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Reverse mortgages

A new loan concept for elderly homeowners who have lots of equity but little cash.

Frank Grandone, 69, a retired textile factory worker, never seemed able to make much of a dent in the $28,000 in debt he had from a home equity loan, credit-card charges, and other bills.

House rich and cash poor, with only Social Security for income, last month Grandone decided to get a so-called reverse mortgage, allowing him to tap the equity in his home to pay off the old debt and get a credit line, without having to add new monthly payments.

"I've been here 27 years," says Grandone, who owns a five-room ranch-style house in Worcester and got the reverse mortgage through Wells Fargo Home Mortgage, one of the nation's largest reverse mortgage lenders. "It was one thing or another. I did the reverse mortgage instead of selling it and moving out."

Reverse mortgages, a relatively new financing instrument, allow the elderly to get cash from what is usually their major, if not only, asset - their home.

Just as the name implies, reverse mortgages work in the opposite way that a traditional house mortgage works.

Instead of making a monthly mortgage payment, paying down the debt and building equity, the homeowner with a reverse mortgage receives a monthly check, a credit line, or a lump sum, while the loan balance grows and the equity shrinks. The reverse mortgage is typically paid off when the homeowner sells, moves out permanently, or dies, although some must be paid off with the sale of the home after a certain number of years.

Reverse mortgages are typically not offered at fixed rates, and the interest is adjusted annually or monthly, with varying caps, depending on the version chosen. Currently, interest rates for reverse mortgages range between about 7.4 percent and 10 percent.

"It is a very good way to turn equity in property into immediate cash," says Frank Pilk, senior product manager for Fannie Mae, which offers a reverse mortgage known as Home Keeper. "It's certainly worth investigating," along with other options, he says.

But reverse mortgages are not for everyone.

They are one of the more expensive ways to borrow money, because interest compounds, the loan balance keeps growing, and no payments are made until the end. The mortgage could use up the equity in the house, leaving little or nothing for heirs.

Leonard Raymond, director of Homeowner Options for Massachusetts Elders, or HOME, acknowledges that his agency prefers to avoid loans to help seniors solve financial problems. He says reverse mortgages are extremely expensive transactions. "They're wonderful innovations," says Raymond, but may come with high closing costs, monthly compounding of interest, monthly mortgage insurance that rises with the loan balance, and servicing fees. Instead, HOME works with elders to find other alternatives to meet specific cash needs and uses reverse mortgages as a last resort.

But thousands of elderly homeowners nationwide, like Grandone, have found reverse mortgages suit their needs. "So far I'm satisfied," says Grandone, who has an available line of credit of more than $20,000 in addition to $28,000 he received in a lump sum to pay off the old debt. "It's there to dig into if I want. You try not to." As long as he doesn't tap his credit line, he won't lose more equity in his house.

In May, Andrew Cuomo, secretary of the US Department of Housing and Urban Development, reported that the number of HUD-backed reverse mortgages had more than quadrupled since the early 1990s, to about 40,000 today. HUD also found that 78 percent of those getting the agency-backed mortgages were either very satisfied or satisfied.

It is estimated that more than 12 million homeowners are 62 or older and, therefore, eligible to participate in the HUD program. The number is expected to grow as baby boomers age.

A Cornell University study suggests that more than 620,000 low-income elderly homeowners could lift their income above the poverty level with a reverse mortgage.

Since the first reverse mortgages were written under a HUD demonstration program in the late 1980s, various types of such loans have been created and various lenders have gotten into the business. Each product works differently and comes with its own set of advantages and disadvantages.

"It's important for consumers to take their time and not to make the decision too quickly," says Bronwyn Belling, a reverse mortgage specialist with the Washington-based American Association of Retired Persons Foundation.

She suggests that seniors consider other options to meet their specific needs before considering a reverse mortgage. For instance, many communities offer property tax deferral programs for seniors unable to pay their tax bills, or assistance for medical or heating bills.

Advocates for the elderly recommend that seniors get free or low-cost reverse mortgage counseling from a HUD-approved agency and make use of such resources as HOME in Boston and the nonprofit National Center for Home Equity Conversion in St. Paul. They also warn elderly homeowners to beware of estate planning services that charge a percentage of a reverse mortgage, usually amounting to thousands of dollars, just for providing mortgage information and a lender referral, both of which should be easily available at no charge. Some lenders, such as Atlanta-based Unity Mortgage and Wells Fargo, refuse to do business with estate planning services that charge such fees.

Here are some other things to consider before taking out a reverse mortgage:

While the money from a reverse mortgage is tax-free because it's considered a loan advance and not taxable income, the cash may still affect your eligibility for Medicaid and Supplemental Security Income. However, it does not affect Medicare or Social Security benefits.

Because of a complicated formula that takes into account average life expectancy, and because the amount paid back can never be greater than the value of the house when it's sold or passed to heirs, a reverse mortgage's cost is lowest for people who live longer than expected and whose property values appreciate less than expected.

There are three basic types of reverse mortgages: the HUD-backed mortgage, the lender-insured mortgage, and the uninsured mortgage. In most cases, the mortgagor can receive his or her cash as either one lump sum, a monthly check, a line of credit, or some combination of the three. How much you can get depends on your age (the older you are, the more money you may qualify for), the value of your house, the interest rate, and the type of mortgage program you choose.

Reverse mortgages are only available on primary residences. To qualify, you must be at least 62 years old and own your home free and clear (or use a lump sum from the reverse mortgage to pay off existing debt). The home must also meet standards set out by each mortgage program. For instance, some programs won't write a reverse mortgage for condominiums, while others will.

Many reverse mortgages are open-ended and don't have to be paid back until the homeowner sells, moves out permanently, or dies. The money to pay back the loan comes either from the owner's sale of the house or, if the owner dies, from the heirs selling it or getting a traditional mortgage to pay off the reverse mortgage.

The amount paid back on an open-ended reverse mortgage can't ever be more than what the house is worth. A monthly mortgage insurance premium that may be added to the loan balance covers the lender in case the house is worth less than the loan balance.

There are also so-called term reverse mortgages that come due after a set period and are typically paid off with the sale of the house. These are usually less costly than open-ended mortgages and help to preserve more of the equity in the house for the owner or his or her estate. The HOME program offers such mortgages in Massachusetts.

The leading type of reverse mortgage is the HUD-backed and Federal Housing Administration-insured product, called the Home Equity Conversion Mortgage, or HECM. It's available through such private lenders as Wells Fargo and Unity Mortgage, which both do business in Massachusetts. Primarily intended for low- and moderate-income families, this mortgage is limited by FHA maximum mortgage amounts, depending on housing costs in your area. It can't exceed about $209,000. The FHA insurance guarantees advances will continue if a lender defaults, but it also makes the loan more expensive.

If you use the HECM for a credit line and don't draw on it all at once, the unused portion of the credit grows over time, allowing you to have more money later.

An example of a lender-insured mortgage is the Home Keeper Mortgage by Fannie Mae, a federally chartered, publicly traded company that provides the nation's largest source of funds for home mortgages. The Home Keeper is also available through private lenders.

The Fannie Mae loan has a higher maximum, $252,700, than the HECM, but that means the final amount owed is higher. The Home Keeper's credit line is set at a flat amount and doesn't grow over time as the HECM's does.

There also is the uninsured mortgage, which provides fixed monthly amounts for a set number of years. The balance must be paid when it comes due, either by selling the house or by using other assets to pay off the loan.

In Massachusetts, the Boston-based HOME program also has worked with more than 60 community banks on a specially designed loan that meets an elder's needs while growing to no more than about 60 percent or 65 percent of the value of the home, over a term of between two and 15 years. That preserves some equity so that when the house is sold at the end of the term, there's enough money to help the senior make the transition to a new residence.

While all reverse mortgages are expensive, HOME prides itself on the lower cost of its term reverse mortgages, which have lower closing costs, no mortgage insurance, and are not sold to other lenders. The money can be received as a lump sum or a monthly payment.

This product may be appropriate for elderly homeowners facing in-home care situations, says Raymond, because it preserves equity, which can then be used for expenses related to the transition to a new residential situation such as an assisted living or nursing care facility.

It also may be appropriate for those who are ineligible for other reverse mortgages. "We had a woman just recently who got a term reverse mortgage," says Raymond. "She was in her 60s and facing foreclosure. With the size of her debt, she couldn't qualify for an open-ended reverse mortgage."

By using a term reverse mortgage, she was able to spend three more years in her house and still walk away with 35 percent of the equity while avoiding a foreclosure auction, says Raymond.

As reverse mortgages grow more popular, lenders are increasing the number of options available to seniors. Says Belling of the AARP Foundation, "Make sure you get a lender who tells you all your choices."