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Are Reverse Mortgages Easy Money or Just a Dumb Move?

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Reverse Mortgages
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By Shelly K. Schwartz, special to CNBC.com

Faced with rising medical expenses and longer life expectancies, many seniors are turning to their single largest asset as a source of supplemental income: their home.

Indeed, reverse mortgages enable seniors who are 62 and older to convert a portion of the equity in their home into cash without having to sell.

As the name implies, such loans are structured as the mirror image of a regular mortgage. The lender makes payments to you in either a lump-sum amount or in monthly installments based on a percentage of your home's appraised value. Eligible homeowners can also set up a reverse mortgage as a line of credit, providing access to emergency funds on an as-needed basis.

The money received can be used to pay off your existing mortgage loan and halt your monthly payment, supplement your retirement income, finance a home-improvement project or pay for health care costs.

And the balance, including interest and financed closing costs, need not be repaid until you sell your home, no longer use it as your primary residence or pass away. Another perk? Proceeds are generally tax-free.

Yet such loans, while potentially solving a host of problems for retirees who are house-rich but cash-poor, also come with some pretty significant risks.

"Reverse mortgages are a useful tool for some people," said Lori Trawinski, senior strategic policy advisor with the AARP Public Policy Institute. "They can enable retirees to age in place, but we always emphasize that these are loans, and as such, borrowers have obligations."

Among those obligations, borrowers must stay current on their property taxes, homeowners insurance and any homeowner's association dues and assessments. They must also keep their home well maintained. Failure to comply can send the loan into default and result in a foreclosure, according to Trawinski.

The amount you owe on a reverse mortgage also grows over time.

Interest is charged on the outstanding balance and added to the amount owed every month.
Thus, your total debt increases as the loan funds are advanced to you and interest on the loan accrues.

That means fewer assets left in your estate to pass along to your heirs, which may not matter if you don't intend to preserve your assets for future generations, said Marla Mason, a certified financial planner and vice president of Presidential Brokerage.

"If you plan to live out your life in your house and you don't care about leaving a legacy behind, the reverse mortgage is a very valid option," she said.

However, Mason explained, these loans come with a lot of fees.

The maximum origination fee allowed for a federally insured reverse mortgage, formerly called a Home Equity Conversion Mortgage, or HECM, is 2 percent of the initial $200,000 of the home's value and 1 percent of the remaining value, with a cap of $6,000, according to the National Reverse Mortgage Lenders Association.

You will also owe a mortgage insurance premium fee based on the amount of funds withdrawn during the initial year. That fee is 0.50 percent of the appraised value of the home if you take no more than 60 percent of the amount available in the first year, and 2.5 percent if you take more than 60 percent of the available amount. On a $200,000 home, 2.5 percent amounts to $5,000, and 0.50 percent is $1,000.

You will also owe a mortgage insurance premium annually, which accrues over time when the balance comes due. The annual premium is equal to 1.25 percent of the outstanding loan balance.

There are also appraisal fees, which vary by region but average around $450. If the appraiser determines that your house requires repairs, you will be required to complete the repairs as a condition of approval, as well.

Finally, there are closing costs, which are comparable to those of any mortgage loan and often amount to about $1,000. Some lenders will also charge a $35 monthly service fee for the life of the loan, but most have dropped that fee, according to Trawinski.

"These loans can be expensive," she said, noting it all depends upon how much you borrow initially.
"If you take out a lot of money upfront and exit the home in a very short period of time, it can be a very expensive way to borrow money.

"But if you borrow less and stay longer, the costs amortize over time, so it's comparatively less costly," she added.

Reverse mortgage loans come in three flavors: single-purpose reverse mortgages, which are offered by some states, local government agencies and nonprofit organizations; federally insured reverse mortgages; and proprietary reverse mortgages, which are private loans backed by the companies that develop them.

According to the Federal Trade Commission, single-purpose reverse mortgages are the least expensive option, but they're not available everywhere and can be used for only one purpose, which is specified by the lender. The lender might indicate, for example, that the money can only be used to pay for home repairs, improvements or property taxes.

HECMs and proprietary reverse mortgages can be more expensive than traditional home loans, and the upfront costs can be high.

The amount of equity you can borrow in a reverse mortgage depends on your age; the type of reverse mortgage you select, such as lump sum, monthly payments or line of credit; and current interest rates. In general, the older you are, the more equity you have in your home and the less you owe on it, the more money you can take out, according to the FTC.

Other Sources of Cash

Before taking out a reverse mortgage, homeowners should consider alternatives, said Sean Keating, a certified financial planner and principal and founder at Patriot Financial Advisors. (All borrowers, in fact, must complete government-approved counseling before they can qualify for a HECM loan.)

For those with the means to pay off a home-improvement project or pricey dream vacation over the course of a few years, it's generally less expensive to take out a home-equity loan, which involves only an appraisal fee and closing costs and does not deplete the value of your estate. The interest you pay is also generally tax deductible.

Seniors who assume a regular home-equity loan, however, must be prepared to make monthly payments until the loan is repaid.They should also be aware that failure to meet their home-equity loan obligations could result in the loss of their home.

Cash-strapped homeowners who are using a reverse mortgage as a last-ditch effort to hang on to their home should also think twice, Keating said.

When an older couple cannot afford to live in the home anymore, getting a reverse mortgage will only delay the loss of the house and will leave them with no assets.

"When an older couple cannot afford to live in the home anymore, getting a reverse mortgage will only delay the loss of the house and will leave them with no assets," he said.

Better to sell the house and downsize, move in with a family member, take on a roommate or explore whether one of your adult children might be willing to purchase the family house through an installment sale, Keating added.

"The kids may not have a lump-sum payment to buy the house outright, but by making monthly installment payments, their parents get to stay in the home, collect a monthly income and the kids eventually own the house so it preserves that asset for the next generation," he said.

Well-heeled homeowners with a highly appreciated home may benefit the most from a reverse mortgage, according to Keating.

Rather than using bond ladders to create consistent income -- a strategy in which bonds' maturity dates are evenly spaced to enhance liquidity -- they can instead keep more of their money in higher-growth equities and use a reverse mortgage line of credit for living expenses during the months or years when the market is down. A more aggressive equity allocation also protects against longevity risk or the chance of outliving your savings.

"That way, you're not pressured to sell in a down market," said Keating, noting such strategy only works for homeowners with enough equity to cover one or two years' worth of living expenses if necessary. "When the market rebounds, you can take out the amount of money you were expected to withdraw from your stock portfolio and pay back the reverse mortgage loan."

Many state and local governments also offer low-interest and low-cost deferred-payment loans for improving or repairing your home that function like a reverse mortgage.

When mining your home for money, be aware of the fees you'll pay, the impact on your estate and any alternatives that might be a better bet. At the end of the day, the math must make sense.

"For people who have a need for cash, reverse mortgages can be a useful way to access funds without having to sell their home," Trawinski said. "But you are also spending down your equity, and the balance of your loan continues to grow, so it's a good idea to think about alternative programs and sources of cash."


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16 Comments

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Dan

Too complicated. I'm suspicious. It's a shame some older people are in bad financial shape and will go along with this. Bankers trying to be helpful to seniors? Hmmmm.

March 24 2014 at 4:46 PM Report abuse rate up rate down Reply
marty

One thing to remember...1) Both parents need to be on the loan, so if one dies, the other lives in it until death. If there is a remarriage, they need to add that person...do the research...it is a good thing, but must be researched and understood...stop the negative...it is a good thing...

March 24 2014 at 2:59 PM Report abuse +1 rate up rate down Reply
marty

I have researched this at great length...this is an excellent option for seniors who want to stay in their home, have the funds to pay insurance and taxes and keep up repairs annually...it means 1) they have no more mortgage payments, 2) they have a wonderful home they love, 3) they do not leave anything to heirs-because they need it to live, 4) they leave something to heirs if they pass within a couple years, as the heirs can sell it, pay off mortgage and keep it, but my question is why? It was the parents to start with, they earned and paid, so let the kids do their thing..parents MUST prepare for the future and it is an excellent way to do so. 5) The fees are a bit higher, but, the positives outweigh the negatives and the objective is acheived, 6) You will be dead when it comes due as you cannot outlive the loan...7) Your heirs have a choice-a let them have it, or acquire new loan, or pay it off if they want,8)You in the meantime are releived of the stress of meeting a big mortgage payment, 9) Do your research..it is a good thing...!!!

March 24 2014 at 2:56 PM Report abuse +1 rate up rate down Reply
RMS

For me it makes sense. No heirs to worry about. It frees up the equity in the home without having to sell it or take a loan that requires monthly payments.

March 24 2014 at 2:08 PM Report abuse +2 rate up rate down Reply
drmike15

Reagan, who was responsible for deregulating the banks in the 1980s (and thus the Great Recession of 2008), was behind Reverse Mortgages. That's all you should need to know.

March 24 2014 at 1:26 PM Report abuse -1 rate up rate down Reply
2 replies to drmike15's comment
marty

Thank goodness he did so for seniors....who can now have a great future living in their own home..

March 24 2014 at 2:58 PM Report abuse rate up rate down Reply
Brett

You are right, it is a good thing

March 24 2014 at 4:33 PM Report abuse +1 rate up rate down Reply
Judith

If your kids (or whomever your heirs might be) are okay with the reverse mortgage then go for it. Mine were - and when it comes time to repay (after I'm deceased) they all agreed to just let the bank have the condo because none of them want to live in it or go to the bother of renting it out. However, there could be one problem - you absolutely must make sure that you supply the mortgage company with proof of insurance every year and proof that you've paid your real estate taxes every year. Unfortunately, some senior citizens don't really understand that not complying will cause them to lose their house. So, they ignore the reminders/requests from the mortgage company because it really can be a pain to send copies of current insurance coverage and tax receipts every year. My neighbor was one of them - she lost her condo and ended up in a nursing home at the age of 69 after having had a reverse mortgage for only three years. She had no children and her handicapped niece (her only heir) was not in a position to take her in.

March 24 2014 at 1:05 PM Report abuse +1 rate up rate down Reply
elowery715

Reverse mortgages are a very good product for the right people in the right circumstances. Unfortunately in the mortgage business there are some who are more interested in lining their commission pockets then in doing whats right for the customer. Their is nothing wrong with the product the issue is some greedy people and that can be very dangerous to the elderly.

March 24 2014 at 11:26 AM Report abuse +4 rate up rate down Reply
Scottilla

Reverse mortgages are just another way for banks to steal your house. Yes, the heirs can choose to pay off the mortgage and keep the house, but presumably, if there was any money there, the parents would never have mortgaged the house in the first place.

March 24 2014 at 11:13 AM Report abuse +9 rate up rate down Reply
Joey

Just another SCAM on the elderly.

March 24 2014 at 9:44 AM Report abuse +10 rate up rate down Reply
2 replies to Joey's comment
cmck004

You obviously do not understand the HECM nor the elderly.
Its ok you are not alone

March 24 2014 at 10:16 AM Report abuse -4 rate up rate down Reply
ocbrog

I have been working with reverse mortgages for 8 years and can tell you they are not a scam. They have changed the lives of hundreds of thousands of seniors. Whether it's to get rid of a mortgage and free up money or to take trips and buy new car, it's up to them and it's their money. People like you that have no idea what they are talking about and just throw stupid statements out there like they have clue, have hurt many seniors that should have gotten a reverse mortgage but were afraid to because they heard negative things from the uneducated. Anyone that wants the real truth about how they work can email me for honest answers. ocbrog@aol.com

March 24 2014 at 2:36 PM Report abuse -2 rate up rate down Reply
3 replies to ocbrog's comment