USE REVERSE MORTGAGES WITH CAUTION

Many older house-rich, cash-poor Americans may want to consider reverse mortgages as a source of supplemental cash, but they should tap into this source only after careful review and consideration of financing alternatives, caution many CERTIFIED FINANCIAL PLANNER™ professionals.

A reverse mortgage is a loan against the equity in your home that, unlike a standard home equity loan or line of credit, you don’t have to pay back until you sell the home, permanently move away or die. Unlike a standard mortgage, where your mortgage payments reduce debt and build equity, reverse mortgages reduce equity and build debt.

With few exceptions, to take out a reverse mortgage you and any other owners of the home must be 62 or older and own the property free and clear. If you still owe money on your regular mortgage, you must either pay off the old debt first or use money from the reverse mortgage to immediately pay off the old mortgage. In addition, you don’t have income, asset or medical requirements to qualify.

You can take out the cash from a reverse mortgage in a lump sum, fixed monthly payments for up to life, a line of credit or a combination. The amount you can draw out depends on several factors: the amount of available equity, your age (the older you are, the more you can get), the interest rate charged by the lender, and in some cases, where you live.

For example, using a calculator provided by AARP at www.reverse.org, a 70-year-old single woman with a home valued at $300,000 might receive a lump sum or line of credit of $122,180, or monthly payments for life of $809.

One other especially important fact that many homeowners are confused about regarding reverse mortgages: You continue to own your home during the time of the reverse mortgage, and you don’t have to pay back principal or interest for as long as you own and occupy the home. Let’s say you take out fixed payments for life. Upon your death, the mortgage lender recoups the payments it made, plus accumulated interest payments and other upfront costs (if rolled into the loan) from the sale of the home. (You or your heirs do have the option of paying off the lender by other means and keeping the property). Any equity left after the lender is paid off usually is passed on to your heirs, though some reverse mortgages are designed to share in any appreciation of your home during the time of the loan. Another feature is that you never can owe more than what your home is worth, even if you live long enough that the total payments exceed the total equity in your home.

Some state or local governments offer reverse mortgages for single purposes, but most loans are taken out through private lenders. Most private loans are backed by the Housing and Urban Development’s FHA program, which limits the amount of equity that can be borrowed against. Private lenders will lend against higher equity values, but their interest rates and costs are typically much higher.

With the exception of single-purpose government loans, homeowners can use a reverse mortgage for anything, including home repairs, medical and prescription bills, long-term care insurance, property taxes, to pay off other debts, or just to help supplement daily living needs.

While reverse mortgages can be an excellent option for cash-strapped older homeowners, CFP™ professionals recommend that you check other funding options that might be less expensive or that don’t commit your home, including selling your home and moving into a smaller home or renting. If you plan to move within only a few years, a reverse mortgage usually doesn’t make sense because of the upfront fees and commissions. Don’t use the equity on something frivolous—you may need the income for more critical issues later. [Consumers Union, p6,7] Income from reverse mortgages is tax free and doesn’t affect Social Security benefits, but the income could jeopardize your eligibility for such needs-based programs as Medicaid or Supplemental Security Income.

Also, shop around and have an independent expert read any contract (counselors are required for all reverse mortgages). Reverse mortgages are complicated and their costs and interest rates are higher than a traditional mortgage. For more information, go to www.aarp.org/revmort/.

September 2001— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by McGuire & Co. LLP, a local member in good standing of the FPA.