Paychecks from Your House: Understanding Reverse Mortgages

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People tend to shy away from the very idea of reverse mortgages, partly because of their former bad rap and partly because of all the scary terminology. If you're one of millions of people who are unfamiliar with real estate terms, when someone starts spouting off about how you can "utilize the equity in your home on deferred payments with a conversion mortgage," chances are pretty good you're going to tune it out.

In fact, that's why we wrote this article: to give seniors and their families facts and tips about reverse mortgages in language that's as approachable as a big-eyed puppy (unless you're a cat person " then just think of it as a little fluffy kitten). We want you to fully understand the benefits and disadvantages of getting a reverse mortgage. We want you to walk into that loan originator's office knowing exactly what you want. And most important, we want you to feel good about whatever decision you make for your financial future.

Checking out how it works

Reverse mortgages pay you to continue living in your home. You can think of your home as the Bank of You: You're borrowing money that you would have earned had you sold your house. You can then use the money for whatever you want. Anything your heart desires (and your wallet can handle) is yours for the taking, whether it's vacationing in Switzerland, moving your master bedroom to the first floor, or sending yourself to college!

The concept is kind of abstract if you've been paying a lender for the past 30 years or so, and it may be difficult to grasp at first. Take a look at the following quick reference points. When you get the gist of it, you can educate your friends and family about reverse mortgages. Next time you're at a cocktail party, holiday dinner, social lunch, or anywhere else reverse mortgages may come up in conversation, you can dazzle everyone with your knowledge.

Consider this quick rundown:

• You're a homeowner who owes little or nothing on your home. You decide you need more money to live the lifestyle you want, but your biggest asset is your home and you certainly don't want to sell it to get the money you need.
• A reverse mortgage lender figures out how much it can lend you based on your home value, your age, and interest rates, and lends you some percentage of the money you would have gotten if you'd decided to sell your home.
• You still own your home and continue to live in it, but now you're
  getting payments from the lender, so you've solved your cash flow
  problem.
• You pay back the loan (with interest) only when you don't live in the house full time anymore, usually when you move out or die.
• You never owe more than your home is worth, no matter how much you've accumulated in debt.
• You keep any leftover equity after the sale of the house; if you owe the lender $67,000 and your home sells for $200,000, you put the difference in your pocket and walk away smiling.

A reverse mortgage is sometimes called a deferred payment loan, for a very good reason. Instead of paying off the home loan as you borrow money, you put off (defer) the payments. Reverse mortgages can be such a good choice for seniors because, when you have a fixed income or are living off of your savings, it can help to have some extra cash in hand to supplement. Because payment is deferred, you are spending the equity in your home instead of earning it (as you would with a traditional forward mortgage). Because equity is an intangible value, you never feel the effects of the equity going down, but you sure feel the money flowing steadily into your checking account.

Being over the hill pays off

Society experiences a lot of ageism today, especially from employers and retailers. Even Hollywood starlets have a hard time finding work at a certain age. After a while, you may start to think that the only advantage to old age is the 10-percent-off discount on Tuesdays at the local Bar & Grille. But reverse mortgages operate for seniors only " whippersnappers need not apply. If you are a homeowner age 62 or older, you will probably qualify for a reverse mortgage and you won't need to worry about credit scores or income requirements.

Even better, the older you are, the more money you can usually get from your reverse mortgage. The reverse mortgage lenders (big companies such as the Department of Housing and Urban Development, Fannie Mae, and Financial Freedom) are playing the odds. If you're 86, chances are good that they won't have to service your loan for very long " you may need to move to assisted living or will die within only a few years, thus ending the loan. A 62-year-old, by contrast, probably has about 20 good years before the lender even needs to think about ending the loan. When has your age ever worked to your advantage like this?

Getting rid of common misconceptions

Seniors often tell us that they were considering a reverse mortgage until a friend or relative said something like, "Reverse mortgage? Don't you dare! They'll take your house! Stay away!" We'd like to say that these fears are completely unfounded; unfortunately, they stem from a very old version of reverse mortgage (which is no longer done) that, in hindsight, wasn't such a hot idea. Today's reverse mortgages are safe, effective, and definitely in the best interest of the borrower. It's a whole new generation of loans. Although they were revamped and vastly improved in the past 20 or so years, people still tend to think of them as a poor choice for seniors. We're here to fix that. Take a look at these misconceptions and the truths that follow:

• The lender gets your house. This fallacy is by far the most widely misunderstood about reverse mortgages. In fact, you keep ownership of your home. The lender has no rights to your home and can't foreclose on you as long as you keep up with your taxes and insurance. Part of the confusion about this area stems from the fact that many reverse-mortgage borrowers choose to sell their homes to pay off the loan when they move. And it makes perfect sense " why do you need that house if you're not living there? But remember, you're selling to another regular buyer, not the lender.
• You'll have no estate left. This one is sort of up to you. If you own anything when you die, you'll have an estate left. If you spent all your money on pinball machines and then donated everything else to charity, you won't. Many seniors are concerned that a reverse mortgage keeps them from leaving anything to their children. The fact is, the way you pay off your loan is up to you and your heirs. You also decide who you want to leave your estate to. Unless you form an emotional bond with your lender and leave your estate to it, your family or whomever you name in your will is the inheritor of your estate. Of course, they need to pay back the loan, but it's up to them how they carry out that responsibility.
• You won't qualify because of poor credit. If you have bad credit, or even moderate credit, you may have been turned down for a loan in the past. It's embarrassing, frustrating, and inconvenient. Reverse mortgages work differently: You can never be denied a loan because of bad credit " it's not even a consideration in your approval. The originator or lender runs a credit report, but it's only to make sure you don't owe the government any money (usually in back taxes). If you do, you have to use a portion of your reverse mortgage money to pay back those debts before you can start spending on yourself.
• You must be debt free. Although you are required to own a home to get a reverse mortgage, you don't have to own it "free and clear." One of the benefits of a reverse mortgage is that it can help pay off your remaining forward mortgage, leaving you without house payments for what may be the first time in your adult life. Here's how it works: The lender determines how much it can let you borrow and then deducts the amount you still owe from your available funds. That money pays off the first loan, and then you're free to do what you want with the rest of the money.
• Only desperate people get reverse mortgages. At one time, this assumption may have been true. However, today's reverse-mortgage borrower is more likely to get a loan out of want than need. In fact, a growing number of people who have no immediate need are taking out these loans because they like the security of having a financial cushion or are planning for future expenses. Take a look around and ask yourself if you could use several thousand dollars. Who doesn't? Don't let an antiquated stigma keep you from getting the money you want or need.

Knowing what it isn't

A reverse mortgage can be a lot of things: a way to make ends meet, a nice chunk of change for a rainy day, a fabulous dream vacation, or a remodeled kitchen. But it's definitely not free money. Reverse mortgages offer many wonderful benefits, but your loan must be paid back, just like any other loan (whether it's due when you move or upon your death).

The fees involved can include payments to the originator, the appraiser, postage fees, flood certificate fees, recording fees . . . the list goes on and on. Of course, these fees are the same sort you paid for the mortgage that bought you the home you live in now. You also have to pay interest on your loan, which is generally right around the interest rates on traditional mortgages. You pay interest only on what you borrow, so any money that you don't use from your pool of reverse mortgage funds isn't charged. People still get the idea, however, that lenders simply hand you checks every month out of the goodness of their hearts. Now, they're not bad people, but they certainly aren't looking to give away billions of dollars per year in reverse mortgages.

Because it's not a cheap loan, a reverse mortgage is also not the best way to pay off a small debt. Would you really want to spend several thousand dollars in fees and closing costs just to pay back a $900 credit card debt? You know that wouldn't make sense. But what if you owed the IRS $12,000 in back taxes? In most cases, a reverse mortgage is still too costly for this kind of debt. Okay, that's easy for us to say, and if it looks like the best option, then by all means take the first step and call a reverse mortgage counselor. If you're in a similar situation, you may also contact a financial planner who specializes in seniors' money. In fact, you can probably ask a reverse mortgage originator to refer you to someone. They love to hand out referrals.

A reverse mortgage is also not a direct value-to-dollar loan. In other words, a lender won't lend you the actual value of your home; you'll get a percentage of that value, based on age, interest rates, and area. For example, a 66-year-old in a high-end county with a $500,000 home may expect to receive around $200,000 with a Home Equity Conversion Mortgage (depending on interest rates). Don't expect the full value of your home, or you'll be very disappointed. Before you make plans to spend money you don't yet have, go online to www.reversemortgage.org and click on the reverse mortgage calculator. This very cool tool gives you an estimate of what you may be able to borrow. Remember, you're not selling your home for the amount you're lent " you're simply borrowing equity that you already own.

Finally, a reverse mortgage is not a panacea or some kind of all-encompassing loan that's right for everyone. Just because you qualify by being a 62-year-old homeowner doesn't mean you're an ideal candidate. Consider a few of the basics:

• Are you at least 62 and own your own home?
• Do you plan to be in your home for at least five years?
• If you're getting the loan to purchase or pay off something specific, have you looked into other options for financing those expenses?
• Are you comfortable with the terms of the loan?

The more of these questions you can answer "yes" to, the more ready you are for a reverse mortgage. When you feel you meet all of these suggested criteria, you're ready to seek out a reverse mortgage counselor.

This article was authored by Ted Benna, Stephen R. Bucci, James P. Caher, John M. Caher, N. Brian Caverly, Peter Economy, Jack Hungelmann, John E. Lucas, Sarah Glendon Lyons, Margaret A. Munro, Brenda Watson Newmann, Mary Reed, Jordan S. Simon, Kathleen Sindell, Deborah Taylor-Hough, John Ventura.