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.