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Reverse Mortgage

Might a reverse mortgage be an optimific option for you?

Let’s assume that you are 62 or older and own your own home.  Either it’s a single-family home that is your primary residence or your primary residence is one unit of a property that has 4 or fewer units on a single tax map.

Equity is the market value of your home less the amount required to pay off the balance of the mortgage.  If your home would sell for $300,000 and the amount required to pay off your mortgage is $170,000, you have about $130,000 equity in your home.

If you own your home free and clear, a reverse or backward mortgage is the wrong option for you.  Your best option to obtain money from the equity in your home might be a home equity loan or a line of credit.  Even if you never use one, because it shows up as a second mortgage, it will help protect you from lawsuits.

Realize that you may need to tap into that equity in some point in the future.    It’s almost always foolish to take money out of the equity in your home for any consumer purchases such as a new car or vacation.  It’s wise to consider obtaining a backward mortgage loan or any other kind of loan using your equity as collateral only if you absolutely require money for a necessary expense such as health care or to acquire an asset.

If you have a (forward) mortgage on your home, a backward mortgage might be the best choice for you.  Let’s consider it.

Essentially, a reverse mortgage is a way of refinancing your home.  It’s a way of obtaining a loan that enables a borrower to convert a portion of the equity in a home into cash.

The amount you receive in cash from a backward mortgage refinancing would be the amount of the balance on your present mortgage subtracted from the new loan amount.  (See the example below.)

The bank would pay off your present mortgage and you would have no more principle or interest payments on your property until you die.  You would still own the property and pay for insurance, taxes, and maintenance just as you do now.  When you die, your heirs would inherit your home and be responsible for paying off the backward mortgage.

Therefore, a backward mortgage does not free up equity in your home to use for other purposes.

The biggest advantages of a backward mortgage to you, the homeowner, are that you would never have any more monthly principle or interest payments on your property, which would obviously increase your monthly cash flow, and you would receive a one-time payment that you could use for almost anything you wanted.

The only good you could not use the cash to purchase would be another primary residence.  If you did that and the lender discovered it, the loan could be called due.

The biggest disadvantage to you is that a reverse mortgage is very expensive.

The amount required to pay off the loan grows each month.  Because of compound interest, the younger you are when you do a backward mortgage, the more it will cost eventually to retire the loan.  Even if you should you sell and move after only a few years, however, high up-front costs make these loans very expensive.

Let’s consider a concrete example.  The following is a current [February 2012] example I obtained from a banker who has been doing these kinds of loans for over twenty years.  Of course, it’s extremely unlikely that the figures used will match yours if you take out a reverse mortgage, but they’ll give you the idea.

The overall plan is this: the lender will pay off your mortgage and give you cash in exchange for your loan commitment. You will live in your home until you die without making monthly mortgage and interest payments.  You’ll continue to pay for taxes, insurance, and maintenance.

When you die, your heirs will inherit the loan along with your home.  They will have to pay off the reverse mortgage loan at the rate you selected when you took it out.  It may be either a fixed or an adjustable rate.

How much money will you receive if you take out a reverse mortgage loan?  Here are some current estimates.

Let’s suppose that you owe $170,000 on a first mortgage and take out a reverse mortgage loan at a fixed rate of interest at 4.99%.  The amount you receive would depend upon the appraisal the bank will have done on your property.

The higher the appraisal, the more you will receive. For example, a $318,000 appraisal would get you about $27,000. A $340,000 appraisal would get you about $40,000. A $390,000 appraisal would get you about $71,000.

If you are interested in obtaining a reverse mortgage loan, the first step is mandatory counseling.  You can do it right over the telephone from your home.  You’ll probably have to pay for it ($125), but that payment may be refunded to you when, and if, you close the loan.

The second step is the appraisal.  Again, you’ll probably have to pay for it, but that payment may be refunded to you when, and if, you close the loan.  Expect it to cost at least $300.

If the appraisal doesn’t come in high enough to suit you, just pay for it and walk away.

If the appraisal comes in high enough to suit you, you’ll probably have to pay 2% of the appraised value to the FHA at closing.  All other closing costs are negotiable with the lender.

To determine the value of the reverse mortgage, just add the balance of the first mortgage to the cash you’d receive.  So, for example, with the $318,000 appraisal, the value of the loan would initially be $197,000 ($170,000 plus $27,000).

Because you won’t be making monthly payments on it, it will grow each month.  That’s the difference between a reverse and a forward mortgage.

Typically, a reverse mortgage will be made at 62 to 65% loan to value.  The collateral for the loan is a portion of the equity of your property.  This protects the lender.

If you take out a reverse mortgage loan, the lender will pay off your current mortgage. You probably already understand that a (forward) mortgage loan is structured so that initially the amount you pay each month goes mostly towards the interest and not the principle.  That amount decreases so that, as time goes by, you are paying a bit more towards retiring the principle each month.

Therefore, if you pay off a mortgage early, you are losing the money you paid on its interest.  This is another disadvantage of taking out a reverse mortgage loan that pays off your (forward) mortgage.

On the other hand, this will probably be partially offset by the fact that you gained income tax breaks for those interest payments.

Here’s another factor to consider.  Recently, housing prices have fallen by about one-third nationwide.  In many areas, they are likely to fall farther.  The real estate bubble that began to deflate in 2007 is still deflating.

Typically, too, bubbles over-correct. Therefore, if you wait to get a home equity loan, a line of credit based on the equity in your home, or a reverse mortgage, you are risking a lower appraisal.

The market value is never known until a property actually sells.  An appraisal provides only an estimate of actual market value.   If you do take out a reverse mortgage loan, you should be able to pay it off at any time without penalty.  Don’t worry:  the lender will make plenty of money whether the loan is retired sooner or later!

Assuming you are qualified for a reverse mortgage, if you genuinely need money now, what should you do?

I don’t know.

My best suggestion is to try to obtain a home equity loan or line of credit before seriously considering a reverse mortgage.

If you must consider a reverse mortgage, you’ll be doing yourself a favor if you do not take one out unless you really need the cash and have no other options.  It might even be better to sell your home and either downsize or rent.

The bottom line is that a reverse mortgage is a very expensive way to obtain a loan.

If you are nevertheless interested, you may obtain more information from the government.

As always, please consider forwarding this to a loved one if that person might benefit from it.

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