Given the downturn in home prices, some seniors who took out reverse mortgages — especially in places like Florida, Arizona and California — are now upside down, or owe more than their homes are worth.
But with reverse mortgages, being upside down has almost no downside.
Dale Milfay of San Francisco says her 86-year-old mother, Florence, took out a reverse mortgage on her home in Cape Coral about four years ago.
At that time the home was appraised for $260,000. Florence qualified for a $160,000 reverse mortgage guaranteed by the Federal Housing Administration.
This type of loan, known as a home equity conversion mortgage, lets seniors 62 or older borrow against the equity in their home without making monthly loan payments. Interest costs and an annual mortgage insurance premium are added to the principal.
The loan balance doesn't have to be repaid until the borrower dies, sells the house, or moves out for more than 12 months. At that point, if proceeds from the sale of the home fall short of the loan balance, the FHA insurance fund — not the borrower or heirs — pays the lender the difference.
Borrowers can take their reverse loan proceeds in a lump sum, fixed monthly payments, a line of credit or some combination thereof.
Each monthly payment, and anything taken from the credit line, is added to the loan balance. Interest is charged only on the unpaid balance, not the untapped credit line. The unused credit line grows at a certain interest rate, so the longer it's left untouched, the bigger it gets.
Florence's loan balance is now about $75,000, and she has about $105,000 left in her line of credit. But her home value has fallen to roughly $80,000.
Milfay asks, "Does she have the right now to take the remainder of her equity as a lump sum while remaining in the house?"
Yes. "She can absolutely take out that $105,000," says Susanna Montezemolo, a vice president with the Center for Responsible Lending.
That would bring her loan balance to almost $200,000. "If the house sells for $80,000, she does not owe the difference. That's what the insurance pool is for. One of the great features of these reverse mortgages is that the borrower never owes more than the house is sold for," Montezemolo says. "Borrowers never have to worry whether they are underwater or not."
Whether she should is a tougher question.
If she knew she might die soon or move into a nursing home, she could take out $105,000, put it in a bank account or money market fund and use it to pay her expenses and leave the rest to her heirs.
No matter what happens to the home's value, she will always be able to take out whatever remains on her equity line. "The lender must honor the mortgage contract as originally written," says FHA spokesman Lemar Wooley.
The reverse loan is nonrecourse, which means neither the lender nor the government can come after the borrower's other assets, nor the borrower's heirs' assets, for any unpaid balance.
Not surprisingly, "The decline in house prices has adversely affected the projected credit performance" of FHA-insured reverse mortgages, the Obama administration noted in its proposed fiscal 2011 budget. To shore up the program, the FHA recently announced changes designed to reduce risk and increase annual mortgage insurance premiums.