A Reverse Mortgage for Less

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.

Does a HECM Saver make sense?

If you've made the decision to take out a reverse mortgage and can meet your needs with the lower amount offered under the HECM Saver, then go for it. The new HECM Saver is always less expensive than the new HECM Standard. But if you need to borrow the maximum available to you, then you'll now pay considerably more for the new HECM Standard than you would have for the old HECM Standard.

The HECM Saver also makes sense when you want to take out only a small loan, say to redo your kitchen, or you don’t plan to stay in your home for very long. The upfront insurance premium is substantially less than what’s charged for a HECM Standard — 0.01 percent  versus 2 percent , you’ll recall — and the ongoing premiums (at 1.25 percent) will only accrue for a relatively short time.

"If someone only needs to borrow a small amount and knows they will be moving in a couple of years, the HECM Saver may make sense," Redfoot says. "The HECM Saver is less expensive if you take small loans for short periods."

And if your house is worth a lot, then you stand to benefit even more upfront from the HECM Saver. Let’s say your home is valued at $550,000. Eliminating the 2 percent upfront insurance premium will save you nearly $11,000.

Reverse mortgage basics

Ultimately with a reverse mortgage, the amount you get is based on your age, current interest rates and the appraisal of your home. The older you are, in general, the more you receive. To qualify for a reverse mortgage, you have to be at least 62 years old, and any outstanding mortgage balance must be less than the loan amount that can be received by a HECM, since other liens must be retired as a condition of the loan.

With a reverse mortgage, you won’t undergo a credit check or have to have a specific amount of income to qualify. You’ll need to go through a HUD counseling session, which provides helpful information about reverse mortgages and alternatives you should consider before taking out a loan. While you don't have to worry about making monthly mortgage payments, you're still be responsible for keeping current on real estate taxes and homeowners insurance premiums.