can live in a nursing home or other medical facility for up to 12 consecutive months before the loan must be repaid.

If you are considering a reverse mortgage, here are some things to consider:

• Lenders generally charge an origination fee, a mortgage insurance premium (for federally insured HECMs) and other closing costs. Lenders also may charge servicing fees during the term of the loan. The lender sometimes sets these fees and costs, although origination fees – but not interest rates and other fees – for HECMs currently are dictated by law.
• The amount you owe grows over time. The origination fee, along with the loan interest, is added to the outstanding balance. That means you are being charged interest on the loan principal, the origination fee and the accrued interest.
• Although some reverse mortgages have fixed rates, most have variable rates that are likely to rise in the long term, given that interest rates are currently near historic lows.
• A reverse mortgage can deplete the equity in your home, leaving fewer assets for you and your heirs. Most reverse mortgages have a nonrecourse clause, which prevents you from owing more than the value of your home when it is sold. However, if your heirs want to retain ownership of the home, they usually must repay the loan in full – even if the equity is negative.
• Because you retain title to your home, you are responsible for property taxes, insurance, utilities, fuel, maintenance and other expenses. Failure to pay property taxes, carry homeowner’s insurance or maintain the condition of your home may cause your loan to become due and payable.
• Interest on a reverse mortgage is not tax-deductible until you actually make payments on the loan.

If you are considering a reverse mortgage, shop around. Compare your options and the terms various lenders offer.

Learn as much as you can before you talk to a counselor or lender. A little research can help inform the questions you ask and could lead to a better deal.