- The Washington Times - Friday, November 2, 2007

Q:My father is a widower in his 70s, owns a home in Northern Virginia and lives

on a $40,000 annual pension. He owns his home free and clear and doesn’t want to move. The problem is that his $40,000 income isn’t enough to live on.

He wants to travel, make some home repairs and improvements and basically improve his lifestyle. He doesn’t have a lot of savings, but his house is worth well over $500,000. He has no debt.

My father contacted a bank that specializes in reverse mortgages and claims to be able to pay him $1,000 per month by extracting the equity in his home. I spoke with the loan officer and got the impression that while this can be done, the costs were high.

He told me that the fees associated with the reverse mortgage would total nearly $16,000 and the interest rate was 8.50 percent.

This seemed high to me. What’s your opinion of reverse mortgages?

A: Reverse mortgages are products that are growing in popularity. The borrower typically must be 62 years of age or older. The concept is to allow a retiree to receive monthly cash payments by tapping into his home’s equity every month.

This is similar to a home equity line, where a borrower may simply write a check when he needs money. The amount of the check is added to the loan balance. The borrower then pays the interest owed on the outstanding balance each month.

I made a few phone calls to lenders offering reverse mortgages, and I received a virtually identical sales pitch each time. Reverse mortgage loan officers are clearly trained to tout the notion that a borrower never needs to write a check if he has a reverse mortgage.

Here’s a summary of my conclusions about reverse mortgages.

m Reverse mortgages provide cash payments to the borrower for as long he owns and occupies his residence. There are also some programs that offer lump-sum payments. Instead of making interest payments each month, the interest is added to the balance of the reverse mortgages. Debt against the property increases each month.

m Many, but not all, reverse mortgage programs do not have income qualification guidelines. If the applicant is retired and has no income, he still may qualify for a particular reverse mortgage program.

m The interest rates vary greatly depending on the type and amount of reverse mortgage. Expect current rates to fall between 5.75 percent and 9 percent on most reverse mortgage programs.

m The sunken costs associated with reverse mortgages are high. Expect to lose $15,000 to $20,000 in equity immediately to pay for closing costs, origination fees and insurance premiums.

m Some reverse mortgage programs carry “appreciation sharing” clauses. This means that when the borrower sells or moves out of the house, the lender will collect not just the principal balance and accrued interest, but some or all of the appreciation the house may have enjoyed during the loan term. Avoid this like the plague.

My take on reverse mortgages has never changed: While these programs may be helpful to some folks, they are always expensive. Before any retiree takes out a reverse mortgage and gets sucked into the notion of not having to write an interest check, he should check to see if a reverse mortgage is the only alternative.

It would make far more sense for your father to take out a lump-sum second trust or home equity line of credit (HELOC) instead of a reverse mortgage. These programs will carry far fewer sunken fees than a reverse mortgage, and the interest rate will also probably be lower.

In fact, banks offer equity lines with zero closing costs all the time. This saves your dad perhaps $15,000 in equity from the start.

After making some quick calculations, I determined that your father should be able to qualify for a HELOC in the range of $200,000. This will provide an income supplement of $1,000 per month for many years to come.

Many, if not most, retirees have some kind of fixed income. While reverse mortgages may not require any income to qualify for the loan, folks with some income should consider other less expensive options.

As far as writing a check every month to service the interest on a home equity line, who cares? The borrower can simply write the interest from the equity line itself. It’s no different than a reverse mortgage.

The difference is cost and rate. If a retiree can qualify for a HELOC or second trust, it will be a far less expensive method of cashing in on home equity.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavage@pmcmortgage.com).

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