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Straight Talk on Reverse Mortgage Procedures

May 25, 2006
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A reverse mortgage can be a powerful tool for converting home equity into cash that can help you make ends meet. However, reverse mortgages also present some financial risk.

The following information, provided by the Pennsylvania Institute of Certified Public Accountants, can help you determine if this financial strategy is right for you.

• How They Work. Reverse mortgages work like traditional mortgages, only in reverse. Rather than paying your lender each month, the lender pays you. These payments are cash advances against the equity in your home.

The maximum amount that can be borrowed is usually based on the age of the homeowner, the appraised value of the home and the current interest rate. Generally, the more equity you have in your home, the older you are, and the lower the interest rate, the more you can tap into it for cash.

With most lenders, you may choose to receive your payment as a lump sum, in regular monthly payments, as a line of credit you can draw against when you need cash - or some combination of these options. Through the reverse mortgage, you continue to own your home, and are responsible for property taxes, operating expenses and maintenance. Because you make no payments on the loan, the balance owed increases each month as interest is applied and compounds.

• Who Qualifies? To qualify for a reverse mortgage, you must be age 62 or older and must occupy the home as your principal residence. Your home must be owned free and clear, or have a small outstanding mortgage balance that can be paid off with the reverse mortgage. Unlike a traditional mortgage, there are no income, employment or credit-qualifying requirements.

• Repayment Issues. With a reverse mortgage, repayment is due when you die, sell your home or no longer occupy it as your principal residence. When payment is due, there is no requirement that the property be sold, only that the loan be repaid. This can be achieved through the sale of the home or through other resources.

• The Benefits. The cash payments you receive are tax-free since they are loan proceeds and not income, and they do not affect Social Security or Medicare benefits. There are no minimum income requirements to qualify and no credit checks; you can use the money for any purpose. You may be able to create a cash-flow stream for the remainder of your life.

• The Drawbacks. Reverse mortgages are complex. In fact, you must attend a counseling session before applying for a reverse mortgage. Reverse mortgages can have very high up-front closing costs. If you think you might move in a few years, a reverse mortgage may not be the best decision. They make the most sense for those who plan to stay in their homes permanently.

Reverse mortgages are relatively expensive. The interest is added to the loan balance each month, and the total interest you owe increases greatly over time as the interest compounds. A reverse mortgage uses up the equity in your home, so it reduces what you have left to leave your heirs.

Your home is likely to be your most valuable asset. Before you tap into any equity, consult with a CPA who can examine your financial situation and help you determine if a reverse mortgage makes sense for you. 

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