Reverse Mortgages Demystified

If you are among the 18 million homeowners who are 65 or older, your equity in your home is likely your largest financial asset. A reverse mortgage is a way to turn home equity into cash. These days, seniors are signing up for reverse mortgage loans in record numbers, partly because today's low interest rates translate to greater loan advances. Yet these complex loans often carry high costs, and they are considered by many financial planners to be a last resort for getting cash.

The Fundamentals
Reverse mortgages are adjustable-rate home loans that are not required to be repaid until the borrower dies, moves out, sells, or fails to comply with loan agreements (covering upkeep, taxes, insurance, etc.), whichever comes first. The amount you can borrow depends on your age and the value of your home. With a reverse mortgage you and your heirs will never owe more than the home's value.

As a borrower, you must be at least 62 years old, and if your spouse co-owns your home, then you both must be 62 or older. You may have an existing (but small) mortgage on your home. You can take your loan proceeds in three ways:

• a lump-sum amount;
• a series of monthly payments for a specified period or for as long as you (and your spouse) live in your home; or
• a credit line, which you may draw on when you need funds.

Income Taxes
The money you receive from a reverse mortgage is considered a non-taxable loan. You can deduct the interest on a reverse mortgage when you actually pay it, that is, when the loan is paid off. Since reverse mortgages are home equity loans, you can deduct interest only for loan amounts up to $100,000. Thus, if the loan balance is more than $100,000 when the mortgage is paid off, not all of interest will be deductible.

Public Benefits
In general, money received from a reverse mortgage is not counted by Medi-Cal (Medicaid) and Supplemental Security Income (SSI) as income in the month it is received. However, if the money is not spent, it will count as an asset in subsequent months. If you hope to use Medi-Cal or SSI benefits, you should consult with an elder law attorney or other professional  who knows these programs' rules before obtaining a reverse mortgage.

Beware of High Upfront Costs
Compared to conventional home loans, reverse mortgages carry high upfront costs. With the possible exception of an application fee, you won't need to provide cash to pay these costs when you obtain the mortgage, but they become part of your loan balance and accrue interest. The high initial costs make reverse mortgages prohibitively expensive for the short term user; however, if you stay in your home for many years after you've obtained the mortgage, the upfront costs become less of a factor.

Here's a hypothetical (but realistic) example calculated by the non-profit National Center for Home Equity Conversion and shown on AARP's web site on reverse mortgages. A single woman, age 75, obtains a $150,000 federally-insured reverse mortgage on her home, financing her $6,500 in upfront costs as part of the loan. She begins taking monthly advances of $562 that will continue as long as she lives in the home. Her home appreciates at 4% per year.

If this reverse mortgage is paid off two years later, the loan's effective interest cost is a whopping 49.5%! This is because the upfront costs ($6,500) and accrued interest are high relative to the amount of advances she receives over two years ($13,488). If she stays in her home and receives the monthly advances for 12 years ($80,928 in total), then the effective cost is a more reasonable 10.8%.

Single-Purpose Loan Programs

There are other, fairly simple ways to obtain cash flow assistance for specific costs such as property taxes or home improvements and repairs. You may find it best to start with these programs. Consider California’s Property Tax Postponement program. If you are a homeowner with annual household income of $24,000 or less and otherwise qualify for this program, the State will pay your annual property taxes. When your home is eventually sold, the State will be reimbursed for the property taxes paid plus interest at a relatively modest rate. More information is available by calling (800) 952-5661 or visiting http://www.sco.ca.gov/col/taxinfo/ptp/geninfo/index.shtml Other help may be available for home repairs and improvements, depending on the programs available in your local area. Contact your Area Agency on Aging and ask for more information. You can find the nearest AAA by calling (800) 677-1116 or by accessing the eldercare locator site at http://www.eldercare.gov and entering your state and zip.

Federally-Insured Mortgages
A reverse mortgage insured by the Department of Housing and Urban Development (HUD) is in most cases the best choice if you need more money than you can borrow under a single-purpose loan program (see box). A federally-insured reverse mortgage is called a Home Equity Conversion Mortgage (HECM).

With HECMs, you choose from a list of HUD-approved lenders. You pay mortgage insurance premiums both in your startup costs and in a slightly higher interest rate. The insurance guarantees that the loan advances will continue, even if your lender goes bankrupt or your home's value drops.

HECMs have another unique feature - the unused credit line portion of your loan grows each year at the same interest rate as does the loan balance. For that reason, seriously consider including a credit line in your HECM, leaving most or all of it unused so that it may grow. Proprietary mortgages also have credit lines, but with fixed limits.

Although HECM loans are  standardized in certain respects, there can be very significant cost differences among HECM loans. The differences are primarily in the loan origination fees, where lenders make most of their profits. Other expenses, including insurance premiums, interest rates, closing and loan servicing costs, are fairly standard, according to AARP. By shopping around, you should be able to find a HECM whose total upfront costs, mortgage insurance premium included, are less than 5%.

Proprietary Mortgages
Often offered by the same lenders who offer HECMs, proprietary reverse mortgages are usually more costly. Among these loans is Fannie Mae's Home Keeper Reverse Mortgage. A shareholder-owned agency, Fannie Mae does not originate mortgages, but purchases them - both the HECM and proprietary versions - from originating lenders. According to an analysis by AARP, the Home Keeper is usually a more expensive reverse mortgage than a HECM, and in some cases much more expensive.

Proprietary products may work well for people whose home is valuable and who want to borrow more than they can get from a HECM, where mortgage amounts are limited by each local county's median home value. If the loan amount you are seeking is within the HECM limits, AARP says use the HECM.

Get Thee to a Counselor
Whether you should obtain a reverse mortgage may not be a simple question, even aside from its financial aspects. If you do decide to acquire one, then you need to evaluate more than a single product.

Lenders are required to provide you a Total Annual Loan Cost analysis, showing a mortgage's total costs at three intervals. While helpful, a TALC analysis may not be enough, mainly because it shows limited information that may not apply either to your expected mortgage duration or to your selected payment options.

HECMs require that you talk with a HUD-approved counselor (at no cost to you). Call HUD's Counseling Clearinghouse at (800) 569-4287 to find an approved counseling agency. Or go to the list of HUD-approved counselors in California at www.hud.gov/offices/hsg/sfh/hecm/hecmlist.cfm

Not all HUD-approved counselors offer reverse-mortgage guidance. Find an agency that provides HECM counseling. If you don't find this help on your own, HECM lenders are required to refer you to a HUD-approved counselor before they close the loan.

For its Home Keeper loans, Fannie Mae also requires counseling, which can be done by HUD-approved counselors as well as by other entities. Fannie Mae also asks that the counseling include a comparison of its Home Keeper product with a HECM.

If you feel you need more help than you've received from a HUD-approved counselor, who may not have the time to help you compare several products, you may want to hire someone. Possibly your CPA or a financial planner can do this for you, or can recommend an independent expert who may have software designed to compare reverse mortgages. Although you may pay $150-$250 for this service, your money is well spent if it results in a greater payout and more economical terms.

Words for the Wise Think a reverse mortgage makes sense for you? Note these precautions, before you commit: Seek reverse-mortgage counseling from an independent HUD-approved expert - not from a counselor affiliated with a bank or lender. To help you analyze offers, you might also consider hiring a financial planner or CPA who’s not affiliated with lenders - particularly if you need a more detailed analysis than a HUD-approved counselor has time to give you. A reverse mortgage is very expensive if you must move out of your home within the first five years. This makes them more risky for people needing in-home care. If their health condition requires a move to assisted living or a nursing home, the reverse mortgage stops making advances and the loan must be repaid. In most cases, stay away from reverse mortgages with equity-appreciation and equity-share provisions, which will give you slightly higher advances but can wind up costing you or your heirs much more money. Look at more than one loan. Before you sign a mortgage contract, a lender must give you a Total Annual Loan Cost projection. TALCs help you to compare mortgage costs. Use them. Even after you’ve signed a reverse-mortgage agreement, you have a three-day period during which you can void the agreement. Do not pay anyone, including an estate-planning firm, referral fees for finding you a lender or arranging for you to secure a reverse mortgage. HUD provides names of its approved lenders at no cost, and the lenders will guide you (again, at no cost) through the application and approval process. Other than to pay off your existing home mortgage, make sure none of your loan proceeds is going to someone else or some other entity as a disguised referral fee or kickback. Get a solid, independent second opinion before you use a reverse mortgage to purchase an annuity or insurance policy. Lenders who encourage you to do this end up making money on the loan and on the sale of the annuity or policy.

Finding a Lender
HUD provides a list of its approved mortgage lenders at http://www.hud.gov/offices/hsg/sfh/hecm/rmtopten.cfm

Other Resources
In our view, the most complete consumer information on reverse mortgages is from AARP (http://www.aarp.org/revmort/home.html). Obtain a copy of AARP's free 68-page booklet Home Made Money by downloading it, ordering it online or calling (800) 209-8085. The AARP web site also gives you a basic method for comparing reverse mortgages and provides an online calculator that estimates how much you can borrow.

Also read the 59-page Consumers Union report There's No Place Like Home: The Implications of Reverse Mortgages on Seniors in California. This report has excellent consumer tips, and is available at http://www.consumersunion.org/finance/revpresswc899.htm