SALEM, Ore. (CNN/Money) – "House rich, cash poor" is a common predicament for older Americans whose homes have appreciated in value while their incomes have failed to keep up with rising healthcare costs, property taxes and other living expenses.
Rather than sell their homes, many are taking out reverse mortgages, which allow homeowners age 62 and older to borrow against the equity in their homes in one lump sum, via regular monthly payments or, most commonly, with a line of credit.
Although reverse mortgages still represent a fraction of the mortgage market, the number of loans originated in 2004 was more than double what it was the previous year.
"Demand for information on reverse mortgages has increased exponentially," said Bronwyn Belling, a reverse mortgage specialist for the AARP Foundation.
The advantage of a reverse mortgage over traditional home equity loans is that borrowers don't pay principal or interest on their loans until they sell the home or pass away. The downsides are high upfront fees and compounding interest.
There are three national providers of reverse mortgages, the Federal Housing Administration, Fannie Mae and the Financial Freedom Senior Funding Corp. The most popular reverse mortgage by far is the FHA's Home Equity Conversion Mortgage (HECM).
To qualify for any kind of reverse mortgage, you must be at least 62 years old and own most of the equity in your home. Loan amounts are determined by your age, the value of your house and current interest rates.
A 75 year old with a $300,000 house could qualify for a $193,000 HECM, for example. A 65 year old with a $200,000 house could borrow about $108,000 against the house.
The FHA caps loans based on the maximum FHA mortgage limit for an area, currently $172,632 to $312,895. Fannie Mae has a slightly higher limit, while Financial Freedom loans are designed for more expensive houses and have virtually no limit.
The interest on the HECM, was recently 4.37 percent for loans adjusted monthly and 5.97 percent for loans adjusted annually, according to Peter Bell, president of the National Reverse Mortgage Lenders Association, while Fannie Mae's HomeKeeper carried an annual rate of about 5.88 percent. The Financial Freedom reverse mortgage, which is tied to the 6-month LIBOR index had a rate of 7.92 percent.
Most borrowers, said Bell, opt for a line of credit, allowing them to borrow money as they need it and pay interest only on the amount they draw down. When borrowers sell their homes or pass away, the principal and interest owed on the house is subtracted from the proceeds of the sale.
The interest can add up pretty quickly. A homeowner who borrows $100,000 from the house at today's annually-adjusted HECM rate would owe $200,000 in interest and principal on that loan 12 years from now, and that's assuming rates don't increase.
If the amount due is greater than value of the house, the loss is absorbed by the lender. But that's not common. "Your home continues to appreciate in value," said Bell. "It's not unusual for borrowers to have substantial equity left in their house."
High up-front fees
If you're not sure how long you think you'll stay in your house, think twice about a reverse mortgage. The reason: Up-front fees for a reverse mortgage can easily add up to $10,000 for a $200,000 loan limit, regardless of how long you keep the loan or how much you borrow.
"This is not a loan you would want to get for the short term," said David Carey, senior product manager for Fannie Mae's HomeKeeper. "If you don't hold this loan for five or 10 years you're going to pay a lot of money for it."
Up-front costs for the HECM include:
- Origination fee equal to $2,000 or 2 percent of the loan whichever is greater.
- Mortgage insurance premium equal to 2 percent of the maximum claim amount or home value, whichever is less. (This up-front insurance is waived only if the all of the loan is used to pay for long-term care insurance.) There also is an ongoing annual premium equal to 0.5 percent of the loan balance.
- Other closing costs, such as title insurance, and fees for appraisal, credit reporting, escrow, document preparation and recording vary depending on the size of the loan but $1,700 is typical according to Carey.
- Servicing fees of $30 to $35 a month, added to the balance of your loan.
Also keep in mind that because you don't pay down your debt until you sell, move or die, the interest you owe could add up to quite a bit over time. Mandatory mortgage insurance ensures that you (or your heirs) don't end up owing more than the house is worth. But it's entirely possible to drain all or most of your home's equity.