Rethinking Reverse Mortgages

Unless you're the person these products were designed for, it's better to stay away.
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You bought your house for $375,000 and your neighbor just sold his for $599,000. That's great -- but unless you want to downsize or move to a cheaper part of town, the best you can do is brag about it at parties.

The mortgage industry begs to differ. It purports that a reverse mortgage could be the key to your untapped pot of gold.

And if you listen to actor James Garner, he thinks so, too. As spokesman for Financial Freedom, a California-based company that is currently the nation's largest provider of reverse mortgages, Garner is out there telling folks that reverse mortgages can be your salvation (times must be tight for the actor).

Personally, I think he should go back to the big screen and you should stay away from these things.

A reverse mortgage is just that -- instead of making monthly payments on your home to the mortgage company, it'll send you a monthly check or lump sum that you can draw on, whichever you prefer. The proceeds from this reverse loan are tax-free and will not affect your ability to qualify for Social Security. Each payment will reduce your equity in the home but you still retain title so you must keep paying your homeowner's insurance and real estate taxes. The good news is you don't have to pay the loan back until the house is sold at the very end.

Ideally, you'll die before the payments, plus interest, exceed the value of the house. In that case, your heirs would sell the house, repay the loan and get to keep the leftovers.

If you happen to be a Sicilian who thinks he's going to live forever (a.k.a. my 96-year-old grandfather), your loan payments may exceed the value of the home. In that case, it's not your problem, because these loans are insured by the government.

Sounds great. Should you consider one? Yes, but only if you're the person these products were originally created for -- an elderly person with no other assets who wants to die in his house.

"Generally we don't think they're appropriate for most people," says Michael Anderson, vice president of panning at Evensky & Katz in Coral Gables, Fla. "They're a last-resort type option."

That's because the fees are huge, the interest rates can be very high, you don't get nearly as much money as you'd expect, and your heirs may end up with nothing.

Granted, in times of desperation, these products work perfectly. If an elderly person needs the money to live, then who cares about the heirs' inheritance or the fees? The reverse mortgage will help them survive.

But for the rest of us who have savings, IRAs, 401(k)s and investment accounts, reverse mortgages should be your absolutely very last resort.

Dispelling the Unknowns

You have to be at least 62, fully own your home and live there as your primary residence to even qualify for most reverse mortgages.

Then you have three options. First, single-purpose reverse mortgages are offered by some state and local government agencies and nonprofit organizations but are generally used only for home repairs, improvements, or to pay property taxes. Next you have federally insured reverse mortgages, aka Home Equity Conversion Mortgages, or HECMs, which are backed by the U. S. Department of Housing and Urban Development, or HUD.

And finally, there are proprietary reverse mortgages available, which are private loans that are backed by the companies that develop them, a la the ones from Financial Freedom and Mr. Garner.

Granted, you must sit with a counselor who's supposed to discuss the intricacies of these products with you before you dive in. Unfortunately, there are still too many unknowns out there.

The biggest is how much you can actually get out of your house. People assume that just because the fair market value of the house is, say, $2 million, someone is going to hand them a $2 million check to draw on and pay for that trip around the world.

Not so.

Because the amount offered is generally based on the median home in your area.

The average max on a HECM is somewhere around $312,000, which is based on the median home value in most areas, says Anderson. With a private loan, the most you'll get is anywhere from 30% to 35% of the value of your house.

Anderson offers an example based on his recent research in this area. Let's take a 75-year-old who owns a home, currently valued at $3 million, in downtown Seattle.

With the HECM, our elderly person would get approximately $185,000. That's it because that's the median home value in the area. With a Financial Freedom product, he'd end up with around $924,000. Much better but the fees and interest will also be correspondingly higher. And neither loan is coming close to $3 million.

So you're not getting nearly as much money as you originally expected -- and the fees you pay on that money can be outrageous.

Most products require you to pay origination fees or points, annual servicing fees and other closing costs.

The interest rates can be steep, too. The HECM loan is the current T-bill rate plus margin. Financial Freedom's rate is based on LIBOR plus margin.

Even worse, it's difficult to lock into a rate with any of these products. Most have variable rates that cap anywhere from 12% to 15%. Big deal.

Marketing Mayhem

Remember, interest is charged on the outstanding balance and added to the amount you owe each month. That means your total debt increases over time as loan funds are advanced to you and interest accrues on the loan.

That is exactly why you should never consider this product for investment purposes, even though I know your wheels are spinning. But even a home-equity line is safer because you can lock into a rate with that loan, says Anderson.

"But in the last couple of years,

these loans have gotten away from their original premise and are now being pushed on younger homeowners for liquid cash-type purposes," says Keith Gumbinger, vice president of HSH financial publications in Pompton Plains, N.J., which tracks a variety of loan products.

Think about it. If users don't fully understand what a reverse mortgage is, they would be a very easy sell.

"Improve your lifestyle with increased cash flow!"

And plenty of people are buying into the rhetoric. Heck, even

Fortune

magazine recently suggested that readers should consider a reverse mortgage so that they could get some "dough while staying put." C'mon.

"But these products are being oversold -- and that's the word 'sold' -- because of the real estate market," says Patricia Houlihan, founder of Houlihan Financial Resource Group in Reston, Va.

"I'm leery because most people spend their lives trying to get to end with no debt in their house," says Houlihan, who says she would rather see a client in an immediate annuity if they needed a guaranteed income stream.

So beware. And if it happens that you believe a reverse mortgage is right for you or your elderly parent, then just make sure you understand all the conditions that could make the loan due and payable. Be sure your broker gives you the total annual loan cost, or TALC, rates, which shows the projected annual average cost of the reverse mortgage, including all itemized costs. This way you're not blindsided.

In addition, remember that you generally have at least three business days after signing the loan documents to cancel it for any reason without penalty, according to the FTC.

So unless you're the elderly person these products were originally created for, stay clear. Even if the sales pitch is coming from James Garner.

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