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Related topics: homes, elder care, reverse mortgage, financial planning, Liz Weston

Reverse mortgages are kind of like your black-sheep uncle. No matter how much he's cleaned up his act in recent years, people are still going to be suspicious.

And reverse mortgages have certainly had their problems. These loans -- which allow people 62 and over to tap their home equity without having to pay back the money until they die or move -- can be expensive, with fat upfront fees on top of continuing insurance costs.

Reverse mortgages also can be weapons in the hands of unscrupulous salespeople who persuade vulnerable seniors to take out loans on their properties so they can invest in overpriced annuities and other unsuitable products.

Jerry Vincent of San Diego remembers trying to convince his parents several years ago that they should get a reverse mortgage so they could have more money for living expenses. The elderly couple was on the verge of signing up when a friend mentioned he'd heard something negative about these loans, although he couldn't say exactly what. That was enough to scare them, and they never went through with the deal.

"I said, 'What is the point of living a long life if every day you are stressed about where the money will come from for the next routine maintenance of the house or car? Or denying yourself health care because some costs might be out of pocket?'" Vincent remembers telling them.

"Both of my parents ended up living hand to mouth until they died. I just wish I could have eased some of that stress for them."

Image: Liz Weston

Liz Weston

Tougher regulation, new restrictions on fees and a brand-new type of federally backed reverse mortgage that's substantially cheaper have made these loans better deals for more seniors. There's anecdotal evidence that reverse mortgages may be helping some older people avoid foreclosure, replacing unaffordable payments with a no-payment loan, said real estate columnist Tom Kelly, the author of "The New Reverse Mortgage Formula."

"They can get a reverse mortgage and not have to worry about (mortgage) payments for the rest of their lives," Kelly said. "If they have enough equity and the loan balance is low enough, they can take out a reverse to simply stop the payments, plus have the possibility of pulling more cash out."

Paul Lints, 45, is helping his 85-year-old father set up a reverse mortgage on the dad's St. Louis home. The proceeds will be enough to pay off the $113,000 balance on the first mortgage, a $100,000 home equity loan balance plus $85,000 in credit card debt.

"My dad's been so strapped . . . and this will free up $3,000 to $4,000 a month for him, easy," said Lints, a private banker with PNC. "I'm not looking at it like, 'There goes my inheritance.' I told him, 'You worked your whole life. You've done everything a parent's supposed to do. . . . This is your money and your house.'"

All this still doesn't make a reverse mortgage a slam-dunk move, however, so if you're considering one or want to help your parents decide whether one makes sense, you'll need to do your research. Here's what you need to know:

How they work

A reverse mortgage is a loan against a home's equity, but no monthly payments are due, and the loan doesn't have to be paid back until the borrower dies or moves out. Seniors can get the money as a lump sum, a stream of monthly checks or a line of credit they can tap at will.

How much they can borrow depends mostly on their age, prevailing interest rates, the value of their homes and the caps of the lending program they choose. (AARP has a calculator that can give you a rough idea of how much can be borrowed.)

Seniors don't have to own their homes free and clear to get a reverse mortgage. If they have enough equity built up, they can get a reverse mortgage to pay off their current mortgage. ("Enough" is a relative term -- again, check the AARP calculator to see how much can be borrowed in each homeowner's situation.) This won't help homeowners who are "underwater" or anywhere close to it, since reverse mortgages typically max out at less than 60% of a home's value.

And a reverse mortgage doesn't wipe away other home-related bills. Reverse mortgage borrowers still need to keep current on homeowners insurance, property taxes and homeowners association fees. Otherwise, the loan would be considered in default. Technically, that could result in foreclosure, although the Federal Housing Administration has never thrown a reverse mortgage borrower out of a home and is unlikely to do so, said Peter Bell, the president of the National Reverse Mortgage Lenders Association. The FHA is pressuring lenders to take action on defaulted mortgages, but it wants action that's aimed at counseling borrowers and creating plans to help them get current on their obligations, Bell said.

Who makes them

These days, the vast majority of reverse mortgages are made under the FHA's federally backed Home Equity Conversion Mortgage, or HECM, program. Before the financial crisis, some private loans were available that allowed homeowners to tap more of their equity than was allowed by the FHA, but that market has all but disappeared, Bell said.

The amount that you can borrow is based on either your home's appraised value or the HECM limit of $625,500, whichever is lower.

FHA loans come in two basic flavors:

  • The standard option allows you to borrow somewhat more but comes with a higher upfront insurance premium, which equals 2% of your home's value (or $6,000 on a home worth $300,000).
  • The recently introduced HECM Saver allows you to borrow 10% to 18% less than the standard option, but the upfront insurance premium is just 0.01% (or $30 on a $300,000 home).