Reverse mortgages aren't for everyone

After her husband died, Ernestine Boach felt she needed financial guidance. It was 2003, and Boach had just turned 62. An adviser urged her to take out a reverse mortgage, available mainly to those 62 and older, and use the money to buy deferred annuities.

"He told me that he had a wonderful deal for me," she says.

It turned out to be a huge mistake. Boach wasn't well-suited for a reverse mortgage, which is a loan against home equity that doesn't have to be repaid until the owner dies or sells the home. The estate repays the loan, plus interest and fees. The home is typically sold to make the payment.

But Boach had planned to leave her home to her daughter.

"It's in a trust for her, and I was assured that the home was going to be saved," says Boach, who is now 66 and lives in San Diego.

Reverse mortgages represent a small fraction of the mortgage market. But they're growing fast because of a tantalizing advantage: They let seniors with small nest eggs tap equity in their homes for cash, without having to repay the loans as long as they stay in the homes. As the oldest baby boomers turn 62 this year, they're likely to face high-pressure pitches for reverse mortgages.

As Boach learned, it isn't always a wise idea, especially during the early retirement years. There are other ways to draw income out of a home, such as a home equity loan, that are cheaper and more flexible, experts say.

The amount you can borrow in a reverse mortgage hinges on your age, the home value and interest rates. The older you are, the more you can borrow. Yet the average age of borrowers is falling.

"It's a generational shift," says John Rother, policy director at AARP. "Our parents' generation saw the home as a bedrock of security, and it was a good deal to pay off the mortgage and own it free and clear. Many boomers, on the other hand, are treating the home as a financial asset and are using it to borrow against its value."

Meg Burns, director of the Federal Housing Administration's Single Family Program Development, notes that "as the boomers come of age, they'll be thinking about their home as an asset in their portfolio" that can help ensure a comfortable retirement.

The FHA's reverse-mortgage program, called the Home Equity Conversion Mortgage (HECM), is federally insured and is the most popular type. Those considering a loan that isn't federally insured should be sure they're working with a strong financial institution with a solid track record, says Peter Bell, president of National Reverse Mortgage Lenders Association.

Some reverse mortgages are now available for second homes. World Alliance Financial has introduced Simple60, for those as young as 60. The FHA's federally insured reverse mortgages aren't available for anyone under 62.

The reasons younger retirees might need a reverse mortgage vary. John Dull, now 66, retired in 1995 when his company was downsizing and he'd had some health problems. Since then, Dull and his wife have been relying on his pension and Social Security benefits. But their bills have been rising while their income hasn't.

"We had some debt to clear up and some improvements to make on the house," Dull says.

Still, reverse mortgages tend to be costlier than other home loans. The FHA's loan typically charges an original fee of 2% of the home value and a mortgage insurance premium of 2%. There are title searches, appraisals and other costs, too.

Say, for example, a 62-year-old Michigan woman with a home value of $250,000 applies for an FHA "HECM 100" loan. The total fees and costs would be $11,410. So the loan amount that the borrower is qualified for, $127,556, would be reduced to $116,147, according to World Alliance Financial, a provider of the HECM and other reverse mortgages.

"The fees are kind of high," John Dull says.

But the couple went ahead with the loan because they felt they had no better option for tapping money. "The advantage of the loan outweighs the disadvantages," he says.

Two years ago, William Mansfield considered a reverse mortgage when he needed to fix a summer house on Block Island, R.I. "We had to do extensive renovation," he says. "We were trying to figure out how we might pay for it."

Mansfield waited until his wife, Kit, turned 62. (The FHA requires that both spouses be at least 62.) Before consumers can apply for the FHA's reverse-mortgage program, they must consult an independent counselor. Based on the advice they received, the Mansfields decided against a reverse mortgage.

In part, the high cost deterred them. They also realized that if they took the loan, the 200-year-old home wouldn't stay in the family after they died.

Others start looking toward a reverse mortgage even before they turn 62. Joe Higginbotham, 56, says he's considering one even though he won't qualify for six years. Higginbotham, who retired from International Paper in 1997 after being hurt in an auto accident, moved near Grand Junction, Colo. He's drawn to the idea that a reverse mortgage could let him borrow money and stay at home.

"It's a great thing," he says. "There are no payments. You still own (your home), and you can still live in it until the day you die. And you can do whatever you want to with the money."

Reverse mortgages traditionally have been used by older retirees to pay health care bills. But younger people tend to use the money to pay off credit card debt or pay down their mortgage, according to the AARP national survey.

Affluent borrowers, meantime, often consider a reverse mortgage to buy a second home, Bell says. And others take one out even if they don't need money right away. Some of them, Burns says, worry that their car could break down or their house will need a new roof.

Those may be good reasons for taking out a reverse mortgage. But one thing has caused much concern: Too often, retirees are urged to use the loan to take out a deferred annuity, which typically provides high commissions to salespeople.

And deferred annuities "are almost always inappropriate for seniors, as they can tie up retirement savings far beyond one's life expectancy," Sen. Herb Kohl, D-Wis., said during a recent congressional hearing on reverse mortgages.

Single women — who account for about 45% of reverse-mortgage borrowers, according to the AARP survey — may be particularly susceptible to such advice. Ernestine Boach says her adviser recommended a reverse mortgage and high-cost annuities. Though she underwent credit counseling before she applied for the reverse mortgage, she says her adviser told her it was just a formality.

"He told me not to listen to that, because they don't know what my financial adviser is doing with the money," she says.

To keep her home, she took out a home loan for $140,000 and used it to pay off the reverse mortgage. To do so, she had to cash in the deferred annuities, which caused her to be slammed with high surrender charges. On top of having home mortgage bills to pay, she says, her credit card debt has hit $10,000.

Boach feels embarrassed by the whole situation.

"I was naïve," she says. "I still am. I don't understand all these policies. But I hope this story helps somebody else."