Sunday, June 17, 2007

Reverse Mortgages

Jan. 21, 2011 Update: the FHA has recently announced a "Saver" reverse mortgage, which offers lower fees than traditional FHA guaranteed mortgages (around 40% lower). But you cannot borrow as much under a Saver as you can under a traditional reverse mortgage. At interest rates available in early 2011, you can borrow about 50% of the value of the home with a Saver, compared to 60% to 65% with a traditional FHA guaranteed reverse mortgage. And the interest rate on the Saver may be a little higher than on a traditional loan. The Saver isn't for everyone, but those who need to borrow less (and/or their heirs) may end up better off with a Saver.

Original Blog:

Many, and perhaps most Americans, enter retirement with a modest amount of savings and a house. They have Social Security, and if they're lucky, a pension. Social Security payments are increased for inflation, but most pensions are not. Money may eventually get tight. The cost of living goes only in one direction, and it isn't down. Property taxes increase over time. And medical expenses rise as one grows older. If there isn't a large pool of savings to tap into, what does a retiree do, especially one that still wants to live at home?

Increasingly, retirees have been taking out reverse mortgages. A reverse mortgage is a way for a person who is at least 62 to take the equity out of his or her home, with a unique feature. The homeowner doesn't have to make any payments until he or she leaves the house permanently (e.g., to move to an assisted living facility), sells the house, or passes away. This is a very convenient arrangement for a person without much savings or income. The homeowner can get a lump sum, a line of credit or regular monthly payments.

There must be a catch, you say. And if you said that, you'd be right. Reverse mortgages are a very expensive way to borrow. Part of the problem is the deferral of repayment. Since the homeowner doesn't have to repay the loan for years, or potentially even decades, the interest on the loan will accrue unpaid for a long time and will have to come from the value of the house. The longer the homeowner's life expectancy, the less he or she will be able to borrow. That's because much and even most of the home's value has to be set aside for interest payments. With the best kind of reverse mortgage available, the "home equity conversion mortgage" (HECM), a homeowner at age 62 can borrow around half the value of the house at current interest rates. The older you get, the more you can borrow because your shorter life expectancy means a smaller amount of interest will accrue.

Reverse mortgages also have very high closing costs, potentially as much as 10% or more of the value of the loan. The charges include an origination fee, a mortgage insurance fee, and various closing costs. Fees this large can significantly increase the effective cost of borrowing.

Another consideration is that the cost of repaying a reverse mortgage could consume virtually the entire value of the house. If the homeowner wanted to leave the house behind as an inheritance, a reverse mortgage pretty much switches the inheritance over to the bank.

Americans, on the whole, are lousy savers. They do like to own their homes, however, and will often do whatever they can to own the old homestead by the time they get the retirement watch. With a cash-poor, house-rich retired population, it's no wonder the reverse mortgage has grown in popularity. And with the Baby Boom generation closing in on its golden years, there's no reason to think this trend will change.

Needless to say, the financial services industry hasn't overlooked reverse mortgages. More and more financial institutions are offering them, and there are some indications that the fees may be diminishing a bit. In fact, people with second homes may soon be able to get reverse mortgages on them. Many seniors are targeted by mass mailings touting reverse mortgages.

It's important to be very careful with a reverse mortgage. The math is quite a bit more complex than a traditional mortgage's math (and that's not necessarily simple). Older folks may not understand all of the nuances of the transaction. The elderly make easy targets for fast-talking sales people. In the worse case scenarios, they may be persuaded to take out a reverse mortgage and invest the money in an annuity or other financial product that pays the sales person a juicy commission. That is a bad financial move, but some unscrupulous sales people evidently have done this.

Elderly people may also get less legal protection. They can have wobbly recollections. They sometimes develop mental impairments, and cannot testify. And they might even pass away before the bad guys can be successfully prosecuted. That's why crooks love to prey on them.

If you're thinking of taking out a reverse mortgage, you'll be required to get financial counseling first. Listen closely to the counselor--he or she may have suggestions for other ways for you to deal with your financial problems. Also, talk to your family and friends. You don't want your only source of information to be a sales person.

If it's your parent, or grandparent, who is thinking of getting a reverse mortgage, be willing to help out. Maybe, even offer to help out. It's always difficult for a younger generation to involve itself in an older generation's finances. But you can be respectful and helpful at the same time. Deal with your elder the way you'd like dealt with when you're the elder. A reverse mortgage may be a very good idea, or a very bad one, and you can help out either way.

Strange News: another guy gets his 15 minutes of fame.

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