Insider Darwin Abrahamson

Equity-Rich and Cash Poor.

You may be one of the thousands of retirees, living on a fixed income, who discover you are house rich and cash poor. You've been hearing from your friends that you can tap into the equity in your home without losing your home. So, as you sit in your living room sipping tea, you begin contemplating some of the advice you have been receiving.

Most of your friends suggest that you take out a "reverse mortgage." Like most homeowners, you're familiar with home equity loans, but you realize that you have never heard of the term, reverse mortgage. You puzzle over the meaning of the word and where you might find information.

PRESSING FINANCIAL DEMANDS Since purchasing a home is usually the largest single investment that most of us make in a lifetime, banks and lending institutions rapidly became aware that the number of equity-rich seniors was growing at an astonishing pace. These institutions were also aware that older Americans have a strong desire to remain in their homes, even in the face of pressing financial demands.

Instead of tapping into this financial resource by taking out a home equity loan, these individuals resist, opting instead to do without, because of their great fear of losing their home if they are unable to repay the mortgage. As an acquaintance once told me, "I'd rather eat dog food in the comfort of my own home than steak in some drafty boardinghouse."

THE BUSINESS OF LENDING MONEY Since lending institutions are in the business of making loans, they looked for a way to reach these equity-rich homeowners. In 1970 financial institutions introduced reverse mortgages as a way for senior citizens with sizable equities in their homes to tap that reserve without having to sell their homes or take out traditional mortgages.

Traditional mortgages require that you qualify based on your income to pay back the loan. A reverse mortgage reverses the direction of the payments. Simply, a reverse mortgage is a special type of mortgage that allows you to convert the equity in your home into a lump sum payment, monthly income, or line of credit that comes to you.

HOW DOES IT WORK? The loan is structured so that the loan balance is never allowed to exceed the value of your home. No payments are made on the loan while you occupy the home as your primary residence. If property values should decline and the loan balance exceeds the value of your home, you cannot be forced to sell or vacate your home as long as you continue to occupy the property. When you move or sell your home or in the event of your death, the loan balance is due and payable. If there is any outstanding debt, the debt cannot be passed along to your heirs.

A study by the Federal National Home Mortgage Association (Fannie Mae), estimates that the potential demand for reverse mortgages in the year 2010 will reach 16.1 million households. Fannie Mae offers reverse-mortgage loans through its affiliated lenders. You can receive a free brochure on their program by calling (800) 732-6643.

AM I ELIGIBLE FOR A REVERSE MORTGAGE? You and your co-borrowers must be a minimum of 62 years of age; the home should be mortgage free or have a small outstanding mortgage balance; and the home must be owner occupied. You, as the owner occupant, are responsible for maintenance and payment of taxes and insurance.

As with any home loan, you will pay an origination fee, title fee, escrow fee, recording fee, closing costs, appraisal and credit report fee, and a monthly servicing fee. The lender takes the loan fees and points up front and pays you, the homeowner, the balance of the loan. Up-front fees can amount to 1 percent of the home's assessed value, plus an origination fee of as much as 2 percent of the value. According to the Fannie Mae Foundation, "The biggest question to ask before taking this step is whether or not the additional income is really worth the added costs."

HOW MUCH DO I STAND TO MAKE? The amount of money you get depends on several factors: your age, the appraised value of your home, current interest rates, and your projected life span. The older you are, the more you get due to your shorter life expectancy. The shorter life expectancy decreases the danger that the accumulated interest will exceed a safe loan-to-value level. Some lenders are also subjecting the appraised value, for loan purposes, to be limited to 80 percent of the valuation of your home.

When can the loan be called due? One disturbing peculiarity associated with reverse mortgages has to do with the definition of owner-occupied, primary residence. Reverse mortgages are called due when, by definition of the lending institution, the residence is no longer owner-occupied.

If the borrower moves out of the house or enters a nursing home for a year or more, the loan will most likely be recalled by the lending institution. You are not allowed to rent out the home or have relatives occupy the home in your stead. Elderly citizens who undergo medical treatment that requires extended care for an extended period may find that when they are ready to return home, they have no home to return to.

Also, if you should outlive the term of the mortgage, the lending institution may have the right to call the mortgage due. In that event, if you are unable to repay the mortgage, you will be forced to sell your home.

KEEPING YOUR HOME FOR YOUR LIFETIME Another little known way to tap into the equity in your home may be "giving your home away"--and gaining financial benefits in the process. A number of charities have programs whereby equity-rich homeowners may donate their homes in exchange for a "Charitable Gift Annuity," which pays the homeowner a fixed amount monthly on the lives of one or two named beneficiaries. Plus, the homeowners can retain the right to live in their homes for as long as they live, not based upon owner occupancy.

The financial benefits of gifting your home to a qualified charity are: you will receive a lifetime income benefit; claim an immediate income-tax charitable deduction; obtain reduction of estate taxes for taxable estates in excess of $600,000; and avoid probate on your donated asset. As the life tenants, you would still be responsible to maintain insurance, pay property taxes, and take care of routine maintenance and repairs. However, by donating your home to your favorite charity, you will receive financial and altruistic benefits without incurring many of the costs associated with mortgaging your home.

Retire with Money magazine explains, "With the lure of tax savings and a lifetime of steady income, many retirees are opting to take charitable fixed annuities."

Finding information on gifting your residence in exchange for a charitable gift annuity is difficult. But visit UCLA Foundation, which allows you to submit questions regarding charitable giving with a reply message sent to you. The Foundation also allows you to contact their development office at (800) 737-8252 for more in-depth information on any aspect of charitable giving. It's a good idea to contact your favorite charity for answers to your questions.

SCAMS AND RIP-OFFS For retirees considering a reverse mortgage, you need to be aware of scamsters who pray upon unsuspecting retirees. The Senior News Network issued a report that "...playing off the myth that deals are difficult to get, scammers often urge homeowners to attend meetings in which they'll purportedly learn estate-planning tips and how to get monthly income that does not have to be repaid."

"Not true," retorts Retire with Money magazine. A reverse mortgage is not debt-free money: It must be paid back when you vacate or sell your home or when you die.

The Better Business Bureau (BBB) also warns older homeowners to be wary of scams and rip-offs. The Bureau reports that senior homeowners have become "...the prime target for fly-by-night telemarketing operations."

Some of these telemarketer service providers are charging seniors thousands of dollars for doing little more than referring their loan application to mortgage lenders and life insurance agents. Some are even persuading the homeowner to apply for a large, lump-sum reverse mortgage and then invest the cash in an annuity sold by the insurance company. According to the Bureau, "This allows the provider to pocket 8 to 10 percent of the loan a referred customer receives... ."

The decision to either gift your home to your favorite charity or take out a reverse mortgage on your home is not a decision to be entered into lightly. Discuss your concerns and options with your family and with your legal and tax advisors.

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