Now the house is supporting Dorothy. The $631 monthly payment from her reverse mortgage has allowed her to remain in her home, pay for her prescription drugs and see an occasional movie. Before she received the loan two years ago, she was struggling to get by on her monthly Social Security check, her only source of income since her husband's death in 1976. "It was a blessing," she says.
A reverse mortgage allows homeowners like Rogers to earn tax-free income by tapping the equity in their homes. Unlike other kinds of home loans, the loan doesn't have to be repaid until the homeowner moves, sells the house or dies.
As the name implies, a reverse mortgage is the opposite of a traditional home mortgage. With a traditional mortgage, you borrow a specific amount and pay it back every month, gradually increasing your equity and reducing the size of your loan. With a reverse mortgage, a lender makes payments to you, based on the equity you've accumulated in your home. Over time, your equity decreases and the loan increases, although it can never exceed the value of your home.
While still only a narrow slice of the home loan market, the reverse mortgage business has skyrocketed. Financial Freedom, the USA's largest lender of reverse mortgages, says it funded about 6,000 reverse mortgages in the first six months of 2003, up 80% from the same period last year.
Analysts say the market has been helped by record low interest rates and rising home values. Lenders use three factors when calculating the size of a reverse mortgage:
•The age of the homeowner. You must be 62 or older to qualify for a reverse mortgage. If your home is jointly owned, both owners must be at least 62. The older you are, the larger the loan amount.
•The value of the home. Lenders typically require an appraisal before approving a reverse mortgage.
•Current interest rates. When lenders calculate the amount of a reverse mortgage, a portion is put aside to pay interest on the loan, and the remainder is principal. The smaller the interest portion, the larger the principal, which means more cash for the homeowner, says Bronwyn Belling, reverse mortgage specialist for the AARP Foundation.
Low interest rates and rising home values have made reverse mortgages more lucrative for homeowners, says Peter Bell, president of the National Reverse Mortgage Lenders Association. But fence sitters who are considering a reverse mortgage may not want to wait much longer. If long-term rates continue to rise, the amount of cash available to borrowers will decline. A 65-year-old borrower with a $200,000 home would receive about 15% less today than he would have gotten six weeks ago, Bell says. "If somebody is considering a reverse mortgage, now is an opportune time," he says.
Types of reverse mortgages
The most popular reverse mortgage is the Home Equity Conversion Mortgage, which is insured by the federal government. With an HECM, you'll never have to repay the loan as long as you live in your home, even if your neighborhood goes downhill, you live to be 110 or your lender encounters financial problems. The guarantee is financed by an insurance premium included in the cost of the loan.
Fees on HECMs are generally lower than on other types of reverse mortgages, Belling says. The biggest drawback is the mortgage limit, which varies depending on where you live. HECM limits range from $154,896 in rural areas to $280,749 in large cities.
Financial Freedom offers a "jumbo" reverse mortgage for qualified homeowners who want larger reverse mortgages than permitted by HECM rules. Many customers are affluent homeowners who want to postpone taking money out of retirement savings plans, says CEO Jim Mahoney.
Once you choose a reverse mortgage, you need to decide how you'll get your money. HECM borrowers have three options:
• A single lump sum.
• A credit line for a specific dollar amount that you can tap whenever you need the money.
• A monthly cash advance for a specific period of time or as long as you live in your home.
You can also choose a combination of the options. Most borrowers take part of their reverse mortgage in a lump sum and leave the rest in a credit line, Mahoney says. That strategy provides money for immediate needs, such as a new roof or credit card debt, while leaving some money available for the future, he says. The HECM credit line earns interest, creating a hedge against inflation.
Reverse caveats
For all their benefits, reverse mortgages aren't appropriate for many homeowners. Think twice about a reverse mortgage if:
• You plan to sell your home or move in the next few years. Borrowers typically pay origination fees, closing costs and, in the case of HECM loans, a mortgage insurance premium. Those fees are typically rolled into the loan amount so you don't have to pay them up front, and they help guarantee you won't have to repay the loan as long as you stay in your home. But if you plan to move in a few years, you'll end up paying for protection you don't need, Belling says.
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If you need money for a one-time expense, such as a new roof, check out local and state housing assistance programs before applying for a reverse mortgage, Belling says. Such programs are often cheaper and quicker than reverse mortgages, she says.
• Your reverse mortgage won't cover the costs of keeping your home. Reverse mortgage lenders can force repayment if you fall behind on property taxes or homeowners insurance. They can also require you to repay the loan balance if you fail to maintain your home.
• You want to leave your house to your children. The balance of your reverse mortgage must be repaid in full when you die or move out of your home. If your children want to keep the house, they'll have to repay the loan, either with their own funds or by taking out a new traditional mortgage on the home.
Consult your family before obtaining a reverse mortgage, says Nancy Flint-Budde, a financial planner in Salem, N.Y. "Make sure everybody is in agreement so there are no surprises later."
Flint-Budde recently advised an older client who was considering a reverse mortgage to sell her home to her children instead. The sale included a "life tenancy" provision that allows the woman to stay in her home until she dies, Flint-Budde says. The arrangement provided more income to the homeowner than she would have obtained through a reverse mortgage and ensured the home would remain in her family, she says.
