This article was updated on April 27, 2010.
Patti Andersen was 62 years old and broke when she buried her mom. After several years of working only part-time while taking care of her ailing parents, Andersen had more than $40,000 in debt — and was fast falling further behind.
She had one asset: the expansive Los Angeles home that she'd recently inherited. The home was paid off, but was in need of repair. Then someone told her about reverse mortgages. "It was a godsend," said Andersen, who is now in her early 70s. "I'm in such a wonderful space. I feel like I've won the lottery."
If you're of the right age, short on cash, and sitting on hundreds of thousands of dollars (or more) in home equity, reverse mortgages can be a sweet deal. The government-sponsored products allow seniors — those over the age of 62 — to tap the equity in their homes while still living in them. Essentially, your mortgage pays you, rather than the other way around, and you don't repay the loan until the sale of your house — either when you move or after your death.
Better yet, reverse mortgages have become considerably cheaper over the past year because a litany of big lenders, including Bank of America and Wells Fargo, have waived upfront origination fees which traditionally cost as much as $6000.
But these loans aren't sure things. They can be expensive, and they're sure to affect your estate planning. Here are six questions you need to ask yourself before determining whether a reverse mortgage is right for you.
1. How much home equity do you have?
If the answer isn’t “lots,” start looking at other options. You need lots of equity before a reverse mortgage makes sense — partly because the fees and charges assessed on the loans are going to eat up as much as 10 percent of the amount you get (more on that later). Know, too, that you can’t borrow all of your equity.
Currently, so-called HECM reverse mortgages — the most common and safest reverse loans, because they’re governed by rules dictated by the Department of Housing and Urban Development — base your loan amount on a maximum home value of $625,500. You’ll get a portion of that amount, based on your age and going interest rates when you apply.
2. How old are you?
You have to be at least 62 to qualify — but the younger (and healthier) you are, the better deal a reverse mortgage becomes. That’s because these loans have high upfront costs. If you only have the loan outstanding for a couple of years, those costs can be exorbitant. But if, like Andersen, you expect to have decades to live and “plan to die in this home,” the benefits start to outweigh the costs.}
3. Do your kids want your house?
When you die, the reverse mortgage must be repaid either by your heirs or from the sale of your house. If your heirs don’t care about keeping the home, you’ve got no worries — the government ensures that the loan amount can be repaid by selling the home, even if the home is worth less than the loan amount. But if your heirs want to keep the house, it’s a different story, said Peter Bell, president of the National Reverse Mortgage Lenders Association in Washington. In that case, they’d have to pay the loan amount — even if it's more than the value of the home. So if your kids want to keep the house, consider other options, like having them buy the house from you — either at a reduced price or over time.
4. How much cash do you need?
- An immediate, lump-sum payout of the whole amount available
- A line of credit, which is a lump sum that you don’t tap until you need it
- Monthly annuity payments for life
- Some combination of these three other options.
You get four basic options when applying for a reverse mortgage:
The amount you’d get with each of those options will vary with age and interest rates; you can get a good guesstimate by using the online calculator at reversemortgage.org. But to give you an idea: A 65-year-old with a paid-off home worth $625,500 could get a lump sum or line of credit of about $254,985, or could choose to get $1,673 per month for the rest of her life at today’s market interest rates. When she dies or sells the house, she’ll owe the bank the amount of her disbursements, plus the interest — up to the value of the home.
5. How bad are your financial problems?
Be wary if you’re not absolutely sure that the funds you’re getting from the reverse mortgage will be sufficient to solve your current economic woes. According to Bell, reverse mortgages are perfect for people who are house-rich and cash-poor — but not so cash-poor that the reverse mortgage can’t resolve the problem.
In Andersen’s case, for example, the loan paid off her credit cards, with plenty left over to fund home repairs well into the future. The rest of her expenses are covered by Social Security and some part-time income. If your problems aren’t as easily solved, you might need another option. A reverse mortgage is going to give you access to just a portion of your equity. If you need it all, you might be better off selling and finding cheaper housing.
6. Can you handle the costs?
Most reverse mortgages are insured by the federal government; the policy ensures that the lender won’t lose money — and you won’t get kicked out of the house — if the house’s value drops below your equity level. But to cover the insurance, these loans come with an upfront premium payment of 2 percent of the home value used to fund the loan. (For instance: Your home may be worth $1 million, but the maximum value that they’ll calculate a reverse mortgage against is now $625,500; the insurance fee on that would be $12,510.) In addition, lenders are allowed to charge up to $6,000 in origination fees. These are the fees that an increasing number of lenders are waiving now, though, so be sure to shop around. There are other closing costs for appraisals and title insurance.
NRMLA, which advocates the loans, estimates that a loan that pays you $300,000 today could cost you $29,000 in fees. (That doesn’t include interest.) That said, if you shop around, you’ll get a better deal. The insurance premium is standard and not negotiable, but the rest of the fees vary from lender to lender.
HUD requires that reverse mortgage borrowers get counseling from an authorized housing counselor and will provide you with a list of half a dozen names when you apply. These counselors will go through your finances and your other options, to make sure the reverse mortgage is a good fit. (To some degree, they’re going to run through what we’ve talked about here — but they’ll do it putting your specific budget and mortgage numbers into the calculations.) Bell suggests that you take the counseling seriously and carefully weigh your options before you jump.
For more information, check out the MoneyWatch reverse mortgage resource guide.