What is a reverse equity mortgage and how does it work?

Spring is when everyone seems to want to buy new things, plan vacations, sell a house, buy a house—or just spend money. This year, however, may be different. Credit is not as easily available and everyone needs to look more to spending what they have in their pocket and not on their plastic—not a bad thing.

For seniors who have built up equity in their homes, a reverse equity mortgage is an attractive alternative to a refinancing or home equity loan.

In this economy, seniors may not qualify for a loan that requires a monthly payment because their income is fixed or too low. A reverse equity loan is enticing because it requires no payment while the owner is alive, is using the home as their primary residence, and has not sold or transferred the home. The owner can use the mortgage funds to pay off debts or as a line of credit when they need extra cash.

One less bill to pay can really make this kind of loan seem like a good idea.
However, anyone who is seriously considering this option needs to fully understand that these are mortgages with real dollar costs attached. Investigating and understanding the benefits of this loan product is important.

What is a reverse equity mortgage and how does it work?

Generally, a reverse equity mortgage is available to anyone 62 years of age or older who is living in their home, will remain in the home, and has equity in the property. The more equity, the higher the value of the house, and the older the homeowner, the more a lender will allow a homeowner to borrow.

Typically a lender will appraise the house and do a home inspection to determine the value and condition of the home. A loan amount of up to 80 percent of the value of the home is made available to the homeowner after deducting costs associated with the loan. These costs can include closing costs and insurance.

Interest is charged on the amount the homeowner borrows. Some loans require monthly servicing costs. The senior can do whatever they wish with the loan proceeds.

But the lender will want to ensure that any existing mortgages on the house are paid off and usually will make sure that any other liens on the house are paid well.

So while the homeowner has no monthly payments to make, each time they access the loan and interests and costs are added on, the balance of the mortgage goes up, not down. At some point, the loan may become higher than the value of the house has appreciated.

Does the federal government insure these?

The federal government insures a form of these called Home Equity Conversion Mortgages. Some private lenders offer them as well.

In general, HECM loans will have lower costs or interest rates associated with the loan, and the lender under this program is required to provide counseling to the homeowner before the loan documents are signed.

The homeowner is still responsible for making sure that the property is kept in good condition, that the taxes are paid and that there is insurance paid on the house. If the homeowner fails to keep up these conditions, the loan can be called into default. Another reason default can occur is if the homeowner moves from the property or rents it to another person.

What are the most common problems?

There are two main problems seniors experience with these loans. First, the senior does not understand the actual amount they will have available to them because they do not understand the costs associated with the loan. They understand the available proceeds after they have signed all the paperwork. But often that is too late.

This is a problem for a senior who wants to pay off all their debt but realizes too late that the amount of the reverse equity mortgage will not stretch to cover all the bills owed.

The result is that the senior may no longer have to pay a mortgage, but still have credit card bills or other loans that require a monthly payment.

Second, the senior doesn’t realize that when they use the loan proceeds, interest and other monthly costs are added on to the loan and the balance is going up.

What should you do before signing up?

If you or a friend or relative is considering a reverse equity mortgage, investigate the costs and the benefits. Also, think about alternatives. If you decide you want to enter into a reverse equity loan, compare lenders so that you find the best deal.

Finally, read as much about these loans as you need to in order to understand them. A good source of information can be found at http://www.aarp.org/money/personal/rever…

This column is for general informational purposes only. If you need help, call your local bar association for a referral. Low-income people may qualify for free legal help in some civil cases from Maryland Legal Aid.

Louise M. Carwell is a senior attorney with Maryland Legal Aid in Baltimore, where she has practiced consumer law for more than 20 years. Carwell, a graduate of the Case Western Reserve University School of Law in Cleveland, Ohio, specializes in credit, foreclosure prevention, consumer protection, and bankruptcy. She regularly trains lawyers and paralegals at Legal Aid and speaks to community groups and judges on consumer issues. In addition, Carwell teaches at the University of Baltimore School of Law and the University of Maryland University College.

Are you a credit-wise consumer with a question? Send it to Louise Carwell, Esq., c/o  

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