A new federal housing law has raised the ceiling on the amount of money seniors can obtain from a reverse mortgage and lowered the fees charged for the loan.

Previously, with federally backed loans, the amount a homeowner can borrow had to stay below the dollar limit set by the county. But the new law, which takes effect on Jan. 1, 2009, sets a national limit at $417,000 and up to as much as $625,500 in high-cost areas. The previous range was $200,160 to $362,790.

That means that if you have up to that much equity in your home, you could tap it for a reverse mortgage.

At the same time, the national regulations will put a cap on the origination fee that lenders can charge for federally backed loans. The new rules allow lenders to charge up to 2 percent of the loan amount for the first $200,000 of the home value, and 1 percent on the balance of the value. And the origination fee is capped at $6,000.

Another rule-change is meant to help retirees who want to get into a property that “better suits” their needs, says Hicks. It combines two transactions into one step and allows the borrower to take out a reverse mortgage on the new home. “The intention of the program is to create a greater sense of flexibility,” says Hicks.

It pays to analyze a reverse mortgage the same way you would any financial move that involves the roof over your head: carefully.

Withdrawing your equity
When it comes to the loan, you can take it in a variety of ways, depending on which works better for you:
  • A lump sum.
  • A set amount each month for a certain number of years.
  • A set amount each month for as long as you live in the home.
  • A line-of-credit — about 80 percent of current loans
  • A set amount plus a line of credit

A relatively new addition to the financial world (they’ve been around 19 years), reverse mortgages were designed to let seniors tap home equity without having to worry about repaying it. Instead, the bill is settled when the house is eventually sold. If there isn’t enough profit to pay off the note, then the lender takes the home and the debt is fully satisfied.

For federally backed loans, a borrower must be at least 62. The home owner never owes more than the home is worth. And, in most cases, the lender can’t call the note due while the owner is still in the house.

“It can be a good thing for an older retiree who is house-rich and cash-poor, says Eric Tyson, author of “Personal Finance for Dummies.”

And that seems to be exactly who is using them, according to Bronwyn Belling, reverse mortgage specialist for the AARP Foundation. “Your typical borrower is a 73- or 74-year-old who has lived in the home a long time, seen a lot of appreciation but is having trouble making ends meet,” says Belling.

However, reverse mortgages are not the automatic answer for everyone. “These loans work very well for some people and not so well for others,” she says.

Because the fees are front loaded — paid first out of the proceeds of the loan — reverse mortgages “are better for someone who wants to stay in their home a long time,” says Belling. That’s because, unlike a traditional mortgage, most of the fees associated with a reverse mortgage are paid up front (subtracted from the overall balance that the home owner is borrowing).

Currently, with a federally backed loan, that includes a 2 percent fee for insurance on the loan, plus an equal amount for the lender’s origination fee, plus regular closing costs which often run $2,000 to $3,000, says Belling.

For a 74-year-old borrower, that could total $14,000 to $15,000 on a $300,000 home loan, she says. Over the life of that loan, those costs can easily stretch to $30,000, she says. And that doesn’t include interest.

It’s not a good move for someone who wants to leave a home to their adult children. And, in some cases, the loans can also affect eligibility for Medicaid and Supplemental Security Income, or SSI. So if you rely on those benefits, you want to talk with a knowledgeable, neutral third party (not your lender), to make sure that the loan, or the way you’ve structured your payments, won’t interfere with your income.

Some borrowers are also getting new reverse mortgages to get out from under their existing mortgage for retirement, says Belling. “Depending on where you live and what the house is worth, you may be able to borrow enough to pay off the debt,” she says. But, if you’re in financial trouble because your existing mortgage is a loan you really couldn’t afford in the first place, you might be better off pursuing legal recourse against the original lender, says Belling. Always exhaust the legal remedies first, she says. “Some of those loans shouldn’t have been made in the first place.”

Many financial planners and consumer advocates view reverse mortgages as a tool of last resort.

“Reverse mortgages are a wonderful tool to have at your disposal, but you should only play that card if you’re out of other options,” say Phil Cook, a Certified Financial Planner in Torrance, Calif.

Belling agrees. “We urge people to make sure they really need the loan now,” she says. In some cases, she says, what a home owner really needs is help with home repairs, taxes or utility bills. And often, there are local programs that can provide that assistance, so that the retiree might not have to resort to a reverse mortgage.

Adding to the confusion …

There are two different types of reverse mortgage and that can make the topic confusing. Federally backed Home Equity Conversion Mortgages, or HECMs, are guaranteed and regulated by the federal government. Private or proprietary loans aren’t required to follow the same regulations.

“But up to this point, private lenders have, by best practices, complied with the same regulations,” says Darryl Hicks, vice president of communications for the National Reverse Mortgage Lenders Association.

Because the HECM loans are government-backed, the rates tend to be lower than with proprietary loans, says Hicks. In the past, when the amount of a homeowner’s equity in their homes was higher than local lending limits, they sometimes turned to proprietary loans, he says.

These days, there are not that many lenders making proprietary loans.

In the current economic climate, “at least 90 (percent) to 95 percent of the market” is composed of government-backed HECM loans, says Belling. Many of the companies that offered private loans “are not making them at this time,” she says.

“The market really has changed,” she says.

The trade-off

Reverse mortgage lenders don’t consider your credit history. They will pull a credit report, but only to see if there are any outstanding liens that could affect title to your home, says Hicks. Instead, they look at your age, life expectancy, any existing mortgage and the value of your house. They will calculate that, along with their standard interest rate and fees (including $30 to $35 per month to service your account), and make you an offer.

Borrowers seeking federally backed reverse mortgages are required to take a counseling session (usually about one hour), before they apply for the loans.

For a reverse mortgage, “the only out-of-pocket costs for consumers are the home appraisals and the counseling,” says Hicks. In some cases, the counseling is offered free or at a low cost, but it can run as high as $125. FHA home appraisals generally run about $300.

Problems discovered during the inspection must be corrected, but can be taken care of before or after the loan closes. If the homeowner chooses to do it after, money is set aside for that purpose.

Borrowers also need to know that with the federally backed loans, there are three ways the lender can force a sale:

  • If you’ve vacated the house (leave for more than one year)
  • Failure to pay taxes or required insurance (such as hazard insurance)
  • If the home falls into serious disrepair

With a private loan, the rules could be different, so you want to understand the contract completely.

Smart-money tip: As with any other mortgage, it pays to shop around. You’ll get different offers from various lenders, even if they think your home is worth the same amount. That’s because they have different interest rates and different origination fees. Rates are often tied to indexes, such as the one-year Treasury bond rate, or the London Interbank Offered Rate, often called the Libor. But not all lenders use the same index. And even if they do, they may add a different percentage to it to obtain their total rate.

“Bankers offer different products, and rates change once a week,” says Belling. “It’s a difficult time right now.” Shopping “does require some perseverance,” she says.

With federally backed loans, borrowers can also choose between an adjustable rate that changes either monthly or annually, or a fixed rate (which is usually several percentage points higher), says Hicks. Consumer advocates are cautioning borrowers that this is one instance when a fixed rate is not automatically superior.

One of the biggest problems with reverse mortgages is that they’re complicated. Reverse mortgages “are difficult for the borrower to understand,” says Tyson. And that’s one reason that the government backed loans require a counseling session — a good idea for anyone considering the idea, he says. “It would really be foolish not to take advantage of that,” Tyson says.

It’s the lender’s job to explain the program upfront, says Hicks. They can also give you an estimate, which could change based on the results of your appraisal.

Borrowers should definitely “call around” and compare offers from different lenders, he says. “There’s a lot of competition out there right now for people’s business,” Hicks says. Even though loans are federally backed, terms and fee structures can be very different.

Belling recommends reading all the information you can get your hands on — AARP offers a free 46-page manual, “Home Made Money,” which you can download or have sent to you via regular mail — and talk with your friends. If you have a trusted family member, invite him or her to attend the counseling session with you.

You can also hire a fee-only financial planner for some professional, neutral, third-party advice such as the National Association of Personal Financial Advisors, or call the AARP hot line at (800) 209-8085 to locate an exam-certified counselor.