Register Real Estate Advisors

By David S. Jones, Senior Editor, Real Estate Center

Release No. 26-0810

 COLLEGE STATION, Tex. (Real Estate Center) — Some parents are warning their kids not to bank on inheriting the homestead. Why? Because some parents are considering a reverse mortgage. Such mortgages may not be beneficial for everyone, but their popularity is definitely on the rise.

 “Reverse mortgages are based on the home’s current value, borrower’s age and existing interest rates,.” said Dr. James Gaines, research economist for the Real Estate Center at Texas A&M University. “Borrowers can choose to receive loan proceeds in a single, lump-sum payment, as periodic predetermined payments, a line of credit or both.

 Writing in the July issue of Tierra Grande magazine, the Center’s flagship periodical, Gaines explained the pros and cons of reverse mortgages.

 Pros of a Reverse Mortgage

• A reverse mortgage has no fixed due date.
• No repayment is required as long as the home remains the borrower’s principal residence.
• Loans become payable upon death, sale, ceasing to live in the home or failure to keep taxes, insurance or maintenance current.
• Borrowers cannot be foreclosed on.
• Reverse mortgages are nonrecourse loans. The amount owed can never exceed the selling price.
• Borrowers continue to hold title to the property.
• There are flexible payment options.
• Loan proceeds are not taxable.
• Underwriting and approval do not depend on the borrower’s current income or employment status.
• Would-be borrowers are required to meet with an independent financial counselor prior to getting a loan.
• The lender’s lien on the property is removed if the lender fails to make loan advances according to the agreement.

Cons of a Reverse Mortgage

• Homeowners must be at least 62 years old, own their home outright or have high home equity.
• Reverse mortgages provide around 65 percent of the home’s value. Loan-to-value ratios as high as 80 percent may be available to older homeowners, but higher closing costs and fees and shorter life expectancy offset some of this advantage.
• When the borrower dies, the loan and all accrued interest and costs become due and payable, typically necessitating the sale of the home. Heirs wanting the house must repay the entire amount due, which could be greater than the home’s value at the time. Inheritance planning is tricky.
• Relatively high up-front costs mean borrowers need to stay in the home longer (at least ten years) to make the loan financially attractive. This disadvantage has been offset by some lenders eliminating origination fees, setting aside service fees or both.
• Borrowers are responsible for all other ownership costs.
• Homes can be foreclosed on if borrowers cease to live in them for 12 consecutive months or default on any obligation, such as maintenance, taxes or insurance.
• Borrowers may be targets for aggressive sales pitches for other expensive and potentially inappropriate products or services.
• Reverse mortgages are fundamentally different than forward purchase mortgages or home equity loans. Generally, reverse mortgages have more complicated terms and conditions.

For a comprehensive explanation, read “Reverse Mortgages: Alternative Home Equity Funding” by Gaines and former Center research assistant Beth Thomas. It can be found online at http://recenter.tamu.edu/pdf/1939.pdf.

• Mortgage Term – Mortgages are generally available at 15-, 20-, or 30-year terms. The longer the term, the lower the monthly payment if the same amount is borrowed. However, you pay more interest overall if you borrow for a longer term.
• Fixed or Adjustable Interest Rates – A fixed rate allows you to lock in a low rate for as long as you hold the mortgage and is usually a good choice if interest rates are low. An adjustable-rate mortgage (ARM) is designed so that interest rates will rise as interest rates increase; however they usually offer a lower rate in the 1st years of the mortgage. ARMS also usually have a limit as to how much the interest rate can be increased and how frequently they can be raised. ARMS are a good choice when interest rates are high or when you expect your income to grow significantly in the coming years.
• Balloon Mortgages – Balloon mortgages offer very low interest rates for a short period of time – often 3-7 years. Payments usually only the interest, so the principal owed is not reduced. However, this type of loan may be a good choice if you think you will sell your home in a few years.
• Government-backed loans – Government-backed loans, sponsored by agencies such as the Federal Housing Administration ( http://www.fha.gov ) or the U.S. Department of Veterans Affairs ( http://www.va.gov ), offer special terms, including lower down payments or reduced interest rates – to qualified buyers.
Slight variations in interest rates, loan amounts, and terms can significantly affect your monthly payment. For help in determining how much your monthly payment will be for various loan amounts, use my handy mortgage calculators. I offer over 15 different calculators to service your needs.

This information is reprinted from Realtor Magazine Online by permission of the National Association of Realtors, copyright 2005, all rights reserved.