Reverse Mortgages

Reverse mortgages can help homeowners who are "house-rich-but-cash-poor" remain in their homes and still meet their financial obligations. The proceeds of the loan are tax-free, there are no minimum income requirements, and for most reverse mortgages the money can be used for any purpose.

With a "regular" mortgage, you make monthly payments to the lender. With a reverse mortgage, you receive money from the lender and generally don't have to repay it for as long as you live in your home. In return, the lender holds some - if not most or all - of your home's equity.

But reverse mortgages tend to be more costly than other loans, and there have been cases of abuse by unscrupulous lenders.

If you're considering a reverse mortgage, it's important to understand how the loan work and what your rights and responsibilities are.

The Basics

There are several types of reverse mortgages:

• Federally insured Home Equity Conversion Mortgage ("HECM"), administered by the Department of Housing and Urban Development ("HUD")
• Single-purpose reverse mortgages, usually offered by state or local government agencies for a specific reason
• Proprietary reverse mortgages, offered by banks, mortgage companies, and other private lenders and backed by the companies that develop them

To qualify for a reverse mortgage, you must be at least 62 and have paid off all or most of your home mortgage. Income is generally not a factor, and no medical tests or medical histories are required. If you seek an HECM, you also must undergo free mortgage counseling from an independent government-approved "housing agency." Financial institutions offering proprietary reverse mortgages may require similar counseling or homeowner education.

The amount you can borrow depends on:

• Your age
• The equity in your home
• The value of your home
• The interest rate

If it's an HECM, federal law limits the maximum amount that can be paid out.

You can be paid in a lump sum, in monthly advances, through a line of credit, or a combination of all three.

Disadvantages of Reverse Mortgages

Reverse mortgages tend to be more costly than traditional loans because they are rising-debt loans. The interest is added to the priprincipal loan balance each month. So, the total amount of interest owed increases significantly with time as the interest cocompounds.

Reverse mortgages also use up all or some of the equity in a home. That leaves fewer assets for the homeowner and his or herher heirs.

Lenders generally charge origination fees and closing costs; some charge servicing fees. How much is up to the lender.

Interest on reverse mortgages isn't deductible on income tax returns until the loan is paid off in part or whole.

Because homeowners retain title to their home, they remain responsible for taxes, insurance, fuel, maintenance, and other ho housing expenses.

Getting a Good Deal

If you decide to consider a reverse mortgage, shop around and compare terms. Look at the:

• Annual percentage rate (APR), which is the yearly cost of credit
• Type of interest rate. Some plans provide for fixed rate interest; others involve adjustable rates that change over the loan term based on market conditions.
• Number of points (fees paid to the lender for the loan) and other closing costs. Some lenders may charge steep costs, which your lender may offer to finance. However, if you agree to this, you'll take out fewer proceeds from the loan or you'll borrow an extra amount, which will be added to your loan balance and you'll owe more interest at the end of the loan. 
• Total amount loan cost ("TALC") rates. The TALC rate is the projected annual average cost of a reverse mortgage, including all itemized costs. It shows what the single all-inclusive interest rate would be if the lender could charge only interest and no fees or other costs.
• Payment terms, including acceleration clauses. They state when the lender can declare the entire loan due immediately.

Under the federal Truth in Lending Act, lenders must disclose these terms and other information before you sign the loan. On plans with adjustable rates, they must provide specific information about the variable rate feature. On plans with credit lines, they must inform the applicant about appraisal or credit report charges, attorney's fees, or other costs associated with opening and using the account. Be sure you understand these terms and costs.

Reverse mortgages come with different provisions. For example, with some reverse mortgages, the lender may take a share of equity appreciation. This could create issues for the homeowner or heirs, particularly if the value of the home rises unexpectedly during the loan. Carefully read any provision of the contract about shared appreciation.

Also, be cautious about reverse mortgages offered by door-to-door and other home solicitation lenders. There have been various problems with these types of lenders. Some of the problems have involved steep points and loans that primarily seek to take the owner's equity.

You generally have at least three business days after signing a reverse mortgage contract to cancel it. The cancellation must be in writing.