It may sound hard to believe, but one part of the mortgage market is hot: reverse mortgages. And that's giving older homeowners more options to tap the equity in their homes -- but also opening the door to more confusion and mistakes.
Only a year ago, homeowners interested in reverse mortgages had little to choose from beyond the plain-vanilla, government-backed products that have long dominated the market. Such mortgages essentially allow homeowners at least 62 years old to sell a large chunk of their home equity back to a bank or other lender in exchange for a lump sum, monthly payments or a line of credit.
Now, nearly a dozen large banks and mortgage lenders have launched reverse-mortgage products with lower fees and larger payouts. One lender has reduced the minimum age requirement to 60; others are making loans on second homes and vacation rentals. "Jumbo" reverse mortgages -- for houses valued at as much as $10 million -- are becoming more common.
With a reverse mortgage, instead of the borrower making payments to the lender, the lender makes a payment or payments to the borrower. The borrower keeps control of the house and doesn't have to pay back the money as long as he or she lives there. When the homeowner dies or moves out, the loan is typically paid off by selling the house, and any money left over goes to the homeowner or the homeowner's estate.
The product is evolving from meeting basic needs to fulfilling the desires of a new generation of retirees, from funding a vacation getaway or a recreational vehicle to renting a Paris pied-a-terre. The new options, though, mean more potential for confusion among consumers -- and a bigger chance that they could miss out on getting the best loan for their situation.
And as home prices fall around the country, some homeowners stand to be disappointed. "We're seeing people apply for a reverse mortgage and find out their home is worth 5 percent less than they thought," says Jeff Taylor, vice president of Wells Fargo & Co.'s (NYSE: WFC) senior product group in Greensboro, N.C.
With so many competing offers to choose from, homeowners could easily wind up paying more in fees and interest rates than they should. Fees are typically steep -- more than 5 percent of the home's value -- and most borrowing limits are capped based on where the homeowner lives. Fees are paid upfront or financed, while interest rates affect how much of your equity the lender ultimately takes.
Reverse mortgage lenders traditionally have charged variable interest rates; now, fixed rates are available, but they may cost you more, says Barbara Stucki, director of the National Council on Aging's home-equity initiative.
Because of all the choices, homeowners need to be "a lot more strategic" in how they shop for a reverse mortgage, Stucki says, factoring in how they want to take the payments and how much money they want to take upfront.
The boom in reverse mortgages helped Ronald Prast, a 74-year-old Phoenix retiree. When he first applied two years ago, he was told by a loan officer that he wasn't a good candidate; government rules would have allowed him to cash out only a small portion of the value of his half-million-dollar home. But last November, when Bank of America Corp. (NYSE: BAC) introduced a reverse mortgage that allows homeowners to borrow as much as 65 percent of a property's value, up to $10 million, Prast and his wife, Carolann, quickly signed up.
The couple's house, for which they paid $105,000 in 1981, was appraised at $540,000, Prast says. They used an initial draw of $208,000 to pay off their outstanding mortgage, home-equity loan, one year's property tax and the loan fees, freeing up an extra $21,000 a year formerly used to make mortgage payments for travel and indulgences like paying for a granddaughter's semester in Australia. They also have a credit line worth $75,000 that they are setting aside for medical expenses.
"We were comfortably well off, and we wanted to release some of the funds we had tied up in our home," Mrs. Prast says.
Taking out a reverse mortgage to travel or spoil grandchildren is a far cry from just a few years ago, when such products generally were considered loans of last resort for seniors to avoid foreclosure or simply cover living costs, such as prescription drugs or hospital bills.
In the past, the reverse-mortgage market has been constrained by having one main buyer, Fannie Mae. But a half-dozen investment banks, including units of Lehman Brothers Holdings Inc. (NYSE: LEH) and Bank of America, have started buying reverse mortgages in the past few years, with plans eventually to package and sell them.
Ginnie Mae, the federal agency charged with making real-estate investment more attractive to institutional investors, recently said it's rolling out a standardized government bond issue backed by reverse mortgages -- a key step in creating a secondary market that could help lower borrowers' costs and increase the loans' availability.
The result: The reverse-mortgage business is booming. Though reverse mortgages represent less than 1 percent of the overall U.S. home-loan market, valued at about $10 trillion, the number of federally backed reverse mortgages surged 41 percent in the year ended Sept. 30, according to the Department of Housing and Urban Development.
Bank of America plans to expand its Arizona test of reverse-mortgage products nationwide within six months, says Colin McCormick, the bank's top reverse-mortgage executive. In April, BofA announced it was buying the reverse-mortgage business of Seattle Mortgage Co., the third-largest reverse-mortgage lender by number of loans.
The new products -- and new bells and whistles -- mean that homeowners considering a reverse mortgage are facing more homework than ever before. There are two questions they should ask first:
What index does the loan use?
It could affect your cost. Financial Freedom, the Irvine, Calif., reverse-mortgage unit of IndyMac Bancorp Inc. (NYSE: IMB), launched a product last month that bases its interest rate on the one-month London interbank offered rate, or Libor, index. Reverse mortgages traditionally have used the CMT index, which is based on Treasury bonds.
Using the Libor index should lower interest rates "over the long run" for reverse-mortgage users, says Michelle Minier, Financial Freedom's chief executive. But the borrower may have to give up "a small measure of cash, from 2 percent to 5 percent," to get the lower rate, she adds.
Still, consumers should investigate products that use the CMT index. Different products tack on varying amounts of extra interest to whichever index they use. One product might add 0.65 percentage point; another might add 2.00.
What are the fees?
Fees typically run up to 7 percent on government-backed loans -- in which the Federal Housing Administration insures lenders' and borrowers' risk — but are as low as 2 percent on proprietary loans. If you're seeking a lump-sum payout for a reverse mortgage on a high-value home, some lenders are willing to eliminate or reduce the upfront costs. And if you borrow less, you can often lower your fees, too.
But you may pay higher interest rates in exchange for lower fees, says David Certner, legislative-policy director at AARP, the Washington-based advocacy group.
For a 62-year-old Atlanta couple with a $500,000 house, for example, Financial Freedom's proprietary product would provide up to $148,289, with a 7.79 percent interest rate. The homeowners would pay fees worth 1.4 percent of their home value, or $7,000.
The same couple could get only $140,596 through a FHA-backed Home-Equity Conversion Mortgage, or HECM, from Financial Freedom. In contrast, the interest charged is only 4.93 percent. But they would pay a higher fee -- 5.2 percent, or $13,262 -- based on the federal lending limit for their county, which is $252,890.
If a couple uses the money as a line of credit, though, the balances earn different rates of interest depending on the loan. For instance, the credit line for Financial Freedom's proprietary loan would increase by 5 percent a year, compared with 6 percent for its HECM product. But those rates, being variable, are subject to change.