Loans That Can Turn Your Home into a Cash Flow
If you’re a homeowner who’s thinking about retirement, you may have considered that at a certain age you’ll sell your home and move someplace cheaper, using the difference to make ends meet. After all, your home is probably your most valuable asset, and the revenue sources you will have when you stop working – Social Security, pension (if you’re lucky enough to have one), savings and investments – may not be enough to pay your bills and fund your retirement dreams.

But there’s another way to tap the equity in your home: a reverse mortgage. These loans, which are just starting to become widely known, allow you to borrow substantial amounts of money against the equity in your home. But unlike conventional home equity loans and mortgages, a reverse mortgage does not have to be paid back until you die, sell the home or move away permanently. And you don't need an income or other assets to qualify for a reverse mortgage.

Reverse mortgages are available to homeowners aged 62 and older whose residence is fully or nearly paid off. The loans can be obtained on single-family homes, condominiums and multi-family homes of up to four units. A borrower must occupy the home or one of the units as a primary residence for at least six months per year.

Reverse mortgages enable homeowners to tap the equity in their homes

Money borrowed through a reverse mortgage can be taken in a lump sum, a monthly payment or a line of credit. The size of the loan depends on the homeowner's age, the home's appraised value and current interest rates Payments from a reverse mortgage are not taxable.

"Reverse mortgages have allowed people to turn their homes into a steady source of income. For people on fixed incomes especially, the cash they provide is an economic lifeline that enables them to keep their home and lead a comfortable life," says Jim Bennetts, a reverse mortgage consultant for Wells Fargo Bank in San Francisco.

Although reverse mortgages have been widely available around the country since about 1990, the loans are just starting to catch on in a big way. "Nationwide, sales of the most common type of reverse mortgage (the Federal Housing Administration-insured Home Equity Conversion Mortgage), jumped from 8,127 in 2001 to 21,636 in 2003," says Glenn Petherick, a spokesman for the National Reverse Mortgage Lenders Association. The number is expected to top 40,000 in 2004.

Petherick attributes this growth to increasing awareness of the product among seniors and their adult children, and to the rising number of lenders that are marketing reverse mortgages. Falling interest rates, which allow borrowers to qualify for larger loans, have also played a role in the past couple years.

"The financial need has also been greater than ever for many seniors," due to the rising cost of prescription drugs and other out-of-pocket expenses, and the diminished value of CDs and other fixed-income assets during a time of low interest rates," explains Petherick. "This has caused people to look to reverse mortgages as a way to get the money they need."

According to Petherick, Bay Area residents have originated the fourth-highest number of reverse mortgages in the country, trailing only Los Angeles, Santa Ana and New York City.

But reverse mortgages are not for everyone. "If you’re thinking about selling your house and moving in a few years, a reverse mortgage may not be the best choice for you," cautions Bennetts. "The fees and interest charges can make the loans expensive if they are held only for a short time. They work better as a longer term loan."

When taking out a reverse mortgage, the closing costs and other up-front fees can run into thousands of dollars. The Home Equity Conversion Mortgage, for example, carries an origination fee equal to 2 percent of the loan amount. Other up-front costs include the lender’s fee and charges for title, escrow, recoding and appraisal. However, many of these costs can be included in the loan, so borrowers often need little up-front money – perhaps only a few hundred dollars for an appraisal – to get started.

Given the fees and interest rates, some financial planners question the advantages of a reverse mortgage over alternatives like selling. But it's important to note that alternatives have costs as well - selling a home, for instance, usually involves paying a hefty broker's commission.

Because of their complexity, it is important that you consult with a legal or financial advisor – and with your heirs – before proceeding with a reverse mortgage. Potential borrowers should make sure they fully understand the loan and be certain that it will meet their needs.

More facts about reverse mortgages:

• It's important to note that the total loan payment (principal plus interest) can never exceed the home's selling price. Therefore, no borrower, or their heirs, will ever owe the lender more than the value of the house.
• When a borrower dies, the heirs can opt to pay off the loan and keep the house. Or, they can sell the house, pay the lender and keep the difference.
• Once the home is sold, any money remaining after the debt is paid goes to the homeowner or heirs.
• The maximum loan amount is set when the loan is granted and is based on interest rates at that time. This makes it worth looking at reverse mortgages while rates are low, you can lock in the large loan amount. That figure will stay the same even though the interest rate will be adjusted in the future.
• Future rate changes will have no effect on the amount you borrow, regardless of whether you take a lump sum, monthly income or credit line. However, rate changes will determine how much interest debt accumulates.
• Three reverse mortgage products are currently available. The most popular by far is the FHA-insured Home Equity Conversion Mortgage (HECM), which accounts for about 90 percent of total loans. Other options include Fannie Mae's Home Keeper and the Financial Freedom Cash Account, which is only available in about half of U.S. states.
• Reverse mortgage lenders (usually a bank or mortgage company) are required to comply with the federal Truth in Lending Act, which means they must disclose loan terms, the annual percentage rate, costs and payment requirements.

For more information about reverse mortgages, contact AARP at (800) 424-3410 or www.aarp.org/revmort. Other sources of information include the U.S. Department of Housing and Urban Development at (800) 217-6970 or www.hud.gov/buying/rvrsmort.cfm, and the National Reverse Mortgage Lenders Association at (866) 264-4466.or www.reversemortgage.org. A list of lenders can be obtained by calling Fannie Mae at (800) 732-6643.

(This article appeared in the Summer 2004 issue of Bay Area Summit)

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