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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).

In addition to the upfront premium, there's a continuing annual insurance premium that equals 1.25% of the outstanding loan balance. If you borrowed a lump sum of $150,000 against that $300,000 home, the annual insurance premium would equal $1,875 the first year and would rise as your debt rose.

There is also now an HECM for Purchase Program, which allows older homeowners to make large down payments on new homes and then use reverse mortgages to finance the rest of the costs. This program was created after FHA officials noticed some seniors were downsizing and then getting a reverse mortgage on their new property, paying closing costs twice -- first on the real estate closing and then on the reverse mortgage. The HECM for Purchase has just one set of fees, although as with other reverse mortgages, the homeowner must have substantial equity in his or her current home.

What they cost

In addition to the insurance premiums, you'll face lender fees: an origination fee of up to $6,000 plus closing costs. Some lenders are waiving or reducing these fees, but combined with the insurance costs they can add $15,000 or more to the cost of the loan.

It's important to understand that you don't typically pay these fees out of pocket. They're deducted from your loan amount, so interest accrues on these costs as well as on the money you actually get to use. Since you don't make payments on this loan, your debt grows over time.

It's the traditionally high cost of reverse mortgages that made them a "last resort" option for so many years -- to be considered only after you've exhausted all your other assets. Even downsizing -- selling your home and moving, despite the considerable expenses involved -- was often recommended as a better option, when such a move was feasible and the senior was willing to consider it.

The reduced costs of the HECM Saver have changed the math, however. Now a senior might consider a reverse mortgage instead of tapping other assets, or even if she didn't plan to be in the home for years to come. In fact, Kelly said, it might be an option to go for an HECM Saver while waiting a few years for the housing market to recover, so she could sell it at a higher price.

What the dangers are

There are a number of drawbacks to consider, some obvious, some less so. Here are some of them:

  • Because the accumulated debt grows over time, there may be little or no equity left in the home after the borrower dies or moves out and the loan has to be paid off. That's one of the concerns that Vincent's parents had. "As their only major asset, they felt that their home was supposed to be left for the children," he said. "As virtuous as that was, I tried to convey to them to take care of themselves first and that it was a quality-of-life issue."
  • Complications can ensue if a borrower's spouse or significant other is not on the loan but wants to continue living in the home after the borrower dies or moves out permanently, such as to a nursing home. A change in HUD rules made during the last Bush administration requires the spouse or significant other to pay off the entire loan, even if the balance exceeds the home's value. (See "HUD sued over reverse-mortgage rules.")
  • Homeowners may pull the trigger too soon. If you tap your home equity and run through the money, you won't have that resource to draw on if you later encounter big expenses such as long-term care bills or home repairs. That's why experts recommend putting off a reverse mortgage as long as possible rather than applying for one in your 60s or early 70s and then having to be careful not to squander the cash. If the borrower is in a jam because of overspending, a reverse mortgage won't fix the problem -- it will only postpone the day he or she runs out of cash.
  • Reverse mortgages are complex. They're quite different from conventional mortgages, and there are a lot of moving parts, from the various fees charged to the payout options (there are five) to the interest rates (typically variable, but fixed for the lump-sum payout option). It can be tough for borrowers to wrap their heads around all these details.
  • There may be better options. Some consumer advocates are concerned that lenders eager to make these loans may railroad seniors into deals when the borrowers might be better off refinancing, downsizing, using other assets or arranging a loan from a family member. Here's what Consumers Union said in a recent report: "While the reverse mortgage market continues to grow, there are deep concerns about the suitability of the products for some borrowers, the aggressive marketing and misleading advertising of reverse mortgages to seniors, the susceptibility of vulnerable borrowers to deceptive marketing involving complicated financial products, and the inadequacy of consumer protections to prevent loan abuses that can hurt eligible borrowers."
  • The default issue is something to consider as well. If the house is too expensive to maintain and insure, or if the borrower can't handle the property taxes, the loan would be considered in default and the borrower would be cut off from any remaining funds. He or she could no longer tap the line of credit or receive monthly checks.

Anyone considering a reverse mortgage should review the information on the Department of Housing and Urban Development's website, including a link to a pamphlet about the loans prepared by AARP (.pdf file).

If a reverse mortgage still looks like a good option, take the following steps:

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  • Shop like crazy. Just because HECM loans are federally backed doesn't mean they're all the same. They're made through private lenders, which compete with each other on fees and other costs. Get several offers before deciding.
  • Get help evaluating the deal. The FHA requires borrowers to get counseling from a HUD-approved counselor before a reverse mortgage can be approved, but some -- including the Government Accountability Office (.pdf file) -- feel the counseling may be inadequate. Lenders don't have a fiduciary duty to borrowers, so anyone considering a reverse mortgage would be smart to get a second opinion from a knowledgeable, objective professional -- such as a CPA or fee-only financial planner familiar with reverse mortgages or a lawyer who specializes in elder law. (Referrals can be found from the National Association of Elder Law Attorneys.)
  • Don't use the money to invest or to buy insurance. Reverse mortgages aren't a speculative play. They're meant to be used by seniors who need more money on which to live and who have few other options. An investment salesperson may make gambling with home equity sound like a smart deal, but it's not -- the only person sure to benefit is the person earning the commission on the product being sold.
  • Create a budget. If the borrower is broke because of overspending, the reverse mortgage won't really fix the problem. Set up a consultation with a fee-only financial planner or a legitimate credit counselor (get referrals from the National Foundation for Credit Counseling) to create a spending plan the senior can live with.

Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.