The first part of the above title is the clear consensus of personal finance experts, while the second part represents my own two cents. Allow me to explain.

As a result of both the credit and economic crises, the financial situations for many retirees has become increasingly precarious. The stock market is recovering, but still remains well below its peak in 2008. Meanwhile, the worsening employment picture, combined with stagnating wages, have forced those nearing retirement to dip into their savings accounts. Even worse, many of these borrowers have been unable or unwilling to pay down their mortgages, carrying a significant debt burden well into retirement.

The statistics speak for themselves: “In 1992, 18% of Americans age 65 to 74 had housing debt, according to government data compiled by the Employee Benefit Research Institute. By 2004, that percentage had risen to 32%. And in 2007 — the most recent year available — 43% of 65- to 74-year-olds had a mortgage. The levels of debt have also risen. In 1992, the median amount of housing debt carried by those age 65 to 74 was $24,609; 15 years later, the median amount owed was $69,000.”

The results of this trend, unfortunately, also speak for themselves. “Americans 55 and older have been the largest age group to file for bankruptcy recently, accounting for 23  percent of the more than 1 million filings in 2007, according to AARP. Older seniors are even more vulnerable, with bankruptcy more than quadrupling for those from 75 to 84.” It’s not difficult to connect the dots. Making mortgage payments without a steady source of income is a recipe for disaster. This is especially true in the current lending environment, where banks are increasingly hesitant to facilitate refinancing because falling home values are eroding borrowers’ equity positions.

There is also a common-sense argument for paying down your mortgage early rather than investing it via a retirement account: “In the current environment, your mortgage provides a better return on your money than other risk-free assets. ‘It is unlikely that many retired households will be able to earn a return on risk-free investments, such as bank certificates of deposit, Treasury bills and Treasury bonds, that will exceed the cost of their mortgage.’

For homeowners that qualify, there is an alternative: a reverse mortgage. Reverse mortgages have gotten a bad rap recently, from no less than the comptroller of the currency, who compared them to subprime mortgages. While certainly subject to abuse and scams, reverse mortgages can nonetheless provide a valuable benefit if utilized properly, by enabling borrowers to “extract cash from their home and still live in it.” I’ve explained how reverse mortgages work in previous posts, so suffice it to say that this product will only become more popular as desperate retirees run out of other options.

In a recent speech and accompanying press release, Comptroller of the Currency (”OCC”), John C. Dugan, warned the public about reverse mortgages: “While reverse mortgages can provide real benefits, they also have some of the same characteristics as the riskiest types of subprime mortgages — and that should set off alarm bells.”

Given that reverse mortgages have exploded and are now growing at a record pace (perhaps the only mortgage product for which there is increased demand) due to the economic downturn, increased attention from regulators was inevitable.[Chart below courtesy of WSJ].

As with traditional mortgages, reverse mortgages have been fraught with abuses, such that the drawbacks are de-emphasized, and many mortgagers don’t fully understand the terms of what they are getting themselves into.

Let’s review the basics: “Reverse mortgages or Home Equity Conversion Mortgages (HECM) are designed for mature Americans over the age of 62 to use their current homes as collateral for a home equity loan. Instead of receiving a loan and having to pay it back within a certain time frame a reverse mortgage pays the borrower for staying in their home…A reverse mortgages gives borrowers the ability to either receive monthly payments to help with their current monthly income; a lump sum to pay-off bills and possibly their current mortgage; draw a line of credit for as needed money; or a combination of all three.”

In theory, reverse mortgages represent a great way for those approaching retirement (or already retired) to tap into the equity of their home, minus the loan amortization. Of course, the loan must ultimately be repaid when the mortgager moves or passes away. While there is little or no risk of bank foreclosure (only in the event of extreme disrepair), there remains the risk of foreclosure precipitated by failure to pay property taxes. However, this risk exists even in the absence of a reverse mortgage, and I don’t personally think it represents a consideration.

The main concerns are twofold: upfront fees and conditional mortgaging. First, since the nature of the reverse mortgage is such that the mortgager never pays the bank directly, there is the tendency to overlook large upfront fees, which are simply rolled into the mortgage. The FHA, which insures 90% of reverse mortgages, has\ attempted to crack down on this abuse by imposing fee cap- both a fixed $6,000 cap, and as a percentage of the total loan value.

Second, many reverse mortgages are being marketed in conjunction with other products, such as annuities. In some cases, seniors are encouraged to sign up for additional services; in other cases, they are a condition (i.e. compulsory) of receiving the mortgage. According to the OCC, “With access to large lump sums upon closing, elderly borrowers can be particularly vulnerable to coercive sales of annuity and long-term care insurance products that are expensive and may not be appropriate to their needs.”

Still, that’s not to say that reverse mortgages are inherently harmful. As with most financial products, they are advantageous for some, and inappropriate for others. Generally speaking, for those with little savings (a common phenomenon in the wake of the stock market correction) and/or outstanding mortgages, a reverse mortgage represents a reasonable way to stay in your current home. Of course the adage that “There is no such thing as a free lunch” still applies, since you implicitly forfeit most of the equity in your home.