Reverse Mortgage - Look Before You Leap

Before Entering Into A Reverse Mortgage make Sure You Understand the Pitfalls

If you're still watching your favorite football game on a 20-year-old Phillips TV, perhaps you've considered buying one of those glitzy high-definition TVs that let you count the freckles on Jennifer Anniston's cheeks. You've seen that prices on high-def TVs have fallen. But should you buy now, or should you put up with blurry Minnesota Vikings on the field a bit longer, in hopes that prices will fall even more?

Home owners who are considering a reverse mortgage face a similar dilemma. In recent months, lenders have slashed closing costs and fees and added new features for reverse mortgages — a trend that's expected to continue as more lenders battle for business.

A reverse mortgage is a loan against home equity that doesn't have to be repaid until you move, sell your home or die. You can receive a lump sum, a line of credit, monthly payments or a combination. To qualify, you must be 62 or older. (If the home is owned jointly, both owners must be at least 62.) The amount you can borrow is based on your home's value, current interest rates and your age.

One reason for the growing interest in reverse mortgages is that seniors with lots of home equity can use the loans to pay medical bills or increase retirement income, while staying in their homes.

Though they still represent just a thin slice of the mortgage market, reverse mortgages have boomed. But there are some drawbacks to reverse mortgages:

Costs are High

Unlike with conventional mortgages, which are based on the loan amount, fees for reverse mortgages are based on the value of your home or the limit on federally insured reverse mortgages in your area. So even as rising home values have increased the amount that Home owners can borrow through a reverse mortgage, they've also raised the costs.

Home owners who take out a federally insured reverse mortgage, known as a Home Equity Conversion Mortgage (HECM), typically pay an origination fee of 2% of the home's value, plus a mortgage insurance premium of 2%. Once title searches, appraisals and other expenses are included, closing costs can exceed 5% of the home's value.

Amount You Can Finance Is Capped

The government caps the amount you can borrow through an HECM. The limits range from $200,160 to $362,790, depending on where you live. If your home is worth $600,000, and the HECM limit for your county is $362,790, the maximum loan amount will be calculated based on a home value of $362,790.

Home owners who want to borrow more money can obtain reverse mortgages that aren't federally insured. There are no caps on these reverse mortgages. In the past, costs and interest rates for those reverse mortgages were higher than for federally insured ones. But that's changing.

Countrywide, for instance, recently introduced SimpleEquity, a reverse mortgage intended for Home owners who want to borrow more than the HECM limits allow. Countrywide will waive origination fees and closing costs for borrowers who take their entire loan in a lump sum. Countrywide doesn't charge mortgage insurance premiums, either, says Steve Boland, the company's managing director for reverse mortgages. Borrowers pay a monthly service fee of $20.

Financial Freedom and BNY Mortgage also offer reverse mortgages with no closing costs or fees for lump-sum borrowers. And several lenders have reduced interest rates on their reverse mortgages; that increases the amount that Home owners can borrow.

Meanwhile, the Department of Housing and Urban Development is re-examining the costs for federally insured loans. A reduction in costs for HECMs is inevitable, says Darryl Hicks, associate director for the National Reverse Mortgage Lenders Association. "Otherwise, it's not going to be as competitive" with other reverse mortgages, he says.

Which brings us back to the question of timing. For Home owners who don't need the money immediately, patience could pay off, says John Rother, director of policy and strategy for AARP.

A reverse mortgage "should be done very carefully and only for certain urgent situations," Rother says. "We think that the increasing competition in the next year or two will lower these costs."

Jim Mahoney, chairman of Financial Freedom, acknowledges that reverse mortgages will probably become cheaper. But if interest rates rise or home values decline, the proceeds available from a reverse mortgage will shrink, he says.

Whether you opt for a reverse mortgage now or later, take your time. Home owners are required to meet with a HUD-certified financial counselor before obtaining a federally insured reverse mortgage.

"Given the complexity and cost," Rother says, "this is an example of a transaction where people should seek some help."

Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: sblock@usatoday.com.

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