April 5, 2000 -- Wouldn't it be nice if the mortgage lender paid you for a change?

For borrowers 62 and older, that's increasingly becoming an option. Reverse mortgages allow older consumers to turn built-up home equity into cash without selling their homes. They haven't gained widespread acceptance because reverse mortgages are confusing -- and many of their potential customers were brought up to think that owning a house "free and clear" should be a home buyer's ultimate goal.

But with Americans living longer and the oldest baby boomers nearing 60, more people soon will need a way to pay bills and cover other retirement expenses without driving themselves into bankruptcy. And in a surprising alliance, both lenders and consumer advocates say those who take out reverse mortgages are really on to something.

Special type of loan
"Simply put, a reverse mortgage is a special type of loan that allows a senior homeowner to convert the equity in their home into cash that they can use for any purpose that they want," says Glenn Petherick, a spokesman for the National Reverse Mortgage Lenders Association in Washington. "There's no payments made by the borrower during the life of the loan and the loan becomes repayable either when the borrower dies, if they sell the house or if they move out of their homes permanently, such as to a nursing home.

"But I think the main problem has been and still is trying to get widespread consumer recognition of the products and the benefits," he adds. "People will have to be proud that they took out reverse mortgages and made a smart decision."

Getting borrowers to that point has proven to be no small feat for lenders, government agencies, housing counselors and others, despite the fact they've been trying since the late 1970s. Back then, industry officials worked feverishly to develop the reverse mortgage concept because of the economy's condition, according to Ken Scholen, a program specialist with the American Association of Retired Persons.

He recalls how inflation was soaring in those days, driving the cost of goods and services higher. That reduced the purchasing power of cash and seniors' pensions, which in many cases weren't tied to the inflation rate. Though home values were shooting up at the same time, seniors had a hard time tapping into that rising equity. Home equity loans, or second mortgages as they were called then, weren't as prevalent and cheap as they are today. And selling a house altogether meant giving up property that in many cases had been in a family for more than a generation.

Reverse mortgages to the rescue
Experts hoped reverse mortgages would solve the problem. The loans work by gradually converting home equity into cash that borrowers can use for whatever they like.

How? Most start with a risk judgment on the part of the lender. Reverse mortgage companies analyze a borrower's age and the value of the home in question, as well as interest rates at the time of application.

In general, older homeowners can borrow more equity than younger ones. The amount has to be within limits set by the Department of Housing and Urban Development, the secondary marketing company Fannie Mae or Financial Freedom Senior Funding Corp. of Irvine, Calif. They are the only three organizations offering reverse mortgage programs today through affiliated lenders, banks or their own loan officers.

Depending on the plan they choose, consumers can receive their money on either a line of credit basis, where they draw down cash whenever they need it, or in scheduled installments. With each withdrawal, the mortgage balance increases, just as it shrinks with each payment on a forward mortgage. The money received is not considered taxable, experts say.

How lenders recoup
For their part, lenders recoup principal, plus interest, in one of several ways. If a borrower cashes out the entire balance of available equity and then dies or moves out, for example, the lender can obtain and sell the property. If the amount withdrawn turns out to be less than the full market value of the home, the house can be sold, the balance paid off and the remaining equity returned as cash to the borrower or surviving heirs. Finally, if the heirs want to hold on to the property, they can pay the mortgage off with their own money.

At the end of the loan term, either the borrower or the estate should be able to deduct the interest portion of the mortgage balance from their taxes. Experts suggest consulting a tax adviser on that point.

With HUD loans, which are offered through the agency's Federal Housing Administration arm, it's possible for borrowers to take out more money than the home is worth. That's because HUD gradually increases the size of borrowers' lines of credit as they age. A homeowner who lives longer than average can keep taking money out, ending up borrowing more than the home's value.

If that happens, though, neither the borrower nor the heirs is responsible for the excess. Borrowers pay a little money upfront into an insurance fund to cover that possibility.

Reverse mortgages can be used for virtually anything, but most seniors put the money toward home repairs, medical bills and other large expenses. In some cases, the money just helps supplement other income. With the Fannie Mae program, however, borrowers can even buy a house under a new option made available last year.

Say a senior citizen wants to buy a $115,000 home, but doesn't want to liquidate all available assets. By putting down $67,000, that customer creates an instant $67,000 in equity. In the same all-in-one transaction, the person can use that equity as a basis for qualifying on a Home Keeper mortgage, and hand $48,000 of that loan over to the seller.

If all this sounds confusing, that's because it is. Lenders have to go to great lengths to explain the products to potential borrowers and, even then, some don't like what they hear. As a result, reverse mortgages haven't become that popular.

First introduced in 1989
HUD first introduced its Home Equity Conversion Mortgage in November 1989 and Fannie Mae rolled out its Home Keeper loan in November 1995. But Fannie Mae, which buys both types of loans from lenders after they make them, says it now holds just 27,000 HECM and Home Keeper mortgages in its portfolio. Financial Freedom won't say how many loans it has done since its entrance into the marketplace in 1993, but senior vice president Jim Mahoney indicated the company has loaned money against about $175 million worth of home value. Assuming each house was worth $150,000, that's only equivalent to about 1,150 mortgages.

"You have certain segments of the market that don't see a need for it," says Liz Scholz, director of Fannie Mae's senior products group. "Some don't want to leverage their home in any way, shape or form. I think that there's another segment of the market that just isn't aware of the products or may not understand the product. I think there's another segment that very much wants to keep the equity for their heirs."

In part because of that reluctance, many of the companies that got into the business earlier this decade have dropped out. Others have been unwilling to lend money now on the expectation of a future payoff that may or may not come. As a result, it's unlikely for the time being that there will be many more loan choices for seniors than the three available now. Still, that could change if the industry gets its way and a secondary market for reverse mortgages develops the same way one has for regular home loans. Such a development would allow companies to get at least some money upfront for each mortgage they made.

"In the future we might have more variations of it, but currently you have FHA and Fannie Mae, which are basically the national programs," says Roger Reynolds, national reverse mortgage coordinator for Wells Fargo & Co.'s Norwest Mortgage division.

Nevertheless, reverse mortgages compare favorably to other methods of financing retirement. As more people learn about them, observers say they think more people are getting them, too. Norwest, for one, has seen its loan volume grow by about 15 percent to 20 percent annually in recent years.

"Reverse mortgages are just so different from what people are used to," says the AARP's Scholen. "But you look into the history of any truly innovative product and you see how long it took to gain acceptance. Instant coffee, the zipper or any number of things that we think now, 'So what's the big deal?' took a long time to get public acceptance. And before you have acceptance, people have to understand what it is and try it out."