Reverse Home Mortgage: Risks vs. Rewards

There is an increasing trend among senior citizens in need of money for their rising health care and prescription drug costs — taking out a reverse mortgage or in essence, getting paid by their home. According to the National Reverse Mortgage Lenders Association, the number of reverse mortgages insured by the U.S. Department of Housing and Urban Development (representing 90 percent of all such loans) has surged from 157 in 1990 to more than 107,558 in 2007, with a forecast of more than 200,000 this year. The reason? More than 12.5 million seniors over the age of 65 own their homes free and clear, and are sitting on more than $4 trillion in home equity — money which many need to put toward their daily living and medical expenses.

Mellody, can you help us understand how a reverse mortgage works? How is it different from a traditional mortgage or home equity loan?

A reverse mortgage is exactly what it sounds like — it is the opposite of a traditional mortgage. With a traditional mortgage, you borrow money from a bank to purchase a home and then repay this loan with interest over time. A home equity loan is similar, except you are borrowing against the equity you have built up in your home and repaying that amount with interest over a specific period of time. When applying for both a mortgage and a home equity loan, there are income thresholds to ensure that you can repay whatever you are borrowing.

Conversely, with a reverse mortgage, there are no income requirements, and the lender essentially pays you to live in your home. Specifically, the equity you have built up in your home can be paid back to you in one of the following ways: a single lump sum of cash; a regular payout as long as you live in the home; a credit line to be accessed when you need it; or a combination of these options. And, you do not have to repay any of this money until the last borrower dies, sells the home or moves away permanently. The money you receive from a reverse mortgage can be used for anything, including daily living expenses, medical bills, prescription costs and even home repairs.

Can anyone qualify for a reverse mortgage? What are the costs?

To qualify for a reverse mortgage, you must own your home and be at least 62 years old. The amount you can borrow depends upon your age, how much your home is worth and current interest rates. Additionally, you must meet the following qualifications:

Your home must be your primary residence

You must have paid off your entire loan or have significant equity built up that your mortgage balance can be paid off with a small portion of the reverse mortgage

Your home must be in structurally good condition and free of major problems such as termite damage or roof leaks

In terms of costs, this is where it can get a little tricky. Costs mirror those of typical closing costs on a traditional mortgage and include title insurance, origination and appraisal fees as well as other costs. On average, it might cost $8,000 or $9,000 for a $150,000 loan. Keep in mind, these expenses can be rolled into the amount you receive from the reverse mortgage, so having this cash up front is not necessary.

This all sounds great. Are there any downsides?

There are a few key downsides to keep in mind when considering a reverse mortgage. In addition to the costs I just mentioned, taking advantage of a reverse mortgage may affect your eligibility for state and federal government assistance programs, such as Medicaid. Also, once you begin withdrawing equity from your home, there will be less money left over once the home is sold and the loan is repaid — meaning less money to pass along to your heirs.

Should seniors be watchful about anything when considering a lender for their reverse mortgage?

Unfortunately, the answer is yes. Cash-strapped seniors are likely targets for predatory lenders and brokers who may try to steer them into loan products which generate significant costs for the borrower (and profits for the lender or broker). While counseling on the pros and cons of a reverse mortgage is a requirement for federally insured loans — which account for the majority of loans today — it is not always adequate. If you are wondering whether a reverse mortgage is a good choice for you, try to do as much research on your own about the available options. You also may want to enlist the help of a trusted friend or family member who can help you sift through your finances as well as the details of any potential loan.

So, would you recommend reverse mortgages to seniors?

It really depends on your personal situation. The Federal Trade Commission puts it best — a reverse mortgage is for those who are house rich, but cash poor. Reverse mortgages can provide a great safety net, but it is important to have a long-term plan in place before making any decisions. One of the most important benefits of a reverse mortgage is that the lender cannot remove homeowners from their homes as long as they stay current with their property taxes, insurance and home maintenance. This fact alone can provide important security to many seniors. That said, a reverse mortgage is not necessarily a panacea. And if you live in an area where the housing market is relatively stable (versus depressed), don't forget to consider selling your home and downsizing to a smaller home as an option.