By Lew Sichelman
Last Update: 7:19 PM ET Jan 5, 2006
WASHINGTON (MarketWatch) -- One issue on people's minds: Does it make sense to take out a reverse mortgage to help pay expenses?
I am writing you for your thoughts about reverse mortgages. We have been thinking about this for some time and would like your input. I am 75 and my wife is 71, and it galls me that we are still writing a check to the bank every month for $700. We owe about $100,000 on a property that is worth $600,000-$700,000. Mel.
Answer: I have been a fan of reverse mortgages for years, ever since my aunt and uncle passed away and I found out they were living in virtual poverty so they could leave something behind for me and their other nieces and nephews. It was nice to inherit some money, but I didn't need it, and I would have rather seen them live out their remaining years in comfort.
For the uninitiated, reverse mortgages are loans that allow owners 62 or older to unlock the equity they have built up in their homes without being forced to sell and move out. Many seniors are house rich but cash poor. In other words, they are living on fixed incomes or have no income at all. All their wealth is "paper wealth" that is tied up in their homes. But by borrowing against that equity, they can have money to live on, pay their bills and enjoy the rest of their lives.
It is called a reverse mortgage because instead of the borrower paying the bank, the bank pays the borrower. You can take your equity as a lump sum, as a line of credit to be used when needed, in the form of monthly payments or in any combination of those three.
There basically are two sources of reverse mortgages -- Uncle Sam and Fannie Mae. Neither makes the loans directly -- local lenders do that -- but they are instrumental in the marketplace. The Federal Housing Administration insures the loans against default, and Fannie Mae buys loans from lenders and sells them to investors worldwide.
A third source, Freedom Financial of Irvine, Calif., offers a "jumbo" reverse mortgage, generally on properties worth more than $500,000.
To date, the FHA's Home Equity Conversion Mortgage, or HECM, has proven more popular than Fannie Mae's HomeKeeper largely because the former allows you to take a larger percentage of your equity. But in both cases, the amount you ultimately receive is based on the value of your property, its location, your age and your spouse's and your life expectancy, and, of course, interest rates at the time you apply.
The National Reverse Mortgage Lenders Association has an excellent calculator on its Web site, www.reversemortgage.org, that will help you get an idea of how much you can borrow. NRMLA also has a number of consumer booklets that will help answer a lot of questions. Check out the calculator.
HECMs account for about 90% of all reverse mortgages and in fiscal 2005, for the fifth consecutive year, lenders wrote more federally insured reverse loans than in the previous year. Also, a record number of loans are in the pipeline. A recent poll of the nation's top three reverse mortgage lenders -- Financial Freedom, Seattle Mortgage Co. and Wells Fargo Home Mortgage -- found a 56% increase in applications in process compared to the same time last year.
About the only things holding the product back are a congressional ceiling on the number of loans and a lack of counselors to help folks through the loan process. But both problems are being solved. Legislation is moving through Congress that would eliminate the 250,000-loan cap, and the Department of Housing and Urban Development is working to build a network of counselors who can discuss the pros and cons of reverse mortgages with potential borrowers.
Counseling is mandatory. Before an application can be processed, you must meet with an independent counselor. Both HUD and AARP oversee a network of counselors whose job is to review the transaction, answer questions and suggest alternatives.
But NRMLA President Peter Bell says there aren't enough to handle the volume. In many parts of the country, he says, it can take from four weeks to six weeks "or longer" to meet with someone who's certified. But HUD recently added the National Foundation for Consumer Credit to its network of counselors, which should help break up the logjam.
One of the knocks on reverse mortgages is that they are expensive, at least compared with conventional home loans. But a closer look at the details shows that is really not the case.
For starters, there is 2% mortgage-insurance premium. Other borrowers pay a premium, too, but in the case of the reverse mortgage, the charge is "front-loaded" and must be paid at closing.
Then there's the lender's origination fee, which is capped at 2% of the value of the house or the maximum FHA loan amount for your area, whichever is less. A 2% origination fee is high, but if you are in an area where lenders are competing for your business, it could be less. Of course, there are other charges for a title search, appraisal, document preparation and the like. But they, too, are normal.
Reverse mortgage lenders also can set aside up to $35 a month as a servicing fee. All lenders charge a servicing fee to collect your payments and pay your property taxes and insurance. But in the case of traditional mortgages, the fee is included as part of the interest rate, so borrowers don't realize they are paying it.
In the case of a reverse mortgage, though, the total amount is calculated based on the expected life of the loan. The total servicing fee is set aside, and the lender dispenses a portion to itself for each month the loan is in force. If you should die or move out of the house before the servicing set-aside is exhausted, what's left is distributed to your estate.
You don't have to own your house free-and-clear to obtain a reverse mortgage. But the reverse mortgage must be your primary lien, so part of the proceeds from the loan will be used to pay off what you owe on your first mortgage. This, too, reduces the amount you'll receive.
But one of the main reasons people take out a reverse mortgage is to get rid of their monthly payment. Other popular uses: daily living expenses, home repairs or modifications and health-care expenses.
If you take the entire amount of your reverse mortgage in a lump sum, you get what you get and that's it. If you take it as a line of credit, the proceeds will be there for you as you need until they are exhausted. If you take monthly payments, you can opt for a set term or for life-tenure, meaning you will be paid each and every month for as long as you live, even if you outlive your life expectancy. Your payoff will be different for each option, so consider them wisely and carefully.
Whatever option you choose, the loan need not be paid back until you die or move out of the house permanently. The loan is paid from the proceeds of the sale of the house or from the proceeds of refinancing by your heirs if they want to keep the place, or from any other source for that matter.
If the house is sold, whatever money left after paying off the reverse mortgage is distributed to you or your heirs. If you owe more than the place is worth, too bad for the lender. The repayment amount can never exceed the value of the house, so, in effect, a reverse mortgage is a non-recourse loan. And it can be paid off at anytime before you die or move out without penalty.
Also, the lender does not get to participate in the appreciation that occurs after you take out the mortgage. In some earlier types of reverse loans, a senior could give up a percentage of the future value of the house in exchange for a larger payoff. But no product in the marketplace today has a shared-appreciation feature. So, if you borrow $200,000 on a place that's now worth $400,000 but is valued at $600,000 when you die, all you owe is $200,000 plus accrued interest and your estate gets the rest.
The drawbacks? Twofold, as I can see them.
One is that you are spending down your estate. You may have nothing left to leave your kids or grandkids. But at least you won't be a drain on them as you live out your golden years.
The other is that if you change your mind and decide -- or are forced -- to leave your nest sooner rather than later for whatever reason, you will have lost all your upfront costs.
Nationally syndicated columnist Lew Sichelman has been covering the housing market for 35 years. Because of the volume of mail he receives, he cannot answer individual questions, nor can all questions be answered in this space. E-mail lsichelman@aol.com