Shifting That Home Loan Into Reverse

Eric Gillin

Reverse mortgages are moving full speed ahead.

The often-misunderstood reverse mortgage, which allows homeowners to take equity out of their homes, is rising in popularity among seniors searching for a new source of retirement income.

According to the National Reverse Mortgage Lenders Association [NRMLA], about 15,000 home equity conversion loans, a form of reverse mortgage, were originated in 2001, up from 9,000 the previous year.

"Many members expect business to double over the next year," says Peter Bell, president of NRMLA. While only 60,000 reverse mortgages are in use nationwide, he says a combination of low interest rates, rising home values and a growing awareness of the product has heightened demand. And as health care costs continue to increase, many seniors are tapping home equity to cover the rising expense.

As the name suggests, reverse mortgages work in the opposite way to "forward" mortgages, which are used to buy homes. Instead of making monthly payments, a homeowner who takes out a reverse mortgage receives them, reducing home equity while increasing debt. Borrowers pay nothing as long as they live in the house, but they must settle the debt -- equity borrowed plus interest and charges -- as soon as the last living borrower moves, dies or sells the house.

"One of the biggest myths people have is that the lender takes control or has ownership of the home," Bell says.

Plus, the total debt will never be more than the value of the home at the time the loan is repaid. This limit is called a "nonrecourse" loan: A lender doesn't have legal recourse to anything other than the home's value. All other assets are off limits.

In the event of death, heirs receive the property and settle the debt, pocketing any remaining equity.

Reverse Mortgages: Forward March Originations of federally insured home equity conversion loans
Year	Number of HECM loans originated
1990	300
1991	500
1992	1,600
1993	2,500
1994	4,000
1995	3,750
1996	5,000
1997	6,000
1998	6,500
1999	7,750
2000	9,000
2001	15,000
Sources: HUD, NRMLA

To be eligible for a reverse mortgage, a borrower must be over age 62 and use the home as a primary residence. Outstanding debt against the house must be settled beforehand, or be paid off with proceeds from the reverse mortgage.

The amount received in a reverse mortgage is based on three factors: the borrower's age, the location and value of the home, and the type of loan.

Only three types of reverse mortgage exist: single-purpose, federally insured and proprietary. The first type, generally low-cost and offered by your local or state government, can be used only for a specific purpose, such as repairing your home or paying your property tax.

More than 90% of borrowers use the second type, the Home Equity Conversion Mortgage [HECM], insured by the Federal Housing Authority [FHA], a division of the U.S. Department of Housing and Urban Development [HUD], because it provides the most money at the lowest cost for the majority of homeowners, Bell says.

Proprietary reverse mortgages, backed by private companies, typically come with high expenses but may offer the greatest loan advances.

With all three types of reverse mortgages, borrowers receive payments in a lump sum, on a monthly basis, as a line of credit or some combination of the three. More than 80% take the line of credit, according to a HUD study. That's because the unused part of the line of credit increases at the same rate as the loan balance.

Consider the average person with a reverse mortgage: a 75-year-old widowed female with a home worth $100,000, according to HUD. Under a HECM, the widow is entitled to a lump-sum payment of $56,092, a monthly payment of $391 or a credit line of $56,092 that rises over time.

How Big a Lump Sum or Credit Line to Expect Here's how the payout correlates with age, home value and interest rate
Home Value	Age	7%	8%	9%
$100,000	65	$38,423	$30,455	$23,920
	70	44,383	36,771	30,040
	75	50,815	43,948	37,739
	80	57,653	51,619	46,056
	85	64,544	59,532	54,704
	90	71,257	67,263	63,363
Home Value	Age	7%	8%	9%
$150,000	65	$60,873	$48,705	$38,720
	70	69,733	58,121	48,404
	75	79,265	68,798	59,339
	80	89,353	80,169	71,706
	85	99,444	91,832	84,504
	90	109,157	103,113	97,213
Home Value	Age	7%	8%	9%
$200,000	65	$83,323	$66,955	$53,520
	70	95,083	79,471	66,404
	75	107,715	93,648	80,939
	80	121,053	108,719	97,356
	85	134,344	124,132	114,304
	90	147,057	138,963	131,063
Source: AARP

Any Catch?

Lenders make money by pinning expectations to actuary tables. "This is the first product in the world to take into account how long someone is in the home along with the rising value of the home," says Ken Scholen, a reverse mortgage specialist with AARP.

For example, to hedge against risk, lenders can charge heavier upfront fees -- up to $7,500 total on a $150,000 home. Along with closing costs and loan origination fees, lenders also charge a monthly service fee of $25 to $35 to cover processing costs.

Another way lenders hedge against risk: HECM borrowers pay the FHA a mortgage insurance premium of 2% of the home's appraised value [or of a county's equity median if the appraised value is higher than the median], as well as 0.5% to the interest rate charged on your rising loan balance. "This goes into the fund that covers the potential cost if you overrun [the value of your home]," says Jeff Taylor, vice president of senior products for Wells Fargo Home Mortgage.

This premium not only ensures that lenders don't lose money on the deal but also guarantees that borrowers receive payments for as long as they're in the home, no matter what happens to its value or to the lender. "It provides peace of mind for both halves of the transaction," Bell says.

Who Should Do a Reverse Mortgage?

Because borrowers absorb most of the cost upfront in the form of fees, reverse mortgages are an expensive solution to a short-term liquidity crisis. They certainly aren't for people planning to leave their homes in the next few years. "You're buying something you don't intend to use, because part of the cost is that FHA insurance," says Scholen.

But a recent study from the AARP shows that 83% of people age 45 or older would like to stay in their homes as long as possible. For those with limited income and all their equity tied up in a home, a reverse mortgage is a great way to remain economically independent from other family members.

The money from a reverse mortgage could cover unexpected medical costs, provide funds to make houses more senior-friendly [adding ramps, for example], or offer a means to enhance lifestyle through travel or luxury items.

For baby boomers, who tend to have more debt on their homes at an older age, reverse mortgages are an especially attractive option, says Scholen. With a reverse mortgage, seniors could erase that debt and eliminate monthly payments while providing additional income. "That will be a key factor in this market," he says.

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