Newly available reverse mortgages may appear to be the answer to a cash-poor, house-rich senior citizen's plight, but experts warn people to do their homework.
A reverse mortgage is, simply put, a loan against the value of a home that pays elderly homeowners tax-free cash, either monthly or in a lump sum or in a combination of the two. Unlike a home equity loan or second mortgage, it requires no repayment for as long as either spouse lives in the home.
But like all loans, it does have costs that homeowners must understand.
So far, two reverse mortgage programs are available here:
* The Federal Housing Administration's Home Equity Conversion Mortgage (HECM) Insurance Program, which is being offered by International Mortgage Corp. of Pikesville
* Capital Holding Corp.'s Home Income Security Plan.
"They're just starting to become available. There's not a lot of choice yet," says Ken Scholen, director of the non-profit National Center for Home Equity Conversion. "There's hardly an accountant, financial planner or attorney who knows anything about this."
The true overall cost of the loan, says Scholen, depends on factors that are hard to gauge in advance: How long you will live in the house, how much the home's value will increase during that time, and -- if the interest rate is adjustable -- how much it will be.
"The most important thing to understand is that all of them will be most costly in the short term," he says.
"The longer you live in that house the better it gets. If you expect to live in the house only two years, it's not a good deal. You're buying the long-term guarantee," he says.
People looking at reverse mortgages also should investigate what other options they may have.
For instance, some cash-strapped homeowners might discover they qualify for government programs they were unaware of: a property tax break, help in paying heating bills, supplemental payments from Social Security.
In fact, says Gerry Glavey, insured housing specialist in the regional office of the U.S. Department of Housing and Urban Development, many homeowners interested in a FHA reverse mortgage drop the idea after being informed of other options in the required counseling session.
"You have to look at this as the reverse of a forward mortgage," Glavey explains. "The lender is paying you instead of you paying the lender. The loan balance is increasing instead of decreasing. And the interest rate is compounding."
The American Association of Retired Persons also advises elderly homeowners to be cautious.
"They're new, they're somewhat untested and they're certainly different," says Katie Sloan, manager of consumer affairs for AARP.
L "It's not a social program, it's not a grant. It has costs."
Nevertheless, says Sloan, for some people, reverse mortgages make sense.
The most recent AARP survey, for instance, showed that 86 percent of the elderly prefer to remain in their own house. But rising living costs can make that tough.
"We see a lot of older people, particularly older women, who are in severe financial condition and sitting in a house that's worth a good bit," she says.
While firm statistics are lacking, she adds, "we know anecdotally that many have been able to double their income."
Tricia Snoke, a spokeswoman for Louisville-based Capital Holding, says its typical customer is a 76- or 77-year-old widow looking for extra income.
"We originally thought it would be the really poor," says Snoke, "but it's turned out to be someone who's been retired for 10 years or more and has been watching the spendability of their fixed income dwindle. Many use it to [with an initial lump sum] redo and maintain the house. Many use it to restore a lifestyle they were used to."
One drawback to the FHA program, Glavey points out, is the home value used to calculate payments is limited to the HUD maximum -- $124,875 for the Baltimore area. That means a homeowner with a house worth $250,000 would be able to count only half its value.
Capital Holding, on the other hand, caps maximum home value at $500,000.
Because payments are based on life expectancy, "the older you are, the more money you generate," Glavey points out.
A 65-year-old, for instance, who got the maximum FHA mortgage of $124,875 with $2,500 in closing costs and a $20 monthly service fee, could expect to get $247 a month for as long as he lived in the house; a 75-year-old would get $419 and an 85-year-old $731.
The size of lump sums, too, depend on life expectancy as spelled out in actuarial tables. But in no case does a homeowner get a lump sum anywhere near the home's full value. Since repayment is deferred until the homeowner moves or dies, the amount owed -- the lump sum plus compound interest -- could continue to build over a long time. So the lump sum payout leaves room for the debt to grow.
Scholen advises homeowners to figure out the total loan cost, which combines all the cost factors, and express that as a single average annual rate.
Under the FHA program, the lender is required to provide that information.
That kind of analysis, he says, shows that reverse mortgages are very expensive in the short run, less costly over time and moderate to inexpensive if you live longer than average in a home that appreciates at a low or moderate rate.
"The FHA program really is the most flexible one out there," says Scholen.
Under the HECM program, an insurance premium equal to 2 percent of the allowed home value is charged up front; another 0.5 percent a year is charged on the growing loan balance.
International Mortgage charges a flat $1,800 loan origination fee, and a portion of that also can be financed.
The "expected" interest rate -- the rate used to calculate the monthly payment -- is equal to the rate paid on a government 10-year Treasury bill plus 1.6 percent; it's currently 9.31 percent. But the interest rate the homeowner actually pays -- currently 7.18 percent -- is lower because it's tied to the 1-year T-bill.
The interest rate, which fluctuates weekly with the Treasury auctions, is adjusted annually on the anniversary of the loan's closing but has a 2 percent cap on annual increases and a 5 percent lifetime cap. Changes in the interest rate do not affect the fixed monthly advance; instead, it makes the loan balance grow faster.
A $25 monthly service charge also is added to the loan balance.
Capital Holding charges a $3,000 borrowers fee and a "guarantee fee" to cover the lender's risk that the property could end up being sold for less than the loan balance. That is equal to 7 percent of the home's value and is added to the loan balance.
During the first three years, if the homeowner should die, that amount is refunded to the estate. Its current interest rate, also adjustable, is 10.32 percent.
People contemplating a reverse mortgage also have to consider its possible other effects.
While a reverse mortgage does not affect Social Security or Medicare eligibility, it can affect eligibility for Supplemental Security Income (SSI), Medicaid, food stamps and other income-maintenance programs.
Because payments to homeowners actually are a loan, they are not taxable income.
But homeowners can not deduct the interest on their tax return during the life of the loan; it's deductible only after it's actually paid.
Scholen also notes that if a homeowner expects a large capital gain -- more than the current $125,000 one-time federal tax exclusion -- when the home finally is sold, he may want to set aside enough of the equity to cover the anticipated tax bill.
Reverse mortgage lenders
* The only lender currently offering the FHA's HECM program here is International Mortgage,3701 Old Court Road,Suite 2,Pikesville,21208.Phone 484-6016
* Capital holding Corp.of Louisville,Ky.,offers conventionareverse mortgages up to a maximum home valueof $ 500,000.Phone 1-800-456-8754.
To get more information...
Here are some available publications that help explain reverse mortgages:
* The American Association of Retired Persons offers a free 47-page guide with numerous charts. Written by Ken Scholen, "Home-Made Money: Consumer's Guide to Home Equity Conversion" can be obtained by sending your request to AARP Fulfillment D12469, 601 E St. NW, Washington, D.C. 20049.
Ken Scholen also has written a 340-page paperback, Retirement Income on the House, published by the National Center for Home Equity Conversion. The book contains many charts and goes into many issues in detail. It costs $24.95 plus $4.50 shipping. You can send a check to NCHEC Press, Suite 300, 1210 E. College Drive, Marshall, Minn. 56258, or call 1-800-247-6553 for credit-card orders.
vTC The National Center for Home Equity Conversion offers a free Fact Sheet on Reverse Mortgages. It describes the basic types and includes a list of lenders. Send a self-addressed, stamped business-size envelop to NCHEC Fact Sheet, Suite 300, 1210 E. College Drive, Marshall, Minn. 56258.