Last Updated Dec 17, 2010 9:46 AM EST
You're right to be careful about the loans. If mis-sold, they can leave you poor -- and the press tells plenty of tales about mistakes. On the other hand, the right loan at the right time can lift you out of a pinched life of living on Social Security and measly certificates of deposit.
Reverse mortgages are sold to people 62 and up. They're a loan against the equity in your house. You can take the tax-free money in a lump sum or in gradual withdrawals from a credit line -- giving you more cash to spend to enhance your life. There's no credit check and no monthly payments are due. When your house is eventually sold, the loan, plus accumulated interest, is repaid out of the proceeds. Anything left over goes to you or your heirs. If the house sells for less than the money owed, the Federal Housing Administration, which insures most loans today, swallows the loss.
Here's what today's market for reverse mortgages looks like, and reasons why you should re-consider them:
1. Save money on costs. The standard reverse mortgage is the Home Equity Conversion Loan or HECM. At full price, it's a heavy lift. You pay an origination fee that can rise to $6,000. Plus a mortgage insurance fee, generally equal to 2 percent of the home's value. Plus assorted closing costs -- title insurance, recording, appraisal, and so on. Plus a fee for servicing the loan. We're talking $15,000 to $20,000 here, upfront. The costs are tucked into your loan, so you'll owe interest on the fees as well as the loan principal. Every year, there's another insurance fee, for 1.25 percent. The loan amount grows over the years, because of the fees and the compounded interest that accumulates.
Right now, however, many lenders are waiving some of these upfront fees. That's a big savings, over the life of the loan.
On October 4, a new loan was introduced called the HECM Saver. The interest rate is a little higher, probably because the loan is new, says Peter Bell, president of the National Reverse Mortgage Lenders Association. And you also can't borrow as much with it as you can on a HECM Standard loan. But you pay less upfront for origination and insurance. The lender might even waive both those fees.
2. Save money on interest. You can get both the Standard and Saver HECMs at fixed rates or variable rates. About 70 percent of loans are at fixed rates, Bell says. Borrowers want to know exactly what they're likely to owe in the future. But these loans are running at 5 percent interest, and you have to borrow the full amount available -- even if you don't need that much.
If you choose a credit line instead, you'll get a variable rate, currently running at about 2.5 percent. The rate might go up, but you're paying interest only on the amount of the credit line you use, not the entire loan amount. It's probably cheaper in the end.
3. Consider the loan to fill short-term needs. Normally, you wouldn't consider a reverse mortgage if you expected to stay in your home for only a short time. The upfront cost is too high. But the HECM Saver is changing that story, especially when fees are waived. For example, a Saver credit line is a good way of improving your cash flow while you're waiting to sell your house. When the housing market improves, you can repay your loan and downsize into something smaller. A reverse mortgage could also help you hold off foreclosure while you find another place to live.
4. Take the loan when you're older, not at 62. The older you are, the more you can borrow. In general, it's better not to strip the equity out of your house early in retirement. Save it for later, when your other savings might be used up.
The risk of these loans is that your house might not sell for enough to pay the lender back. You'd be left with no downpayment for a smaller house or condo, or no cash to buy your way into a high-quality nursing home.
That's one of the things that worries Consumer's Union, which put out a negative report on reverse mortgages earlier this month. And there are other issues, when the loans are mis-sold.
For example, say that you live with your elderly mother and take care of her. If she gets a reverse mortgage and then dies, you won't be able to stay in the house. You might not have known about that in advance.
Or, say that you took a loan but still live on a narrow margin. Your homeowners insurance premium suddenly leaps. If you don't keep up the payments, you're in default and, potentially, can be foreclosed. The same will be true if you fall behind on your real estate taxes, too.
Some 10,000 to 20,000 loans are currently in this situation, Bell says, most owing less than $5,000. No grandmas have been turned out of their homes. But in January, they will start getting letters, saying that it's time to settle up.
When you get into a reverse mortgage, you need a plan for getting out of it with some cash intact. Borrow sparingly and be smart about when to sell. You'll need some equity to help fund the next phase of your life.
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