Are reverse mortgages a good deal?
'We own our home and my son thinks we should take out a reverse mortgage on our house to enjoy ourselves. Does that make sense to you?'
By Walter Updegrave, MONEY Magazine senior editor

NEW YORK ( - We own our home outright and are virtually debt-free. My son thinks we should take out a reverse mortgage on our house and enjoy the fruits of our labor even more. Does that make sense to you?

-- Frank Romans, New Bern, North Carolina

More information on Updegrave's new book.

The number of seniors who are tapping the equity in their homes through reverse mortgages has been soaring in recent years. In some cases, retirees may be doing this because their retirement nest egg alone isn't large enough to support them comfortably in their post-career life.

In other cases, homeowners may need to come up with a large amount of cash to meet medical expenses, home repair or renovation costs or other expenses that they can't otherwise fund without jeopardizing their financial security.

And then there are people who may be able to live comfortably in retirement, but figure, hey, rather than just living in the house, why not live it up on the house, so to speak, and draw on that home equity to make those golden years more golden by taking an extra trip or two or whatever.

A reverse mortgage can fit all of these situations and more, but before you take out such a loan it's important that you know what you're getting into -- and understand what you're getting into.

How it works

First, a quick review for those out there who may not be familiar with reverse mortgages. As its name implies, a reverse mortgage is the mirror image of a regular home loan. Instead of you making payments to the lender, the lender makes payments to you.

The amount you can borrow depends on a variety of factors, including your age, your home's value, the level of home prices in your area, the amount of any other loans outstanding against your home, if any, and the current level of interest rates. Generally, the older you are, the lower interest rates are and the higher your home's value, so the more you can borrow

You can take the loan as a line of credit, a lump sum, in monthly payments for the rest of your life -- or as a combination of all three. The loan payments are tax-free and don't affect Social Security benefits. You don't have to repay the loan until you die or move out of your house. If the value of the home isn't enough to cover the amount you've borrowed plus interest, that's the lender's problem.

Neither you nor your heirs are on the hook for anything beyond the house-sale proceeds. (Of course, if all the sales proceeds are needed to repay the loan, there will be nothing left for your son or other heirs. Since your son is encouraging this move, I assume he knows this, however.)

The down sides

Sounds great, so far, no? Well, naturally, there are some potential downsides you've got to consider.

For one thing, the upfront costs on these loans can be quite high, amounting in some cases to 5 percent or more of the home's value. If you borrow only a small amount or stay in the house only a few years, those still upfront costs can push the loan's effective rate through the roof. So a reverse mortgage makes the most sense if you're taking out a large lump sum or if you plan to draw monthly income over a very long period, not if you need only a small sum or plan to repay the loan in a short time.

Evaluating these loans can also be quite tricky. The Department of Housing and Urban Development's Home Equity Conversion Mortgage usually offers the largest loan amount for most homeowners.

But there are cases in which you might want to go with Fannie Mae's Home Keeper reverse mortgage or, if your house has a very high market value, even a reverse mortgage offered by a private firm. To get an idea of how large a loan you might qualify for under different programs, check out the reverse mortgage calculator at the Financial Freedom site.

Beyond the size of the loan you may get at different programs, however, you'll also want to compare the cost -- not just the interest rate, but the total effective rate after factoring in all expenses.

The best way to do that is to check out the Reverse Mortgage Education Project section of AARP's Web site. There, you'll find lots of information about how reverse mortgages work and how the costs can vary depending on the size of your loan and how long it's outstanding. If you're then serious about proceeding, you can contact a reverse mortgage counselor, who can provide you with personalized comparisons of the costs of different loans.

So if you think money from your home can significantly improve your quality of life in retirement, by all means look into a reverse mortgage.

Just be sure that before you sign up that this boost in your living standard comes at a cost you feel is acceptable -- and that you're okay knowing you won't be leaving the house as a legacy to your son or other heirs.


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