Article:
Living on the house
Would a reverse mortgage make sense for you someday?
Original location:
http://www.consumerreports.org/cro/money/retirement-planning/reverse-
mortgages-4-08/overview/reverse-mortgages-ov.htm
Consumer Reports
By Consumer Reports Money Adviser
Published: April, 2008
Anyone who's at least 62, has significant equity in a home, and has a mortgage that's paid up (or nearly so) probably knows by now that they're eligible for a reverse mortgage. The loans are widely promoted in mail solicitations and TV ads featuring such celebrities as James Garner, Robert Wagner, and Pat Boone. The promos tout the potential advantages of reverse mortgages to older homeowners and invite them to call for more information.
Once they do, they'll learn that reverse mortgages are complex and expensive. For some eligible homeowners, the loans are a costly means of tapping cash that could be accessed more prudently some other way. For others--especially financially distressed homeowners in their 60s--a reverse mortgage will ease their money troubles in the short run but could leave them in even worse shape when the cash runs out. And perhaps worst of all, critics charge, some reverse-mortgage providers are using hard-sell or deceptive techniques to pressure seniors into taking out loans they don't need.
But for people in their 70s whose other assets are dwindling or who face long-term care or medical costs beyond their means, a reverse mortgage could be a solution. "Reverse mortgages provide a promising way to convert home-equity savings into cash," says John Rother, AARP's director of policy and strategy. But "high costs and abusive marketing practices" by some lenders must be addressed, he adds.
Reverse mortgages are quite complicated, with different types offering an array of rates and terms. This guide should leave you a bit less overwhelmed by the decision, though no less bombarded by the ads.
How They Work
With a reverse mortgage, homeowners borrow part of the equity they have in their property, and the principal and accrued interest are repaid only after they die or move out. Over time the owner's equity diminishes while the amount of the loan increases--the opposite of a traditional mortgage. Unless you fall behind on taxes or allow the house to slip into disrepair, the lender can't foreclose on the property, even if you live many years beyond expectations and the size of the debt surpasses the value of the house itself. In most cases, the proceeds of a reverse mortgage can be taken in a lump sum, an open line of credit, or as monthly payments.
Though reverse mortgages have been available for more than 25 years, they've become more widespread recently. In fiscal 2007, the Department of Housing and Urban Development insured upward of 100,000 reverse mortgages, compared with less than 7,000 in 2000. HUD, through its many authorized lenders, is by far the largest reverse-mortgage provider, with almost 90 percent of the market.
Several factors have fueled that growth. For one thing, older long-time homeowners have a tremendous amount of home equity, thanks to the run-up in property values over the last few decades and the fact that they've paid down or paid off their mortgages. On average, the home equity in a household headed by someone 62 or older was $230,000 in the first quarter of 2007, compared with $126,000 for the same period in 2000, according to Hollister Group, a risk-management consulting company.
Moreover, as average life expectancy continues to rise, older folks need more money than before to get through their retirement years. And they may be less concerned about passing on large sums to their children, who are often middle-aged and financially settled by the time of their parents' deaths.
"The combination of today's real-estate and aging trends makes the reverse mortgage a desirable alternative to cashing out your property without having to move out of your home," says Marc Louargand, principal at Saltash Partners, an investment company, and president of the American Real Estate Society.
Types of Reverse Mortgages
The most prevalent reverse mortgage is HUD's Home Equity Conversion Mortgage. Under the HECM program, the size of the loan is determined by the homeowner's age, the current interest rate, other loan fees, and the appraised value of the property up to the Federal Housing Administration's mortgage limits for the area where the home is situated. FHA limits on single-family homes range from $200,160 in small metropolitan areas like Baton Rouge, La., and Rapid City, S.D., to $362,790 in San Francisco and New York City, among other high-priced locations.
The lending formula is drawn from actuarial and compound-interest tables, among other factors. HUD estimates that on a loan with a 9 percent interest rate, a 65-year-old could borrow about 22 percent of the home's value, a 75-year-old up to 41 percent, and an 85-year-old about 58 percent. (The National Reverse Mortgage Lenders Association's reverse-mortgage calculator can help you to figure out about how much you might be eligible to borrow.)
Interest rates on HECMs have traditionally been linked to the 1-year Constant Maturity Treasury rate, which was 3.26 percent in December 2007. For monthly adjustable-rate loans, HUD lenders generally tack about 1 to 1.5 percent onto that rate, a surcharge called a margin. Over the life of the loan, interest-rate resets are capped at 10 points. Annual adjustable reverse mortgages are also available. Slightly more expensive, they have a margin of about 3 percent over the CMT and can be raised or lowered by 2 percent each year, with a lifetime cap of 5 percent.
Recently some HUD lenders have introduced new versions of the loan that are tied to the London Interbank Offered Rate, a common adjustable-mortgage benchmark that tends to have fewer wide swings than the CMT. But the LIBOR was at 4.41 percent in early January, and lenders usually add a margin of 0.65 to 1 percent. Interest rates on CMT-based loans now have lower initial rates than LIBOR-based loans.
Fixed-rate reverse mortgages are currently available with reasonably low rates of about 6 percent. But there's a catch: You must take your money as one up-front payment. So unless you need the full loan amount immediately, these mortgages might not be the best option.
One nice feature of HECM loans is that the unused available balance will increase in value by the loan's interest rate. This is an advantage to borrowers who take their equity out over a long period of time.
Larger Loans are Available
For homeowners whose equity exceeds the FHA's mortgage limits, Fannie Mae offers the Home Keeper reverse mortgage, which tops out at $417,000. The monthly adjustable Home Keeper differs from HECM in several critical ways. It is linked to a weekly average of one-month CD rates, which was 4.4 percent in January 2008. And the margins on these loans can be as high as 3.4 percent--in all a pricey deal. Moreover, the lifetime interest-rate cap on Home Keeper is 12 percent, and untouched balances do not appreciate.
But you can use Home Keeper proceeds to purchase a more expensive home. For example, suppose a 75-year-old man sells his home in the Rust Belt for $200,000 and wants to buy a condo in Florida for $250,000. To avoid a mortgage, which at his age would be difficult to obtain or pay back, he could buy the property with his cash on hand and a $50,000 Home Keeper reverse mortgage on the condo.
Most reverse-mortgage companies that offer HUD and Fannie Mae products also offer proprietary jumbo loans for people with homes worth more than $417,000. Freed from federal-agency limitations, jumbo reverse mortgages are the go-go face of the business, with fixed-rate, monthly, and semi-annual adjustable programs, some with introductory discounts on rates and fees. These loans are linked to the pricier LIBOR indexes and generally carry margins of more than 3 percent.
Fees Pile Up
As with other mortgages, many extra fees are tacked on to a reverse loan at the closing. First there are the usual culprits: third-party charges for title searches and insurance, credit reports, recording documents, surveys, appraisals, couriers, and inspections. Those costs can total $3,000 or more. The origination fee, which pays the lender for setting up the loan, can be as high as 2 percent of the mortgage, or more than $7,000 for a maximum HUD loan and possibly double or triple that for a jumbo loan. The lender will probably add a loan-servicing fee of $30 or so a month.
HECMs carry a significant additional cost: FHA mortgage insurance to pay the lender the difference if the value of the loan exceeds the value of the property. This is a set fee of 2 percent of either the home's appraised value or HUD's mortgage maximum for the area, if that figure is lower ($7,000 for a $362,790 mortgage) and 0.5 percent on the loan balance each year (if you withdraw $50,000 of your credit line, this would come to $250 per year). While jumbo and Fannie Mae loans do not require mortgage insurance, their interest rate tends to be higher to make up for the additional risk.
All of those fees, which are generally subtracted from the available balance and are not tax deductible, may add another $15,000 to the cost of the loan. Indeed, because of the substantial up-front costs, you should not even contemplate a reverse mortgage if there is any possibility that you may move out of your home in a few years.
Ideal candidates for reverse mortgages are homeowners in their mid-70s whose home equity is significant and greatly outweighs their remaining savings. In other words, it should be a last resort. As fast as compound interest accrues--borrowing $150,000 at 6 percent annually will eat up a total of $272,000 of your home equity in a decade--it is likely that taking out a reverse mortgage means shedding ownership of your home forever.
Weigh Other Options
If you're younger--say, in your 60s--and facing financial difficulties, you should probably avoid taking out a reverse mortgage. Odds are that such a loan would quickly swallow your credit line and sacrifice your home equity without being a long-term solution to your problems.
If you can afford the monthly payments, a home-equity loan is a less drastic alternative. Or perhaps a family member could fund a personal reverse mortgage, in which he or she covers living expenses in exchange for a fair amount of equity in your house paid back when you die. Another option is to sell the home and use some of the proceeds to buy a smaller, cheaper one.
To avoid making a grievous mistake, talk first with a reverse-mortgage counselor (HUD maintains a list of agencies it has approved for housing counseling). He or she will explain how the loan works, what the impact would be on your future finances, and alternative sources of money. HUD requires such counseling for an HECM loan, but it is not mandatory for other types of reverse mortgages.
Finding an honest reverse-mortgage lender is critical. Before doing business with any company, make sure that it is a member of the National Reverse Mortgage Lenders Association and that it adheres to its code of conduct. Also check with your local Better Business Bureau for complaints against lenders. Compare the interest rates and terms offered by two or three reverse-mortgage lenders in your area. And most important, take your time before choosing a mortgage or a lender. If buying a house was the biggest financial decision in your life up until now, then mortgaging it back to the bank shouldn't be a smaller one.
Watch Out for Sneaky Sales Tactics
Consumer advocates and lawmakers are concerned about reports of high-pressure sales tactics aimed at elderly homeowners to persuade them to take out reverse mortgages and use the proceeds to buy annuities, long-term-care insurance, and other financial products.
"We are now seeing insurance brokers actively recruiting insurance agents to promote reverse mortgages at senior centers," said Prescott Cole, speaking for CEASE, the Coalition to End Elder Financial Abuse, in testimony before the Senate Special Committee on Aging in December 2007. "Some brokers are even offering to help insurance agents become HUD-certified counselors. They are instructing the agents that they can ethically get the senior to pull out home equity in order to buy insurance products."
Mary Munoz knows the dangers of reverse mortgages. The 80-year-old Los Angeles woman says she was pressured by a lender into taking out a $209,000 reverse mortgage on her ranch house and then using the money to buy two annuities totaling $80,000, the larger of which had a 20 percent penalty for withdrawals during the first 10 years.
"She didn't need the reverse mortgage or the annuity," says Ingrid Evans, her San Francisco-based attorney "She just wanted a little cash to fix her porch." Munoz is suing the lender in what Evans hopes will become class-action litigation.
AARP warns older homeowners against taking a reverse mortgage to get money to invest. "It is extremely unlikely that you can safely earn more from an investment than the loan would cost," the group says in its online guide to reverse mortgages.
