Reverse Mortgages

Every morning I wake up to my tv turning on.  Because I feel I owe it to myself and those around me to keep up on financial and business news, and becuase I've had a small obsession with investing since the time I was 9, I watch CNBC.  

Every morning the same grouping of ads appear.  Every monring I see an ad for reverse mortgage, and every morning I get a  little peeved.

You've probably seen them.  The lenders that participate in them get actors from yesteryear to support them such as Robert Wagner or in a case specifically to St. Louis even former St. Louis University Billikin's former coach Charlie Spoonhour.

The process sounds simple right?  Call a lender, and instead of them giving you money to buy the house, they'll give you the cash in exchange for the right to the house in the future.  

Let me explain how these work:

The the lender looks at the following different factors:

• Current appraised value
• Your Current age
  
• Life expectancy
• Current prevaling interest rate based on 1 Year T-Bill, LIBOR, or 1 Year CMT
• Payment taken as monthly installments, lump sum, or line of credit
• Location of home and any maximum restrictions

These items create what's called a TALC or Total Annual Lending Cost.  A value for the home's equity is then made.  Closing costs are then deducted from the value, usually around 4%.  2% usually goes to buy insurance for the lender against the value dropping and 2% is an origination fee the lender gets as profit. 

The value is then divided by the number of months left in life according to the life expectancy table.  

You then either get monthly payments until you die, move out of the home for 12 months, or sell the home or the lump sum.  (Most people choose the monthly payments.)  If you choose the monthly payment option, the lender usually charges between $25-35 a month for a "check processing fee."

One important item to know is that most of these loans are ARMs or Adjustable Rate Mortgages.  That means if rates go up the lender can send a lower check.  For a senior relying on that income, that could be devastating!

After the person vacates the home or dies, the home is then sold and the bank is paid back their money.  They get to keep the interest collected that made the difference between what the actual equity in the house was and what they agreed to pay. (Beyond that figure the bank is required to give back any additional funds to the heirs.)

The homeowner must also remember to continue to pay taxes and insurance on the home as they are not escrowed.

The reason you've seen an increase in the number of ads for these lenders is because they are smart.  They know that right now the values of real estate are down and they can go in and value the homes at a much lower rate then at the highs of the market thereby taking less risk.  They also know that in a climate where it's difficult to sell loans to people participating in a regular mortgage, this option might get their fees up.  Remember the lenders usually make more on these than on a regular loan.  

My issue here is that due to all the fees and changing payments etc that are involved these typically aren't a good decision for most elderly individuals.  The goverment is so worried about them getting taken advantage of that they now require people taking out these loans to attend a 45 minute class at a HUD office.

With these two factors it's important to realize there are other options available to borrowers that might be more advantageous including taking a HELOC or Home Equity Line of Credit out of the home.  That way the homeowner is only charged interest on taking out the money they really need thereby accruing less total interest over the life of the loan.

I'm not saying that a reverse mortgage is bad for everyone, but please understand it isn't as peachy as they make it look on tv.  If you or a family member are considering a Reverse Mortgage please seek out the advice of at least a few mortgage representatives before going forward.  If you have a financial advisor I would definitely recommend you seek their advice first.

Click here for more information on Reverse Mortgages from WikiPedia

Click here for more information on Reverse Mortgages from AARP