The New Plan for Seniors

Retirement planning is getting much simpler for a lot of seniors these days - reverse mortgages are multiplying like subprime loans did a couple years ago.

With soaring home equity in recent years added to the equity that accumulated in the closing decades of the 20th century (back when homeowners actually worked toward paying down their mortgage principle), many seniors are house-rich but cash poor.

Naturally, in a world of ever-evolving technological innovations in the world of finance, a solution to this problem is at hand. A recent article in BusinessWeek explains:

Pumping Up Your Reverse Mortgage
New 'jumbos' are giving retirees the cash they need to stay in their houses

From the living room of her Huntington Beach home, Jean Ingram enjoys sweeping views of pristine California wetlands and, off in the distance, Catalina Island. She and her late husband paid $135,000 for the 2,200-square-foot Tudor-style home in 1978, and it's now valued at about $1.2 million. Yet until late last year, the 69-year-old widow, awash in home equity but light on monthly income, feared she would have to sell.

Ingram was able to hold on to the house by taking out a jumbo reverse mortgage on the property--"jumbo" because the amount was $388,000, and conventional reverse mortgages would not offer as much on a $1.2 million home. Either way, these financial deals allow homeowners 62 and older to take the equity out of their houses without having to make monthly payments to the bank. The balance comes due when the homeowner moves out or dies. Then, the mortgage holder or the heirs have to sell the property or use other funds to pay off the loan if they want to keep it.
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Ingram's mortgage, like most of its ilk, is variable, with the interest rate tied to the widely quoted London Interbank Offered Rate. Her rate is currently 8.42% and can readjust every six months, up to a maximum of 14.92%. The 8.42% rate is about two points higher than the interest on a regular adjustable-rate mortgage. What significance is the interest rate if you're not making monthly payments? It's the basis for calculating how much Ingram or her heirs will eventually have to repay the lender.

Because she chose to take all the money up front, rather than in a line of credit, the mortgage company waived its regular fees and closing costs. With cash from the reverse mortgage, Ingram paid off her original loan, upgraded her roof and patio, and stashed $150,000 in certificates of deposit. She hopes to buy a condominium that will throw off rental income.

How much do the jumbos really cost? Suppose you took a $700,000 reverse mortgage on a home valued at $2 million, with a fixed interest rate of 8.85%. Depending on how fast you took money out, the debt could balloon to between $915,000 and $1.7 million in 10 years, says Jim Mitchell, a reverse mortgage specialist at Financial Freedom. The final bill would include accrued interest, service charges of $20 a month, and the original closing fees. If the home appreciated 4% per year during the 10 years, it would be worth nearly $2.7 million. You or your heirs could sell it, pay off the loan, and have a tidy profit.

Plans can go awry, however. Say you become ill and need to move out and sell the home immediately. If interest rates have skyrocketed and the property value has remained flat, your equity could be wiped out. But at least the amount you owe would never exceed the market value of the home.

Jean could probably do a little better than CDs and condo rentals with that hundred and fifty grand, but it's probably a nice feeling having some cash handy even if she's losing three percent a year to banks - that's a problems for Jean's heirs now.

If you aren't fortunate enough to live in a million dollar home in one of the bubble areas, you'll have much less to work with with a reverse mortgage, though every hundred thousand dollars goes a long way. If you have no equity available at all, you'll have to find some other way to borrow money to make ends meet.

How is it that the banks always come out ahead?