Reverse Mortgages Sound Good But Could Have Hidden Risks

Reverse mortgages are becoming more popular among baby boomers these days. A decade ago, reverse mortgages were something only widowed or single women in their 70s would get into, but as boomers today are experiencing losses to their retirement savings, this non-traditional mortgage alternative is gaining more hype, according to Business Week.
This type of loan, known as a home equity conversion mortgage, lets seniors 62 and older borrow against the equity in their home without making monthly loan payments. Interest costs and an annual mortgage insurance premiem are added to the principal.
The loan balance doesn't have to be repaid until the borrower dies, sells the house, or moves out for more than 12 months. At that point, if proceeds from the sale of the home fall short of the loan balance, the Federal Housing Administration insurance fund -- not the borrower or heirs -- pays the lender the difference.

Borrowers can take their reverse loan proceeds in a lump sum, fixed monthly payments, a line of credit or some combination thereof.
Each monthly payment, and anything taken from the credit line, is added to the loan balance. Interest is charged only on the unpaid balance, not the untapped credit line. The unused credit line grows at a certain interest rate, so the longer it's left untouched, the bigger it gets.
No matter what happens to the home's value, the borrower will always be able to take out whatever remains on her equity line. "The lender must honor the mortgage contract as originally written," says FHA spokesman Lemar Wooley.
David Certner, AARP's legislative policy director, says that borrowing money at a higher rate and investing it at a lower rate is "a guaranteed losing strategy." The only advantage of taking the money out now is that "if (the borrower) should have a heart attack and die tomorrow, (his or her) heirs could not take out any credit line that (he or she) had not exhausted, but they could inherit a money market account that (he or she) had stashed away."
The reverse loan is non-recourse, which means neither the lender nor the government can come after the borrower's other assets, nor the borrower's heirs' assets, for any unpaid balance.
Not surprisingly, "The decline in house prices has adversely affected the projected credit performance" of FHA-insured reverse mortgages, the Obama administration noted in its proposed fiscal 2011 budget. To shore up the program, the FHA recently announced changes designed to reduce risk and increase annual mortgage insurance premiums.