NEW YORK (
BankingMyWay) -- For all its expenses and confusing terms, a reverse mortgage can be a godsend for an older homeowner, allowing one to tap home equity without having to make loan payments or move out. But a new study from a government consumer watchdog finds that typical borrowers do exactly what the experts say they shouldn't -- tapping too much equity too soon. The study, released this week by the Consumer Financial Protection Bureau, found that the most common age for taking out a reverse mortgage is 62, the first year a homeowner is eligible. Two out of three homeowners using reverse mortgages take lump sums rather than steady income or a line of credit. In other words, these borrowers have ignored, or are unaware of, the best advice: to take a reverse mortgage as late in life as possible, and to borrow a little rather than a lot. To back up for a second, a reverse mortgage is a federally backed loan against the equity in the home, which is the difference between the home's value and any debt remaining on a mortgage or home equity loan. Unlike a regular mortgage or home equity loan, a reverse mortgage requires no monthly payments. Instead, the debt and interest charges are paid when the home is sold, the owner moves or dies. This total can never exceed the proceeds from selling the home, so the borrower's other assets are not as risk. Because there are no payments, the homeowner does not need an income to qualify for one of these loans. These features obviously pose a risk for lenders, who compensate by limiting these loans to less than the home's value at the time the deal is closed. The older you are, the more you can borrow on a home of a given worth, since there is less risk you'll live long enough for the debt to grow larger than the property's value. If the home eventually sells for more than the debt, the difference goes to the owner or owner's heirs. Owners who take loans when they are younger can borrow less and are less likely to have any equity left 10, 20 or 30 years later, when all their other financial assets are more likely to be gone. Borrowing at 62 increases the chances you will run short of money at 85.
Borrowing the maximum in a lump sum compounds this risk because the snowballing interest charges will be bigger. Because interest charges are deferred, they are added to the debt, forcing the borrower to pay interest on interest. The bigger the debt and the longer you have it, the more dramatic the effect. So why are so many reverse-mortgage borrowers so reckless? Economic conditions and the slow to recover housing market are probably one reason. People who need money and cannot sell their homes, or feel prices are too low, may resort to reverse loans out of desperation. Others may find the chance to tap equity without monthly payments irresistible. The CFPB worries that many homeowners have been conned by lenders seeking big fees, another of the reverse mortgage's shortcomings. Before choosing a reverse mortgage, the homeowner should weigh alternatives like taking out a standard mortgage with payments, downsizing or getting a home equity installment loan or line of credit. The reverse mortgage is best kept as an ace up your sleeve -- the income source to tap late in life when everything else is gone. --By Jeff Brown Follow TheStreet on Twitter and become a fan on Facebook.