Reverse Mortgages – What should you know before applying?

The number of reverse mortgages backed by the government jumped nearly 20 percent in March and April alone from the same period in 2008. At a time when seniors have seen their retirement assets depleted by market losses, tapping their home equity has become an attractive but potentially risky option. A reverse mortgage can turn your home equity into tax-free cash without forcing you to move or make a monthly payment. This can be a worthwhile financial tool if used in the right situations. If not, you can end up with serious complications to your financial future.

A reverse mortgage gets its name because of the way it works. Instead of the borrower making payments to the lender, the lender releases equity to the borrower in a number of forms, including:
- A lump sum cash payment;
- A monthly cash payment;
- A line of credit;
- Some combination of the above.

To qualify for a reverse mortgage a borrower generally needs to own a home, reside in it as their principal residence, be at least 62 years of age, and have significant equity in the home. When the owner dies or moves away, the house can be sold, the loan paid off and any remaining equity value can go to the living owner or the borrower’s designated heirs. Heirs don’t have to sell the house. They can either pay off the reverse mortgage with their own funds or refinance the outstanding loan balance within a certain amount of time after the owner dies or moves away.

There are three basic types of reverse mortgages:
- Single-purpose reverse mortgages, which are offered by some state and local government agencies and nonprofit organizations;
- Home Equity Conversion Mortgages (HECMs) are federally insured reversed mortgages backed by the U. S. Department of Housing and Urban Development (HUD);
- Proprietary reverse mortgages are private loans that are backed by the companies that develop them.

The size of a reverse mortgage is determined by the borrower's age, the interest rate and the home's value. In general, older borrowers can borrow more but the amounts are capped by the maximum Federal Housing Administration (FHA) loan limit for each city and county.

Reverse mortgages have traditionally been chosen by older Americans who can’t cover everyday living expenses or who otherwise need cash for such things as long-term care premiums, home healthcare services or home improvements. Reverse mortgages have also been used to pay off a current mortgage or credit card debts. More recently, though, they’ve become popular with individuals who see them as a better alternative to home equity lines.

Here are some of the other things to consider:

- Reverse mortgages can be complex and risky: Borrowers should consider discussing the appropriateness of a reverse mortgage given their current financial situation and the other options available to them before applying for a reverse mortgage. Borrowers of HECMs are required to consult with a counselor from a HUD approved agency before they are granted this loan.

- Cost can be substantial: Reverse mortgages are generally more expensive than traditional mortgages and home equity lines of credit in terms of origination fees, closing costs and other charges. The basic FHA-backed HECM loan finances these fees into the initial loan balance but they can run between $12,000 - $20,000 dollars. The loans are based on anticipated home value appreciation of 4 percent a year, so if the housing market is healthy, those costs are generally recovered in a short period of time. But if the housing market sours, it will definitely take longer to recoup those fees.

- Borrowers need to make sure they are not jeopardizing their Federal retirement benefits: The basic FHA HECM is designed as tax-free income to the senior receiving their Social Security income. However, if a borrower’s total liquid assets exceed allowable federal limits, the borrower’s federal retirement benefits may be negatively impacted.

- Interest Rates can be higher: Reverse mortgages have rates that are typically higher than those charged on conventional mortgages. Interest is charged on the outstanding balance and added to the amount they owe each month.

- The mortgage can be called: The homeowner or estate always retains title to the home, however, the lender can declare the mortgage due or reduce the amount of monthly cash advances to pay those overdue amounts if the borrower fails to pay the property taxes on the home, fails to adequately maintain the home, fails to pay the home insurance premiums, or changes their primary residence.

- Estate Planning Implications: Repayment of a reverse mortgage will impact the borrower’s estate and potentially reduce the asset being passed on to the borrower’s heirs. It is important to factor in the potential effects of a reverse mortgage on the borrower’s estate plan to ensure that the borrower’s estate planning goals are met.