NEW YORK (CNNfn) - Several years ago, a retiree in his 90s who owned his $300,000 house outright walked into a bank and asked for a loan for living expenses, which he had trouble meeting -- he was turned down.|
"They said 'We only loan against income,'" said Ken Scholen, a program specialist at AARP and founding director of the National Center for Home Equity Conversion (NCHEC).
Today, that same man might consider going to a mortgage company in search of a reverse mortgage on his home.
Such mortgages are designed for seniors who may be house-rich but cash-poor. They are loans made against the equity of your house, not your income, as with most loans.
"A reverse mortgage is the true home equity loan," Scholen said.
A look at the basics
To qualify for one, you must be age 62 or older, your home must be your principal residence and you must own it in full or have a relatively low balance left on your mortgage.
How much you can get is calculated by a formula that takes into account, among other things, your life expectancy, the value of your home and current interest rates.
The federally insured "Home Equity Conversion Mortgage" and Fannie Mae's "HomeKeeper Mortgage" - the most widely available programs - also apply "maximum claim amounts" on your home's value to determine the loan for which you qualify. So even if you live in an $800,000 house, it may be valued at no more than $200,000.
"It's a complex product," said certified financial planner Phil Storms. But, if it works for you, he said, "It's a good way to get some income."
How would you like your money served?
With a regular mortgage, you pay the lender on a monthly basis. But a reverse mortgage pays you in one of several ways: as a lump-sum cash advance; a line of credit; a monthly cash advance; or any combination of these methods.
The method you choose may greatly affect how much money you will get - and owe -- so it pays to explore all your options. In fact, with most programs, you are required to get housing counseling, which is available free or at low-cost from several sources, including the U.S. Department of Housing and Urban Development (1-888-466-3487).
And, as with all loans, there comes a day when the money plus interest is due. Under a reverse mortgage, that day is when the last surviving borrower dies, sells or moves away for good, meaning you live elsewhere for a year.
Still a small market
Despite their advantages - letting you remain in your home and giving you the security of a cash reserve -- reverse mortgages have not been as popular as once was expected.
"I don't see a lot of people doing it unless there's a need ... (unless) they're not making ends meet," said Patti Wallace, a reverse mortgage counselor at ECHO Housing, a HUD-approved counseling agency in California. Wallace said that if a person is willing and able to move to a less expensive home, that is usually the first option she discusses with them.
For those who might simply wish to live less frugally, the temptation to take a reverse mortgage is often tempered by a distaste for IOUs.
"(Reverse mortgages) don't seem to have a very wide appeal," Storms said. "Often the people who would benefit from them have an aversion to debt."
And many senior would rather leave their house to their kids free and clear, he said.
What about my heirs?
Indeed, with a reverse mortgage you are the one who benefits from the cash in your walls, not your children.
But there are some loan features that protect your heirs and your remaining assets.
According to the NCHEC, the mortgages are generally lower than the value of your home when the loan is made to account for the fact that your loan balance grows over time, Scholen said. And it allows for the possibility that your house may decline in value.
Secondly, you will never owe more than the value of your home when the loan is repaid, even if you have outlived your life expectancy and the total payments you received exceed the amount your house fetches on the market. If your loan is less than the market value at the time of sale, you or your estate only pay the lender what is owed and keep the rest.
Should you die before leaving your home, your heirs are not liable for your debt, according to HUD. If, however, they want the title of the house, they must pay back what you owe in full.
Lastly, reverse mortgages are usually deemed "non-recourse loans," which means the lender cannot claim rights to anything but your home in seeking repayment.
Factor in your costs
In addition to interest, expect to pay several costs, including an insurance premium to protect the lender against the possibility that your loan will trump the value of your house.
You may wrap most costs into your total loan package, but you should compare the fees charged between lenders to make sure you get the best deal, especially if your home exceeds the maximum claim amount, Wallace said.
Do so by comparing the Total Annual Loan Cost (TALC), which lenders are required to disclose. The TALC, in essence, tells you exactly how much you will pay for the money you are getting by showing what the annual interest rate on your loan would be if it included all costs and fees.
Are reverse mortgages for you?
As with any complex financial product, reverse mortgages work better for some people more than others. For instance, Storms said, if you're in your early 60s you may not get enough money to make much of a difference since your life expectancy is still quite long and payments are spread out over an extended period of time.
"The older you are, the more money you can get because life expectancy is shorter," Scholen said.
A reverse mortgage might also hurt you if you only stay in your home for a few years and the house appreciates, NCHEC points out.
"If you leave in a year or two, your TALC will skyrocket," Wallace said.
But whatever your circumstance, keep in mind that a reverse mortgage is a big deal and a long-term one, she stressed. "It's a huge decision because you're starting to liquidate your estate."