The Backwards Loan

The

buzz among homeowners continues to be about mortgage refinancing. Why? Because interest rates are still so low (6% for a typical 30-year loan). But what's more intriguing — and maybe a little scary — is the big surge in people taking out reverse mortgages. These are loans that let homeowners who are 62 or older take cash from their home equity and pay nothing back — not a cent — until they move out or die. Some reverse mortgages guarantee a fixed monthly payment for life (an annuity). By the latest measures available, the pace of new reverse mortgages has leaped 74% in just one year.

Here's my concern: though a reverse mortgage can be a good financial move under the right circumstances, it can also be an unnecessary straitjacket. Many seniors, hurt by falling yield payouts from their retirement accounts, are casting about for ways to maintain their standard of living. At the same time, lenders are marketing reverse mortgages more aggressively — all in all, a recipe for trouble. So here's what you (or your parents) need to know:

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--THE MECHANICS. Reverse-mortgage payouts come in three forms: a monthly payment for as long as you or your spouse lives (the annuity), a lump sum or a line of credit. You can combine these options.

There's no credit or income requirement. The amount you can get depends largely on the value of your house but also on your age. The older you are, the more you can get, but loan caps usually range from $155,000 in rural areas to $281,000 in metropolitan areas.

As an example, consider a 77-year-old Chicago couple with a home worth $250,000. On the basis of life expectancies, they would qualify for a reverse-mortgage lump sum or line of credit of $175,600 or a monthly payout that would add up to that amount by the time they were both expected to be dead, minus loan costs (in this case, they would net $1,069 a month).

The lenders who dreamed up reverse mortgages in the 1950s figured the annuity option would be the most popular, since it gives homeowners a chance to beat the bank (if they live longer than expected). Instead, two-thirds take the line of credit, figuring to use only as much as they need and preserve the rest, according to Ken Scholen, a home-equity expert at the aarp. Any unused portion of the credit line grows with inflation.

When the homeowner moves out or dies, the amount that must be paid back to the bank is the sum of the payouts plus interest (more on the interest later) as well as any fees financed as part of the loan.

--THE COSTS. Reverse mortgages involve costs, just like regular mortgages, that can eat up any financial advantage in the short term. These costs often get swept under the rug in the sales pitch because they are not up-front charges but are subtracted from the amount the borrower eventually receives. Take the house from the example above, with a $175,600 reverse mortgage. Typical costs would include an origination fee of $4,700, mortgage insurance of $4,700, other finance costs of $1,200 and servicing fees (deducted monthly but computed up front) of $4,500--leaving a payout of only $160,500. Live in the house longer than the bank expects, and you are ahead. Leave (or die) much sooner, and you have paid too much.

--OTHER OPTIONS. Why not just sell your home and move? Particularly now, you may find that you can get more money than you ever imagined, then scale down close by or relocate to a lower-cost area. Also talk to your grown kids. Often parents mistakenly assume that their kids want the family home (when they don't), or they don't have extra money with which to help their parents (when they do). Believe it or not, federal law requires borrowers to go through financial counseling before taking a reverse mortgage — a paternalistic rule but probably a helpful one. The counseling takes two or three hours and is provided free by federally approved agencies.

--THE NEGOTIATION. For the vast majority of people, a reverse mortgage insured by the Federal Housing Authority (fha) is the best deal. This is called a home-equity conversion mortgage, and many of its costs — including interest, which floats with one-year Treasury bills and is now 3.55%--are consistent from lender to lender. So you don't have to shop or dicker. Exceptions include origination fees, which may be as high as 2% of loan value, and servicing fees, generally around $30 or so a month. Non-fha reverse mortgages with higher loan limits are available from Fannie Mae (the Homekeeper Loan, up to $322,000). Just remember that a reverse mortgage is only for people with compelling reasons to stay in their current home.

Jean is a columnist for MONEY magazine. You can e-mail her at moneytalk@moneymail.com