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A Reverse Mortgage for Less

The Home Equity Conversion Mortgage program charges lower upfront fees.

A reverse mortgage offers a way to get at the equity in a home that might not otherwise be accessible. The chief complaint has always been that reverse mortgages come with high upfront fees.

See: More about reverse mortgages

Yet for some older borrowers — you must be at least 62 to apply for one — who've run out of options, a reverse mortgage offered a lifeline that was worth the expense. Now, homeowners have

A less costly alternative

In October 2010 the Federal Housing Administration launched a reverse mortgage called the HECM Saver. In exchange for borrowing a lower amount, the HECM Saver charges drastically lower upfront fees. HECM is short for Home Equity Conversion Mortgage, the reverse mortgage program insured by the FHA. The vast majority of reverse mortgages are HECMs.

The new HECM Saver effectively eliminates the upfront mortgage insurance premium, charging just 0.01 percent of a home's value. On a $200,000 home, that means you'll pay an upfront premium of just $20. The tradeoff with the HECM Saver is that the amount you can borrow against your equity is between 10 percent and 18 percent less, depending on your age, than the FHA's standard reverse mortgage. Borrowers are also charged mortgage insurance premiums on an ongoing basis equivalent to 1.25 percent annually of the outstanding loan balance.

Standard reverse mortgage gets makeover, too

Reverse mortgages aren't like traditional mortgages and home equity loans that require you to make regular payments until the debt is settled. Rather, a reverse mortgage gives you money from the equity in your home in the form of a loan that isn’t paid back until you move, sell or pass away. You can receive the money in a lump sum, a line of credit or periodic payments.

Since interest accrues, the amount due increases over time. If you live long enough or real estate prices decline enough, it’s possible for the loan total to exceed the value of your home. The mortgage insurance premium charged by the FHA partially covers the loan in the event the balance exceeds the value of the property. Those premiums can make a reverse mortgage a lot more expensive than a traditional mortgage or home equity loan.

Before the debut of the HECM Saver, the FHA had just one reverse mortgage, the HECM Standard. The HECM Standard still exists, though it’s been modified. The upfront mortgage insurance premium on a HECM Standard remains the same at 2 percent of a home’s value. On a $200,000 home, that’s still a steep $4,000. The FHA raised the ongoing insurance premium to 1.25 percent annually, the same rate as the HECM Saver. The rate had been 0.5 percent.

In addition, the FHA lowered the amount you can borrow with a HECM Standard by as much as 5 percent, depending on your age. In 2009, the FHA reduced the limit on the HECM Standard by 10 percent.

New HECMs have drawbacks

The FHA created the HECM Saver to give homeowners a borrowing option with a lower upfront insurance premium. That’s a positive development. But in reality, the FHA has raised the ongoing insurance premiums on its reverse mortgages, even as it has reduced the amounts that can be borrowed.

"What is driving this is that the [Office of Management and Budget] determined that the FHA has been undercharging for the risk associated with the program in light of major decreases in home values," said Don Redfoot, strategic policy advisor for AARP's Public Policy Institute. "They have chosen to deal with the underfunding of the insurance by increasing the costs of the standard product and by expanding the market with a lower risk alternative, the HECM Saver."

In boom times, when house prices were on the rise, the FHA didn’t have to worry as much about loan balances exceeding home values. But in a real estate environment in which home prices are declining, and have been for the past couple of years, the risk of loan balances exceeding home values is much greater.

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