The Pros and Cons of Reverse Mortgages

While the recession hasn't spared any age group, it's been particularly brutal for older Americans who were counting on their (now shrunken) nest eggs to last through their retirement years. To supplement their stash, an increasing number of seniors are turning to reverse mortgages, which function essentially as a cash advance on their home equity, repaid only when they sell their home or die. The loans are available to those 62 and over, and lenders have to eat the difference if a home ends up declining in value. In the three months after February--when a provision in the economic-stimulus package raised the eligible home-value limit from $417,000 to $625,500--the number of federally insured reverse-mortgage originations jumped 10% compared with the same period last year. Industry experts predict that reverse mortgages will play an increasingly important role in the coming years as some 70 million baby boomers hit their 60s--often with a lot less saved than they'd hoped.

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This has some folks in Washington concerned. In June, the Government Accountability Office said it had uncovered misleading marketing practices in the reverse-mortgage industry, and Missouri Senator Claire McCaskill, a longtime consumer advocate, chaired a hearing to investigate predatory lending tactics. A big no-no is cross-selling, e.g., trying to persuade a senior to get a reverse mortgage and use the funds to buy an annuity or other financial product.

Comptroller of the Currency John Dugan recently noted that reverse mortgages, like some flavors of the infamous subprime mortgages, are too complex for many seniors to understand. "Millions of older Americans still have a lot of equity in their homes, and it's tempting for them to tap into this pot of money," he says.

Still, under the right conditions, these loans can be a sensible solution to a tough financial situation. So if you or your parents are considering one, here's what you need to know:

The amount you can borrow is based on interest rates, your age and the value of your home. (Use the calculator at rmaarp.com for an estimate.) There are no credit or income requirements to get a reverse mortgage, but you must be able to keep up with property taxes and insurance bills--or you could lose your home. The up-front costs are high. Generally, $10,000 to $15,000 in fees are lopped off the amount you can borrow. Finally, if someone is pressuring you to take one of these loans in order to buy something else, that's a huge red flag. Walk away.

Lenders aren't allowed to close on a federally insured reverse mortgage until borrowers meet with a HUD-approved counselor, who is required to help them explore alternatives such as selling their home or lowering their expenses. That's because the greatest reverse-mortgage risk, especially for younger borrowers, may be that they will live longer than they expected and drain all the available equity from their home. Says reverse-mortgage specialist Bronwyn Belling: "If you borrow the money now, you may not have it when you need it later on."