A mortgage that pays you? Think twice

By MP Dunleavey

Editor's note: Join columnist MP Dunleavey and a group of women as they seek to strip away the myths around money, liberate themselves from debt and find financial sanity. Follow the quest of the Women in Red every other Wednesday in Dunleavey's column on MSN Money.

A couple of years ago, when I first heard about reverse mortgages, I encouraged my father to get one.

I was pretty excited. Like most retirees, he was living on a tight budget, and a reverse mortgage seemed like a no-brainer way to slash his expenses (and a quick way for his worried daughter to have some peace of mind).

But by the time we heard that my dad didn't qualify (he hadn't owned his house for long and didn't have much equity), I had learned a few things that made me realize he had dodged a bullet.

Yet when my mother, who is separated from my father, recently said that she was considering a reverse mortgage, I thought it was a brilliant idea. Her housing expenses are too high, and she has enough equity. In fact, I urged her to get one ASAP.

And those, dear reader, are the two faces of the reverse-mortgage monster: For some homeowners it's too scary to even look upon; for others it offers the promise of financial salvation.

The key is to look both ways twice before you commit to this complex backward loan.

First, the good news

At first, reverse mortgages sound as if the tooth fairy went into real estate with Santa Claus.

Assuming you qualify, the bank pays off your existing mortgage and, after deducting some fees, gives you most of your remaining equity in a lump sum, line of credit, monthly payments or some combination.

That's right: You don't make monthly payments anymore -- the bank pays you!

And although a reverse mortgage is technically a loan, you don't have to pay back a dime as long as you live in the house.

Who invented this, and how fast can you get one? Alas, they're available only to folks who are 62 or older. And before you pay someone to forge your birth certificate, there's more to know.

Now, the not-so-good news

With the economy in a swivet this past year, the popularity of reverse mortgages has been rising.

For the fiscal year ending Sept. 30, about 112,000 reverse mortgages were processed, according to Peter Bell, the president of the National Reverse Mortgage Lenders Association. That's more than double the 40,000 loans that were processed just three years before.

Still, most seniors are wary, and for good reason. A reverse mortgage, also called a home-equity conversion mortgage, is actually a way to refinance your home.

As with a refi, homeowners are on the hook for all the usual closing costs (attorney's fees, appraisals, title insurance, etc.).

Remember: It's your equity, but the bank is lending it to you so that you can remain in your home. Based on new rules, homeowners can borrow up to $417,000 (more if they live in Alaska, Hawaii, Guam or the U.S. Virgin Islands).

Borrowers also have to pay a loan origination fee of 2% on the amount of their loan up to $200,000, and an additional 1% for whatever they borrow above that amount. The origination fee is capped at $6,000.

Thus, if the bank allows you to tap $200,000 worth of your equity for a reverse mortgage, you'd pay $4,000 in origination fees.

You'd also have to pay 2% of the loan for the mortgage insurance premium. Now you're up to $8,000 in fees.

There's more.

In addition, lenders charge a monthly service fee, called the service fee set-aside, that can add on thousands to the final cost of the loan, when the fee is usually assessed.

Most fees are deducted from the amount you borrow; you don't pay them out of pocket, but they significantly reduce the cash you get.

The high cost is why 63% of those who shopped for a reverse mortgage ultimately decided against it, according to a December 2007 AARP survey. Often, people can get more cash by selling their house.

Continued: When the loan comes due

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