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A Reverse Mortgage Is a Costly Option to Use Your Home Equity

By Shane Flait

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Published: 30May2009
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The first advantage of a reverse mortgage is that it allows you to borrow from your home equity without having to pay it back for as long as you live there. But it's a costly way to access your home equity. Here, I consider why it's costly, who might best use a reverse mortgage and other options to access home equity.

The Home Equity Conversion Mortgage (HECM) is FHA's reverse mortgage program. To qualify you must be at least 62 years old and own your home. This program allows you to borrow a fraction of your home equity. That fraction increases the older you are when you apply.

As a rough estimate, a borrower in his or her early 60's may get about 38% of the home's equity, at 75 about 58%, and someone in his 80's about 60%. And you don't have to pay it back as long as you live in that home.

The total amount owed when you do leave your home is subtracted from the then current value of your house. And, importantly, you - or your children - will never owe more than the value of the house. That's the other key advantage of the reverse mortgage.

You can take what you borrow as a lump sum, a credit line, or monthly payments for a term or for life; it's up to you. But realize you're borrowing this money at a rate of interest that's fixed or variable depending on your contract. And since you're not paying anything back, the debt you owe - i.e. what you've borrowed along with the interest charged - is increasing fast. As an example, at a 7% borrowing interest rate, what you owe will be double what you borrowed in just 10 years.

Reverse mortgages come with a hefty amount of fees, too. These include an origination fee, closing costs, mortgage insurance premium, and servicing fees. You can finance these through your loan as well. They'll simply take them out of your lump sum, or credit line - leaving you with less to use of what you've borrowed.

The mortgage insurance premiums guarantee that you'll get all expected loan advances and not have to repay the loan for as long as you live in your home. It also guarantees that your total debt to you or your heirs will never be greater than the value of your home when you sell it. But recognize that you're paying for this.

But all those fees including accruing interest rate charge will cut into a lot more of your home equity than the fraction you were allowed to borrow. And it can do it fast which is why your original borrowing fraction is restricted.

Unless your home is continually appreciating at a good clip, it won't take long until there's little of no equity left as a legacy when you die or move out. This is what makes reverse mortgages so costly to you and you're loved ones.

If leaving a legacy is not an issue and you've the health to live on your own for 10 or more years, then a reverse mortgage may be a reasonable option for you. But if you want to leave a legacy, consider alternative ways to access the value of you home for income. Here are a few:

Renting a portion of you home:

If your home has extra bedrooms you may want to rent a room out for the income it can bring you. You may even consider borrowing a little for creating an in-law apartment for renting. This allows you to remain in your house yet use it to create some income. You may find local programs that allow you to borrow cheaply for the renovation needed.

Sell Your Home to Your children:

Your children can pay you a monthly payment toward ownership of your house. You could arrange that you'd have a right to live in it as long as you live. What better way to have your cake and eat it too - leaving all that equity to your children for the payments made to you.

Sell Your Home And Pay for an In-law at your child's house:

Here, you'll have to move out of your home, but you get to live with your children, increase the value of their home, and have money from your home sale that you can live on -and leave as a legacy.

Sell and Buy-down:

Again, you have to move out of your home, but if you buy down to a condo much better adapted to your age and needs, your extra equity from you home sale can perhaps supply sufficient income for you to live on. You may want to buy a life annuity with it too.

Always consider every option thoroughly.

Shane Flait is an educator and writes on financial, legal, and tax issues. He tells you what the issues are all about and gives you workable strategies to accomplish your goals. Find out more and get a free report on Managing Your Retirement => http://www.easyretirementknowhow.com You can contact him at contact@easyretirementknowhow.com

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