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Reverse Mortgages, Home Equity Loans

Here's the scenario: You have lived in your home for many years and it is worth more now than it was when you bought it. You are finally retiring, but you'd like to be able to eat more than dog food and that isn't looking likely. So you borrow against your equity, which is the amount you have invested in your home less the amount you owe on it, and pay your bills out of the new loan while you continue to live in your house.

Many Americans are opting for this type of mortgage so they can stay in their homes in their retirement years.

How it Works

Think of it as the opposite — or reverse! — of more traditional loans: With other types of mortgages, the equity in your home increases as you make monthly payments, and your debt decreases. But with reverse mortgages, a lender gives you cash and the payments are basically taken out of the value of your home. As the debt increases, the equity in your home decreases. When the loan term is up, the borrower has to pay back the loan, plus interest (usually by selling the house).

The loan is limited by the value of the house; a homeowner cannot borrow more than the house is worth, and a lender can never try to get money to cover the loan anywhere other than from the home equity.

Borrowers generally wish to receive the payments monthly, or in a lump sum and then a line of credit for further payments.

Who Is it for?

Homeowners 62 or older are the only ones eligible for a reverse mortgage. Since the loan is based on equity in a home, and since there are no monthly payments to make, the homeowner does not need to have an income to qualify. However, the borrower still has to pay home maintenance, taxes, and insurance costs. Most lenders will not lend on mobile homes or apartment co-ops.

This is one time when age can be an advantage: The older a borrower is, the higher the amount they can most likely borrow.

Types of Reverse Mortgages

While reverse mortgages can vary, the most popular is a Home Equity Conversion Mortgage (HECM) which is backed by the federal government. Many lenders have software that allows you to compare a HECM with a loan from a private lender.

  • A Home Equity Conversion Mortgage is the only reverse mortgage program backed by the federal government via the Federal Housing Administration, which limits loan costs and oversees the lender. Because the loan is insured, the borrower is guaranteed to receive the amount promised regardless of whether the lender defaults, or the home decreases in value. These loans are flexible in terms of what you can spend the money on and the amount you can borrow, but they can be expensive. They are by far the most popular reverse mortgages.
  • Low-income reverse mortgages are available through state and local governments, but only for specific purposes. Note that all loans are not necessarily available in all locations.
    • Deferred Payment Loans (DPL) are low in cost, but limited in scope. For low-income borrowers, they are to be used specifically for repairing your home.
    • Property Tax Deferral loans (PTDL) are to be used only to pay property taxes. As with all reverse mortgages, you don't have to repay the loan as long as you stay in the house.
  • A Proprietary Reverse Mortgage from a private lender can often get you more money, but is the most expensive loan. It is generally used by homeowners in a very high-value home. The most common is the Fannie Mae Home Keeper Mortgage.

Rates and Fees

With a traditional mortgage, it's easy to itemize the costs in terms of interest rate and service fees. But with reverse mortgages, the cost is dependent on such things as what happens to the value of the house during the term of the loan, and the cash advances received. To give borrowers some idea, lenders are required to disclose the Total Annual Loan Cost (TALC) which does not answer the question definitively, but helps. Borrowers can use the TALC from different lenders to compare mortgages.

One thing stays true: Start-up costs are high, so the longer you stay in the home, the less expensive the loan. You can choose monthly or yearly interest rates, each tied to the Fed Treasury Bill. The best way to estimate the cost is to enter your specific information into a Reverse Mortgage calculator.

In general, fees include:

  • Origination fee: A fee charged by a lender that is 2% of the home's value, or 2% of a county's limit placed on the value of a house specifically for determining a reverse mortgage amount. The amount is negotiable.
  • Closing costs: Service fees covering appraisal, surveys, title search, etc. Varies by the value of the house.
  • Mortgage Insurance Premium: Guarantees your loan and costs 2% of the value of your home, or of a county's limit placed on the value of a home, and 0.5% added to the interest rate as the loan increases. This can be high.
  • Servicing fee: Administrative fee to the lender, about $35 a month, negotiable.
  • Interest rate: Usually adjustable, based on the 1-year Treasury rate, plus a margin. Capped at 2% per year, or 5% over the life of the loan.

Borrower Beware

Reverse Mortgages are complex and hard to understand, therefore may include hidden fees and high overall costs. The AARP site has an entire section devoted to explaining these loans.

Borrowers need to be especially careful on Reverse Mortgages' downside:

  • Cheaper, uninsured reverse mortgages mean the balance is due at the end of the term and the homeowner may have to sell the house to pay off the loan.
  • They are expensive; the loan can end up costing the homeowner more than he borrowed.
  • A borrower cannot predict the true cost because it is based on how long they live or stay in the house.
  • The mortgage could affect government benefits for low-income borrowers.
  • They can invite scams aimed at seniors, including "estate planning" fees.

Where to Get One?

Lenders specializing in reverse mortgages are generally members of the National Reverse Mortgage Lenders Association (NRMLA). (Note: Zillow Mortgage Marketplace does not target Reverse Mortgages as part of its product offering.)

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