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Understand options when it comes to reverse mortgages

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POSTED October 18, 2012 6:41 p.m.

If you know a senior homeowner who is running out of money, a reverse mortgage might generate enough cash to allow them to stay in their home for many more years. Last fall, the Federal Housing Administration created new rules, and opportunities, for lower-cost reverse mortgages. Now that most lenders have launched these new products, it's worth an updated look.

A reverse mortgage turns your home into your pension, either giving you a lump-sum payout from the equity in your home or a fixed monthly check that will keep paying you as long as you live in the home.

This reverse mortgage is available to homeowners age 62 or older who either have paid off their mortgage or have a small remaining balance. The amount you can receive is determined by your age, the value of your home and current interest rates. Basically, the older you are when you take out the reverse mortgage, the more money you can receive -- either in a lump sum or monthly payout.

And all the money you withdraw is tax-free, since it is the return of your own capital.

You don't need a credit check, and you retain title to your home. You won't have any mortgage payments, although you will be responsible for homeowners insurance, property taxes and upkeep on your home. But you'll now have a monthly check to pay for those expenses, or a pool of money in the bank to cover emergencies.

Basically, you are just borrowing from yourself -- although you will be paying interest on that loan. But the interest is added to the amount of equity taken out of the home. When you sell the home, or die, the amount you have borrowed out of your home's equity must be repaid from the sale proceeds.

Importantly, you -- or your heirs -- can never owe more than the home is worth. And you can never be forced out of your home because you've "run out" of equity. Eventually, when the home is sold, because you move or die, any proceeds (minus the withdrawals, interest and fees) are returned to you, or your heirs.

If that sounds too good to be true, this is the one product that really is as good as it sounds -- if you understand all the details and costs.

There are basically two kinds of reverse mortgages, and they are offered by many banks. Since all of these mortgages are insured by the Federal Housing Administration, they must follow the same basic rules -- although there could be some differences in cost.

A reverse mortgage is called a HECM loan, which stands for Home Equity Conversion Mortgage. There are two types of loans -- the Standard HECM and the newer "HECM Saver." Each lets you borrow a different percentage of your equity, and each has different fees.

The amount you can borrow on a reverse mortgage depends on the appraised value of your home. But no matter how valuable your home, the FHA has determined that the maximum amount of equity that will be considered for a reverse mortgage in 2011 is $625,500.

The interest paid (taken out of your remaining equity) on both of these loans can be either at a fixed or variable rate. These days, few lenders will promise a fixed monthly payment at a fixed interest rate for the rest of your life. So most loans are variable rate, based on an index set by the FHA, and typically the interest is adjusted monthly. The initial interest rate on the Saver loan is slightly higher than on the Standard loan.

The Standard HECM loan allows you to access more money from your home equity than the Saver HECM, which allows access to about 20 percent less equity. But the Standard requires a 2 percent upfront premium -- again taken out of your equity -- while the Saver has a tiny .01 percent upfront fee. Both loans also take a monthly insurance premium of 1.25 percent out of your equity to pay for the FHA insurance on these products.

(The FHA insurance protects the lenders, so they don't lose money. Think about it this way: If the bank promises to pay you $2,000 a month for life in a reverse mortgage, and if you live to be 100, instead of the expected 85, the bank will lose out on the deal. The FHA insurance covers that possibility.)

The one place lenders do compete is in origination fees on these loans. The law allows banks to charge a maximum of $6,000 in origination fees, but many lenders today advertise that they will waive the entire origination fee. (They know they will make money on the loan interest over the years -- as long as you don't live too long.)

If you're interested in knowing what you could get in a reverse mortgage, go to ReverseMortgage.org, and use the online calculator to see what monthly payment or lump sum may be received out of your home. You can also search for reverse mortgage lenders in your area.

In the box here, you can see an example of what you could receive in a reverse mortgage.

Are you still worried about taking money out of your home? It's understandable if you are because a reverse mortgage is only available to a homeowner who has paid off the mortgage or has a small remaining balance. If you fall in that category, you've been a good saver all your life. So think of it as your home repaying you for all those years of saving.

Before taking out a reverse mortgage, you must go through a counseling process to make sure you understand how this works. And as part of that process, the lender must estimate for you how much you will have withdrawn from your equity after three, five and 10 years, and up to the youngest borrower's 100th birthday, even if the interest rate adjusts upward to the cap. (Important note: On all these adjustable loans, the rate can rise up to 10 percent higher than the initial rate.)

There is one good way to beat the lender on a reverse mortgage. That's to stay healthy and live in your home for many years, while you keep collecting the money. That's what I keep telling my own father about the reverse mortgage I organized for him nearly a decade ago. I think it's an inspiration for him.

And it could be the answer for you, so if you're planning and hoping to stay in your home for a while, check out a reverse mortgage. Lenders know they are dealing with seniors and their families, so they are set up to patiently explain the process. It doesn't cost anything to investigate a reverse mortgage, and it may pay off big time. That's the Savage Truth.

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