Cash-challenged seniors who want to stay in their own homes have kept reverse mortgages high on the public radar. But, despite glowing testimonials from some customers, not everyone thinks they're such a good idea.
Reverse mortgages hit the scene in the 1960s, according to a 2005 report by the National Council on Aging. Although the public has been generally hesitant to embrace them, their popularity continues to climb. The National Reverse Mortgage Lenders Association recently reported the number of federally insured Home Equity Conversion Mortgages administered by HUD rose from 43,131 the previous federal fiscal year to an all-time annual high of 76,351, a whopping 77 percent increase.
Not surprisingly, five of the top 10 reverse mortgage markets are in California. Also on the list: New York City, Phoenix, Boston, Denver and Coral Gables, Fla.
However, the reverse mortgage market is minuscule compared to that of regular mortgages. The Mortgage Bankers Association estimates that 10.7 million mortgages were originated last year. Reverse mortgages represent a drop in the bucket -- about seven-tenths of 1 percent of regular mortgages.
How they work
In general, a reverse mortgage converts home equity into cash in several different ways, ranging from monthly payments to an equity line to one-time payouts -- or a combination. The amount you can borrow varies according to your age, the value of the home, current interest rates and loan fees.
Are reverse mortgages a good idea? Most news stories imply they are. Reports suggest reverse mortgages can be a source of ready cash when it's needed -- similar to other investments. But, like anything that impacts your bottom line when your earning potential is limited, taking out a reverse mortgage isn't a no-brainer. That's why candidates for these mortgages should consider both the benefits and the drawbacks before jumping in.
Zoran Basich, an elder law attorney and operator of Nursing Home Solutions, a California-based company, says he believes reverse mortgage lenders fail to give seniors the full story when it comes to cashing out home equity.
"What they don't tell you is ... that the front load is very high," Basich says. He says lenders like reverse mortgages because "these (loans) are very profitable to write in the short term."
Front-loading refers to upfront costs, paid out of the home's equity at closing. As with conventional mortgages, reverse mortgage lenders make money the old-fashioned way: through interest, origination fees and points. The interest rate varies according to the market. However, closing costs are significantly higher with reverse mortgages.
In addition, borrowers continue to be responsible for real estate taxes, conventional homeowners insurance and home repairs, and have the added burden of paying for mortgage insurance, too.
Why would borrowers have to pay mortgage insurance? After all, that insurance is required for regular mortgages if borrowers don't have a large enough down payment, and its purpose is to protect lenders in the event of a default. With a reverse mortgage, there's no such risk to lenders.
But other risks exist. Mortgage insurance guarantees the lender will receive its full repayment. For example, a decrease in the property's value adversely affects the lender's reimbursement. Mortgage insurance also covers the lender in the event the mortgage is held over a very long period of time and accrued interest exceeds the value of the home.
It should be noted, though, that when it comes to a home appreciating in value, there is virtually no difference between conventional and reverse mortgages. The lender only recovers what it's actually owed. After the lender's loan, fees and interest are repaid, anything left goes to the homeowner or heirs.
Basich believes seniors should consider borrowing against the value of their homes only as a last resort. If there's no way around it, he says it's smarter to refinance as a 30-year fixed loan.
Here's how that would work: You own a home valued at $300,000. You find yourself in need of a large amount of cash for major home repairs and want a lump sum in the bank for future emergencies. You borrow a combination of cash and upfront costs (rolled into the loan) valued at $100,000 at 6 percent.
Exclusive of taxes and insurance, you'd be paying back a little under $600 per month on a 30-year loan. And you wouldn't need mortgage insurance because you still have plenty of unencumbered equity.
The rub here is the monthly payments. However, Basich contends that the fees for this type of loan are lower, and your remaining equity isn't subject to interest and other costs associated with a reverse mortgage.
True, in a conventional mortgage, the money must be paid back starting right after closing, while reverse mortgages don't fall due until the home is vacated. But, Basich argues, since the payments on a conventional mortgage are stretched out over a longer period of time, they're lower and more manageable.
In the case of a reverse mortgage, younger borrowers can't cash out as much equity as older borrowers. To qualify for a reverse mortgage, you must be at least 62 years old. Since banks are repaid when the house is sold, it's quite possible a lender might have to carry the note for 20 to 25 years or more. For that reason, a 79-year-old is a much more attractive loan candidate from the bank's perspective.
As for the borrower, whether he lives six months or 30 years after the loan is closed, he still pays stiff upfront fees. Of course, statistically speaking, older borrowers are less likely to accumulate as much interest as younger ones.