A Guide to Reverse Mortgages

Updated on June 27, 2008.

RAY RUEBY HAS a lifestyle many retirees would envy. He officially retired at age 75, when his multimillion-dollar business merged with another company. Now 79 years old, the former executive has started a small publishing company that keeps him busy when he wants to work. He's already writing his second book. "I'm in good health, I can do anything," he says.

Money isn't an issue for Rueby. Nevertheless, last year, he decided to add an extra layer of financial security by tapping into the equity of his $300,000 home in Rochester, N.Y.

Instead of a home equity loan or line of credit, which would require him to start making payments immediately, Rueby took a reverse mortgage in the form of a credit line. Reverse mortgages allow people to use the equity in their home without having to pay the loan back as long as they live there. "It's extra availability," says Rueby. "If I wanted to go to Europe for a month or two or if I got a tax bill at an awkward time, I just know I can write a check and not suffer any loss in my net worth."

But reverse mortgages aren't right for everyone. They're complicated, expensive and final — take one, and your heirs will have to sell your house when you pass away or come up with the cash to keep it.

"You have to make sure you understand all the costs and alternatives," says Ken Scholen, director of the AARP Foundation's reverse mortgage education project.

Here's a guide.

1. The Basics
A reverse mortgage is the opposite of a regular mortgage: Instead of using your income to build home equity, you use your home equity to get income. With a reverse mortgage, you remain the title owner, and you don't make payments on the loan as long as you live there. The loan, along with the interest accrued, becomes due when you — and any other owner, such as your spouse — move or pass away.

To qualify for a reverse mortgage, you and any other owners must be at least 62 years old. You also must own the home outright, or be able to pay off any remaining balance with the money from the reverse mortgage. And you must keep the house in good condition and pay your taxes and insurance, or the loan will be considered in default.

Just how much you'll be able to borrow depends on three things: your age, your home's value and interest rates. The older you are, the more your home is worth; the lower interest rates are when you apply for the loan, the more equity you can borrow. The National Reverse Mortgage Lenders Association's (NRMLA) reverse mortgage calculator can help you see how much you can get.

Interest rates are factored in because all reverse mortgages accrue interest over the life of the loan, even though interest isn't paid off until the loan becomes due, explains Peter Bell, NRMLA director. The interest rate is pegged to the one-year Treasury bill and adjusts annually or monthly or to the London Interbank Offered Rate (LIBOR), whichever the borrower chooses. (Since annual adjustments provide more stability, annual rates are higher — and less popular among borrowers — than monthly rates, says Bell.)

What happens when the loan comes due? Contrary to what many people think, the lender doesn't take your house automatically, says Bell. True, your heirs may sell the home in order to pay the balance off if you pass away. But they could decide to keep the house if they can come up with the cash to pay off the loan.

If the house is worth less than the amount due, you or your heirs will owe to the lender only what the house can sell for. If it is worth more than the amount due, you or your heirs get to keep the difference.

2. Choosing a Product
There are three types of reverse mortgages. The most common is the so-called home equity conversion mortgage, or HECM, which is insured by the Federal Housing Administration (FHA), an arm of the Department of Housing and Urban Development (HUD). HECMs make up about 95% of all reverse mortgages in the country, according to the NRMLA.

The remaining 5% is made up of Fannie Mae's reverse mortgage product, called "HomeKeeper," as well as jumbo reverse mortgage products offered by companies, such as World Alliance Financial and EverBank Reverse Mortgage, a subsidiary of MetLife bank.

The FHA imposes limits on the home values that can be mortgaged, which vary by county — from $200,160 in rural areas to $362,790 in metro areas this year. If you live in an area with a $200,160 limit but your home is worth $300,000, you can take a reverse mortgage based on $216,000 of home equity. Congress is currently considering legislation to create a single lending limit for HECMs at a much higher level.

HomeKeeper mortgages generally make much less cash available to borrowers than do HECMs, but can make more sense for borrowers whose homes exceed the FHA limits in their county. Jumbo reverse mortgages, on the other hand, offer higher lending limits than the HECMs.

HECMs are available through roughly 2000 lenders around the country, according to Bell, ranging from small local companies to big lenders like Wells Fargo. Unlike the terms of regular mortgages, which vary by lender, reverse-mortgage terms are set by HUD. The only variable is the origination fees charged by the lender. (For more on the costs associated with reverse mortgages, see No. 4.)