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Reverse
Mortgages: Proceed with Care
Whether
seeking money to pay for medical treatment, finance a home
improvement, buy long-term care insurance, or supplement their
income, many older Americans are turning to "reverse mortgages."
They allow older consumers to convert the equity in their homes
to cash while retaining home ownership.
With a "regular"
mortgage, you make monthly payments to the lender. But with a
reverse mortgage, you receive money from the lender and
generally do not have to repay it for as long as you live in
your home. In return, the lender holds some if not most or all
of your home's equity.
Introduced in
the late 1980s, reverse mortgages can help homeowners who are
"house-rich-but-cash-poor" remain in their homes and still meet
their financial obligations. The proceeds of the loan are
tax-free, there are no minimum income requirements, and for most
reverse mortgages, the money can be used for any purpose.
But, reverse
mortgages also tend to be more costly than other loans, and
there have been cases of abuse by unscrupulous lenders.
If you're
considering a reverse mortgage, it's important to understand how
the loans work and what your rights and responsibilities are.
The Basics
There
are several types of reverse mortgages:
- the
federally insured Home Equity Conversion Mortgage (HECM),
administered by the Department of Housing and Urban
Development (HUD)
-
single-purpose reverse mortgages, usually offered by state or
local government agencies for a specific reason
-
proprietary reverse mortgages, offered by banks, mortgage
companies, and other private lenders and backed by the
companies that develop them.
To qualify for a
reverse mortgage, you must be at least 62 and have paid off all
or most of your home mortgage. Income is generally not a factor,
and no medical tests or medical histories are required. If you
seek an HECM, you also must undergo free mortgage counseling
from an independent government-approved "housing agency."
Financial institutions offering proprietary reverse mortgages
may require similar counseling or homeowner education.
The amount you
can borrow depends on your age, the equity in your home, the
value of your home, and the interest rate. If it's an HECM,
federal law limits the maximum amount that can be paid out.
You can be paid
in a lump sum, in monthly advances, through a line of credit, or
a combination of all three.
Common Features
Reverse mortgages
offer special appeal to older adults because the loan advances,
which are not taxable, generally do not affect Social Security
or Medicare benefits. Depending on the plan, reverse mortgages
generally allow homeowners to retain title to their homes until
they permanently move, sell their home, die, or reach the end of
a pre-selected loan term. Generally, a move is considered
permanent when the homeowner has not lived in the home for 12
consecutive months. So, for example, a person could
live in a nursing home or other medical facility for up to 12
months before the reverse mortgage would be due.
However, be
aware that:
- Reverse mortgages tend to be
more costly than traditional loans because they are
rising-debt loans. The interest is added to the principal loan
balance each month. So, the total amount of interest owed
increases significantly with time as the interest compounds.
- Reverse mortgages use up all
or some of the equity in a home. That leaves fewer assets for
the homeowner and his or her heirs.
- Lenders generally charge
origination fees and closing costs; some charge servicing
fees. How much is up to the lender.
- Interest on reverse mortgages
is not deductible on income tax returns until the loan is paid
off in part or whole.
- Because homeowners retain
title to their home, they remain responsible for taxes,
insurance, fuel, maintenance, and other housing expenses.
Getting a Good
Deal
If you decide to
consider a reverse mortgage, shop around and compare terms. Look
at the:
- annual percentage rate (APR),
which is the yearly cost of credit.
- type of interest rate. Some
plans provide for fixed rate interest; others involve
adjustable rates that change over the loan term based on
market conditions.
- number of points (fees paid to
the lender for the loan) and other closing costs. Some lenders
may charge steep costs, which your lender may offer to
finance. However, if you agree to this, you'll take out fewer
proceeds from the loan or you'll borrow an extra amount, which
will be added to your loan balance and you'll owe more
interest at the end of the loan.
- total amount loan cost (TALC)
rates. The TALC rate is the projected annual average cost of a
reverse mortgage, including all itemized costs. It shows what
the single all-inclusive interest rate would be if the lender
could charge only interest and no fees or other costs.
- payment terms, including
acceleration clauses. They state when the lender can declare
the entire loan due immediately.
Under the
federal Truth in Lending Act, lenders must disclose these terms
and other information before you sign the loan. On plans with
adjustable rates, they must provide specific information about
the variable rate feature. On plans with credit lines, they must
inform the applicant about appraisal or credit report charges,
attorney's fees, or other costs associated with opening and
using the account. Be sure you understand these terms and costs.
Reverse
mortgages come with different provisions. For example, with some
reverse mortgages, the lender may take a share of equity
appreciation. This could create issues for the homeowner or
heirs, particularly if the value of the home rises unexpectedly
during the loan. Carefully read any provision of the contract
about shared appreciation.
Also, be
cautious about reverse mortgages offered by door-to-door and
other home solicitation lenders. There have been various
problems with these types of lenders. Some of the problems have
involved steep points and loans that primarily seek to take the
owner's equity.
You generally
have at least three business days after signing a reverse
mortgage contract to cancel it. The cancellation must be in
writing. |
