Reverse Mortgages - What are they? Is one right for you?

Since their introduction in 1989, nearly 20,000 elderly Americans have obtained reverse mortgages, which are also known as home equity conversion mortgages.

Under a reverse mortgage, homeowners retain ownership of their homes while collecting a monthly payment, or in some cases a lump sum payment, from the lender. When the owners die or move out, the lender gains ownership of the home unless the heirs or the senior borrowers themselves pay off the loan. The homeowners may also sell the home and repay the lender with the proceeds from the sale.

Reverse mortgages may be a good option for seniors for whom selling their home may not be profitable due to capital gains taxes, and who are seeking to improve their standard of living by increasing their income. Some seniors are reluctant to mortgage their house and reduce their estate's value because they worry about what their children might think. However, the peace of mind of knowing that one's parents are more comfortable is a definite plus for many families.

Of course, reverse mortgages are not for everyone. They can be costly, and an elderly homeowner may only see 30 to 80 percent of the value of their home through a reverse mortgage. There are also closing costs and service fees that can range from $20 to $30 per month. Some carry fixed interest rates and some are adjustable.

Reverse mortgages also come in a wide variety of options, shapes and sizes. A reverse mortgage that worked for your neighbor may be the worst thing for you.

How Does A Reverse Mortgage Work?

A homeowner can choose a monthly annuity payment, or opt for a lump sum payment, or a line of credit account from which they can draw money when they need it, or a combination of the three. They are offered by private companies, such as Transamerica Corporation and Amerifirst Mortgage.

The Federal Housing Administration (FHA) insures reverse mortgages offered by HUD approved lenders around the country. Reverse mortgages carry several conditions. The homeowner must live in the residence for the duration of the loan. The amount borrowed must be no more than the appraised value of the home or the maximum value allowed by HUD in a given locality, whichever is lower.

The older a homeowner, the more money they can receive with a reverse mortgage. At current interest rates, a 62 year old can expect to receive about 30 percent of the value of the home, while a 95 year old may receive 80 percent.

AARP outlined several other important characteristics of reverse mortgages. These should be kept in mind when considering whether to obtain a reverse mortgage:

- Reverse mortgagors (borrowers) remain the owners of the home. Accordingly, they are still responsible for all applicable taxes, insurance, maintenance, and repair.

- Reverse mortgagors can never owe lenders more than the value of their home at the time the loan is repaid.

- Reverse mortgage loans must be repaid, either in cash or through transfer of the deed to the home, when the borrower dies, moves away, or sells the house.

Use caution

Most financial counselors advise seniors to be careful when considering a reverse mortgage. While a reverse mortgage can be a great opportunity for an older person to draw on the equity of their home to obtain a better lifestyle, they are not for everybody.

A good thing about them is when you take a reverse mortgage, of course, you don't have a mortgage payment anymore.

However, because of the disparity in the amount of home equity that younger borrowers can get versus what older borrowers can get, it may be wise to hold off. After all, the older you are, the more money you will get from a reverse mortgage.

Reverse Mortgages Examples

Senior homeowners can get monthly or lump sum payments from their home equity, getting loans called "reverse mortgages". Here's what a homeowner might expect from a reverse mortgage, assuming an interest rate of 6.85%, financing of closing costs and the initial mortgage insurance premium, and a monthly servicing fee of $30.

Tenure payment plan (lifetime)

Age Maximum claim amount or property value, whichever is less

$75,000 Monthly Lump Sum 65 $187 $28,300  75 $272 $37,600  85 $437 $47,900

$100,000 Monthly Lump Sum $266 $40,400 $381 $52,600 $602 $66,000

$125,000 Monthly Lump Sum $345 $52,400 $490 $67,500 $768 $84,100

$155,000 Monthly Lump Sum $441 $66,900 $620 $85,700 $968 $106,000

Term payment plan (10 years)

Age Maximum claim amount or property value, whichever is less

$75,000 Monthly Lump Sum  65 $332 $28,300  75 $473 $37,600  85 $561 $47,900

$100,000 Monthly Lump Sum $473  $40,400 $616  $52,600 $773  $66,000

$125,000 Monthly Lump Sum $614 $52,400 $792 $67,500 $986 $84,100

$155,000 Monthly Lump Sum $784    $66,900  $1,004 $85,700  $1,243 $106,000