Reverse Mortgages Explained

How To

photo: sea turtle

About half a million Americans aged 62 or older hold a reverse annuity mortgage today, according to the U.S. Department of Housing and Urban Development (HUD).

As more Americans move into this age group, the volume will increase as well. But exactly what is a reverse mortgage and how does it work?

Also called a “lifetime mortgage,” this is a product in which homeowners receive monthly payments instead of making them, as in the traditional mortgage plan. This is a form of installment borrowing, and it does not have to be repaid until the homeowner dies, the home is sold, or the owner vacates for more than one full year.

A homeowner qualifies for a reverse mortgage once they reach the age of 62. They do not have to meet any income or credit requirements because the deciding factor is the equity in the home. As part of the arrangement, any existing old-style mortgages have to be paid off with proceeds from the reverse mortgage. The maximum amount a homeowner can borrow under this plan is currently capped at $625,000.

The older the homeowner, the easier the terms; this is so because mortality rates also increase with age, reducing lender risks. One of the great features of the reverse mortgage is that the lender cannot request or demand that the homeowner leave the property or repay it, even if they outlive the equity they’re getting through reverse mortgage payments and accumulated interest. That’s the lender’s risk.

How much money can a homeowner aged 62 or older get in the reverse mortgage is determined by five things:

1. Appraised value of the home.

2. Balances of any outstanding mortgages and other liens.

3. Interest rate to be applied.

4. The homeowner’s age.

5. Whether proceeds are taken as monthly payments, a line of credit, or in a lump sum.

One key factor in deciding whether or not to get a reverse mortgage is its cost, which is quite high. Typically, the following costs are assessed:

1. Mortgage insurance at 2% of appraised value (for example, on a $400,000 home, this adds up to $8,000).

2. Origination fee; this is $2,500 on the first $200,000 appraised value, and 1% above (on that same $400,000 home, this comes up to a total of $4,500).

3. Title insurance (usually about $300-$600 depending on area and property age and value).

4. Various recording, title and escrow fees (average about $500).

5. Appraisal (averages $400-500).

This all adds up to about $14,000 for a home appraised at $400,000. Of course, for homes appraised higher, fees are also going to be higher.

A reverse mortgage is an expensive choice, but for those on a fixed income and carrying an existing mortgage, it could also make sense. Someone with high equity and high monthly payments has to struggle to keep their home. That high equity gets converted through a reverse mortgage, and the money flow turns in the opposite direction. When it comes to retirement housing costs, it is better to receive than to give.

Michael C. Thomsett is author of over 60 books, including Winning with Stocks and Annual Reports 101 (both published by Amacom Books), and Getting Started in Stock Investing and Trading (John Wiley and Sons, scheduled for release in Fall, 2010). He lives in Nashville, Tennessee and writes full time.

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