Reverse Mortgages Rise in Popularity; Is it Right for You?

As part of the Federal government’s plan to prop up the housing market and save the ailing economy, nearly $1 billion will be pumped a relatively obscure product known as a reverse mortgage, which allows seniors over the age of 62 to draw down the equity of their home. Under the new rule, HUD can now insure reverse mortgages up to $625,000, compared to $363,000 in 2008. Meanwhile, many states are rushing to pass similar legislation, both to make it easier for seniors to tap what for many of them is their largest source of equity, and to simultaneously prevent dishonest mortgage brokers from ripping them off in the process.

Despite superficial similarities, reverse mortgages are different from negative amortization mortgages and home equity loans, in that the loan does not necessarily need to be repaid directly by the borower, and there is no risk of foreclosure. Here’s how it works:

 ”Senior homeowners…receive proceeds from a lender — either in a lump sum, regular monthly payments, a line of credit or in a combination of those options. Interest is  charged on the amount drawn, adding to the original amount and, thus, negative amortization. The borrower makes no monthly payments and cannot owe more than the value of the  home. When the house is sold, or the last remaining borrower dies or moves out of the home, the loan amount plus the accrued interest is due and repaid.”

Since there’s no exchange of title, it is the lender who bears the greatest risk, which is that the price of the house will decline below the value of homeowner equity. For this reason, most loans are limited to 50-60% of equity.

Reverse Mortgages are slated to become increasingly popular for a couple of reasons. First of all, retirement accounts have been devastated by the credit crisis and lower stock prices. In addition, layoffs caused by the economic downturn have created massive uncertainty, especially for those on the brink of retirement. Many have turned to reverse mortgages to lower their monthly mortgage payment (this is an option for those who still havn’t paid down their original mortgages) and free up cash for healthcare expenditures, etc. The result is that, “The National Reverse Mortgage Lenders Association expects 150,000 such loans to be made this year, up 30 percent over last year.”

The main drawback is probably the high upfront costs: “Taking out a reverse mortgage entails all the closing costs — origination fee, title, appraisal and the like — of a regular mortgage, plus specific fees, such as a monthly service charge.” Not to mention the reverse mortgage insurance premiums. Fortunately, origination fees are now capped at 2%, and almost all the fees can be financed into the mortgage. Still, these costs are significant and will be reflected in the payment(s) you receive.

Another drawback is that many unscrupulous mortgage brokers require borrowers to purchase an annuity at the same time as closing on the reverse mortgage. State governments are moving to ban this “cross-selling,” but it’s still possible that you will be cajoled into it. This isn’t to say that annuities are inherently inappropriate in this situation, but it’s still important to separate them from the reverse mortgage component.

In the end, only you can decide whether a reverse mortgage is appropriate for you. For more information, check out this great guide published by the AARP.