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Understanding the pitfalls of reverse mortgages

What surprised one reverse mortgage holder was the nearly $200 a month charged for mortgage insurance

Retirement is an increasingly scary prospect. Some experts say a couple will require at least $2 million to live comfortably. Some say you should have at least 10 times your annual salary socked away.

My wife and I have been aggressive savers but we're nowhere close to these benchmarks. Our retirement plan currently focuses on three possibilities:

Win the lottery (admittedly a long shot).

Be supported by son (fat chance).

Reverse mortgage.

That last one has been lurking in the background ever since we became homeowners — and it's the one that has seemed the most likely way to supplement whatever we'll end up with in savings and Social Security payments.

After all, a number of celebrities, including Henry Winkler, have taken to the airwaves to tout the benefits of reverse mortgages. And who am I to question the Fonz?

Then I chatted the other day with Jeff Lowe, who related the experience of his 91-year-old father's reverse mortgage.

Basically, the elder Lowe put up his Santa Monica house several years ago for a $180,000 loan. He knew going into the deal that he'd still be responsible for property taxes and homeowner's insurance.

What surprised him was the nearly $200 a month he's now charged for mortgage insurance. Add that to roughly $400 a month in interest payments, and his debt is growing by about $7,200 a year.

"It seems like a student loan," Lowe told me. "You can't get out from underneath it."

He's now wondering whether this was such a good deal for his father.

I'm thinking this is a fine opportunity for all of us to get a little schooling on the subject.

Here's how the Federal Trade Commission defines a reverse mortgage: "In a 'regular' mortgage, you make monthly payments to the lender. In a 'reverse' mortgage, you receive money from the lender, and generally don't have to pay it back for as long as you live in your home."

That might sound good, but experts say you need to be very clear about your goals going into something like this and have reasonable expectations for what you expect to get out of it.

"If somebody wants to leave their home to their heirs, they probably don't want a reverse mortgage," said Philip Goss, a certified reverse mortgage professional in Glendora. "They'll be using up equity in the home."

If, on the other hand, you're figuring that your next of kin can look after themselves and that you plan on staying in your home for a while, a reverse mortgage can be an effective way of turning the roof over your head into cash in your pocket.

"Think of it as a cash-flow tool for older homeowners," Goss said.

Most reverse mortgages are so-called home-equity conversion mortgages that are insured by the Federal Housing Administration. The federal agency writes most of the rules for these things.

To qualify, you have to be at least 62 and use your home as your primary residence. You also have to own a significant amount of the property, although the percentage can vary.

Don't think that if your home is worth a million dollars, say, you'll receive the full market value in a reverse mortgage. There's a $625,500 cap on such loans, and even then you should expect significantly less.

Wild cards include the borrower's age, the appraised value of the property and any outstanding repairs needed to meet federal safety standards.

The most attractive aspect of reverse mortgages is that no payments have to be made to the lender until the homeowner sells or vacates the property, or dies.

If the homeowner dies, heirs or the estate typically have six months to pay off the loan or walk away from the property, leaving it in the hands of the lender.

In the case of Lowe's father, his Santa Monica house is worth more than $1 million and he owns it free and clear, so his $180,000 reverse mortgage won't eat up all his equity.

He can either pay down his debt during his remaining years, or his kids likely will sell the property after his death and use a portion of the proceeds to cover the loan.

But there are a number of things would-be borrowers should keep in mind before taking the reverse-mortgage plunge.

The first is the potentially high upfront cost of these loans. Closing costs typically run in the thousands of dollars, sometimes as high as $15,000. That's a big chunk of change, particularly when you consider that the closing cost of a 30-year mortgage might be around $3,000.

"You'll want to shop these things," said Mark Reeve, reverse mortgage national director for Plaza Home Mortgage in San Diego. "It's a very competitive environment out there right now, so make you sure you get the best deal."

Many reverse mortgages come with variable interest rates, so they can fluctuate over time. Also, interest is charged on your outstanding balance and accrues over time, which means that the size of your loan will keep rising if you aren't paying it down.

And then there are the insurance premiums that caught Lowe's father by surprise. They're required by federal authorities to protect both lenders and borrowers and to ensure the stability of the marketplace. The annual premium is equal to 1.25% of the outstanding loan balance.

"A reverse mortgage can be a helpful financial tool for some people," said Lori Trawinski, director of banking and finance for the AARP Public Policy Institute. "But for others, there may be better ways to go."

Because of the relatively high cost of reverse mortgages, she said, people also should consider refinancing an existing mortgage, seeking a home equity line of credit or even selling their property to bolster retirement funds.

"It really depends on an individual's situation," Trawinski said. "Learn as much as you can about what a reverse mortgage is and what your obligations are. The key is education."

With all that in mind, I'm still open to this as part of my own retirement planning.

But winning the lottery seems better.

David Lazarus' column runs Tuesdays and Fridays. he also can be seen daily on KTLA-TV Channel 5 and followed on Twitter @Davidlaz. Send your tips or feedback to david.lazarus@latimes.com.

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