Photo by C.J. Burton
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Found Money
By Mike Hudson, November & December 2005
Need cash? A reverse mortgage might be the answer, but make sure you know the costs
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As she speaks, Cleo Dunn tends to a vibrant splash of red-and-white Asian
lilies and peach-tinted geraniums surrounding the back patio of her house in
Leawood, Kansas, where she's lived for two decades. The home, which she
shared with her husband, Robert, until he died four years ago, has always been
her pride-and her refuge. She vowed she'd never leave it, even after she
was diagnosed with a rare spinal ailment that requires her to use a wheelchair.
And, so far, she's been able to keep that promise, thanks to a Home Equity
Conversion Mortgage (HECM), better known as a reverse mortgage. The $1,100 a
month that Dunn receives from the loan—and will continue to collect until she
dies or permanently leaves the home—not only allows her to stay put but
pays for her prescriptions and the in-home aide who comes by each morning.
"Without a reverse mortgage," says the 88-year-old Dunn, "it
would have been impossible for me to stay here."
Dunn is one of a growing number of house-rich, cash-poor Americans 62 years
of age and older who've discovered reverse mortgages, a unique financial
tool that lets them tap the equity in their homes while they're still
living in them. The longer Dunn receives the payments, the more equity she
uses. But because the loan is protected by federally sponsored mortgage
insurance, neither she nor her heirs will ever owe more than the value of the
home. Should Dunn live long enough that the monthly payments exceed the value
of her house, she doesn't have to worry. Only when she dies or moves out
does the lender have to be repaid, most likely through the sale of the
house.
If you aren't familiar with reverse mortgages, you'll almost
certainly be hearing more about them as today's hot housing market and low
interest rates continue to fuel their popularity. In 2001 only about 8,000 U.S.
homeowners used a reverse mortgage; in 2004 the number jumped to about 47,000.
And this year the National Reverse Mortgage Lenders Association expects the
number to hit 60,000. HECM loans, the only reverse mortgages insured by the
federal government, account for 90 percent of the market. Other types of
reverse mortgages are usually administered by private companies and local or
state governments.
'This cushion helps me supplement my erratic income.'
Ken Scholen, director of AARP's Reverse Mortgage Education Project, is
among a chorus of consumer experts who agree that a reverse mortgage can be a
good choice for many cash-strapped homeowners. But, he hastens to add, it's
not for everyone. Even though interest on the actual loan itself is usually
similar to interest charged on other mortgages, the up-front costs (origination
fee, mortgage-insurance premium, closing costs, and service fees) can make it
an expensive way to borrow money. "A reverse mortgage should be just one
of many options a homeowner considers," says Scholen.
How It Works
The HECM type of reverse mortgage is offered by many of the same private
lenders that provide regular, or forward, mortgages. The difference is that
instead of your making payments to the lender, the lender makes payments (or a
lump-sum payment) to you. Just as in a conventional, or forward, mortgage, a
reverse mortgage lets you borrow money using your home as collateral. But with
a conventional loan you make monthly payments to reduce the loan amount. With a
reverse mortgage the loan amount and the interest it accrues over the life of
the loan don't have to be paid back until you die or permanently leave the
home. Anything left after the loan is paid is yours or your heirs', just as
with a conventional loan. With a reverse mortgage, you still own your house; of
course, the mortgage company has a lien on it—just as with a conventional
mortgage. And you still pay insurance, taxes, and repairs.
You can take out a reverse mortgage even if your house isn't fully paid
for. But you do have to have enough equity to make the deal cost-effective.
This method served Virginia resident Ruth Hill well. The 63-year-old freelance
journalist used a reverse mortgage to pay off her conventional loan, which had
been costing her about $600 a month. "This cushion helps me supplement my
sometimes erratic income," she says.
How to Qualify
To qualify for a reverse mortgage, you must be at least 62 years of age and
own your home, and it must be your main residence. If you co-own your house
with a spouse or partner, both of you must be 62 or older. Single-family
houses, some manufactured homes, two- to four-family residences, and most
townhouses and condos qualify for a reverse mortgage. Since you aren't
making any payments, your current income or credit history does not matter,
just as long as you haven't defaulted on a federally insured loan, such as
a student loan.
The amount of money you qualify for depends on a mix of current interest
rates, your home's location and value, your age, and, of course, the equity
built up in the home. The more equity you have and the lower the interest rate
and the older you are, the more money you can get. For example, a 62-year-old
borrower who owns a $250,000 home would generally qualify for $132,700 from a
reverse mortgage at September's interest rates; a 72-year-old who owned the
same home would get about $154,500; an 82-year-old, about $178,600.
You can choose one of three ways to receive your reverse mortgage funds: in
a lump sum, monthly payments, or a line of credit. The best choice depends on
your needs. Let's take, for example, the 62-year-old borrower who's
getting a reverse mortgage on her $250,000 house. She could take the $132,700
she qualified to receive in a lump sum. Or she could opt for monthly payments
for a fixed period of time, say 10 years, which would give her about $1,470
each month. Or she might choose to take monthly payments for as long as she
lives in her home and get about $740 a month. If she chooses to access her
money through a line of credit, she can withdraw money as she needs it. The
advantage here is that she doesn't pay interest on the credit line until
she uses it. And, even better, the amount remaining available for her grows
larger each month because of a built-in hedge against inflation that is
included with this type of reverse mortgage payout.
What It Costs
Reverse mortgages come with competitive interest rates, but they also
require significant up-front fees. "That's what makes them
expensive," says Christian Sezenias, a reverse mortgage counselor with
Novadebt, a nonprofit credit and HUD-approved housing counseling agency located
in New Jersey. Consider our 82-year-old borrower. To get his $178,600, he'd
have to pay about $13,700 in up-front fees—$5,000 for the lender's
origination fee, $5,000 for mortgage insurance, and $3,700 for closing costs.
He would also have another $4,460 deducted from his available loan amount to
cover service fees. He doesn't have to pay any of these fees out of pocket,
because they are added to the loan. And the interest he pays on the fees over
the life of the loan fluctuates up or down depending on market conditions.
The fees' impact is stiffest early in the loan. If you plan to stay in
your home for only the next two or three years, paying $13,000 or more in fees
for a reverse mortgage can be a heavy price. But the longer you stay, the more
the relative cost of the fees spreads out. That's the reason lenders and
consumer advocates alike advise against getting a reverse mortgage if
you're not planning to stay in your home.
For Your Protection
The Federal Housing Administration (FHA) requires that all HECM borrowers
consult with an FHA-approved reverse mortgage counselor before they sign the
final papers. The counselor is required to explain the costs and financial
implications of the loan. "Because of this process," says Peter Bell,
president of the National Reverse Mortgage Lenders Association,
"there's a lot less room for misleading information from
lenders."
Before taking out a reverse mortgage, consumers should consider any and all
alternatives that would achieve the same purpose. For instance, there may be
grants or low-cost loans available from local and state governments or
nonprofit agencies to help you pay to fix up your house. You might also qualify
for a new conventional forward mortgage or equity loan. Another option is to
sell your house and move into a less expensive home. Say you sell your paid-for
house for $500,000 and then buy a condo for $300,000. Even after paying real
estate commissions, you could end up with about $150,000 tax- and interest-free
money. And you'd still have the option of taking out a reverse mortgage on
your new home later, if you should need it.
Regardless of how you choose to use your equity, deciding whether or not to
get a reverse mortgage could be "one of the most important financial
decisions you'll ever make," says Scholen. "So be sure it's
the right one."
Mike Hudson, an award-winning journalist, specializes in personal finance
and writes for the Los Angeles Times and other publications. He's based in
Virginia.
Additional reporting: Holly Zimmerman
To calculate what a reverse mortgage might mean to you, use AARP's online reverse mortgage calculators in English (on AARP.org) and in Spanish (on AARP Segunda Juventud Online).
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