When Congress was frantically trying to pass the housing rescue package in July, most people expected all it would do was stem foreclosures and shore up Fannie and Freddie. What a lot of consumers don't know is that it also contains provisions that make reverse mortgages a better deal for older homeowners seeking to turn their home equity into cash. 

Lawmakers are now paying more attention to reverse mortgages because these once-marginal products have skyrocketed over the past ten years as a result of low interest rates and rising home values. The federal government, which backs more than 90% of all such loans through the Home Equity Conversion Mortgage Program (HECM), guaranteed 107,400 reverse mortgages last year (up from 7,900 in 1998). An industry group estimates that even after the housing slump, seniors' equity in their homes was worth $4.2 trillion at the end of last year.  It's looking as if more baby boomers will be returning to reverse mortgages when they retire because of their slimmer savings and impressive pensions. These products are, however, much more complicated than your typical loan, so before you hurry to pick up an application, you should definitely do some research.

The Basics

Reverse mortgages, though they're similar to home-equity loans, have a few key differences. They're only available to people age 62 and older, and the amount you can borrow differs according to your age, the value of your home, and interest rates (look at AARP's calculator at rmaarp.com for a rough estimate). You can choose to receive your funds in a lump sum, monthly installments, or a line of credit. There won't be any monthly payments to make, which means you don't have to meet an income requirement to qualify. 

Also, you needn't repay the loan until you move, sell your home, or die; the debt is settled with the proceeds from the sale of your home. If there is money left over, it will go to your heirs. If your house sells for less than you owe, the federal government will cover any shortfall for HECM loans and for others, the mortgage holder simply covers the loss. 

Though the concept of a reverse mortgage may sound good so far, it's not that simple. Reverse mortgages can turn out to be a very expensive way to borrow. The basic rates are presently lower than those on home-equity loans; the monthly adjustable rate for HECM loans is now around 4.3% vs. 5.3% for home-equity loans of credit. Reverse mortgages are, however, "rising debt" loans. The interest you owe is tacked onto the balance of your loans, eventually becoming a substantial portion of your total debt, and you end up owing interest on the interest, thus compounding the cost.  

Borrowers are also required to pay a variety of upfront charges, including origination fees, the cost of the appraisal, title search, and et cetera, and a 2% mortgage insurance premium for all HECM loans. The new law does bring some relief; it limits origination fees to 2% of the loan up to the first $200,000 and 1% of the rest, with a cap at $6,000.

Deciding if a reverse mortgage is right for you depends on your specific situation. For those who qualify for a home-equity loan and can make the monthly payments, a home-equity loan is usually a better choice. Another thing to consider is how long you plan on living in your home. It makes little sense to pay the fees if you plan to move in just a few years. Since borrowers remain responsible for maintenance, taxes, and homeowners' insurance, selling your home to downsize or rent may be a better way to tap your home equity. 

One Last Thing

Reverse-mortgage brokers have, in the past, pressured borrowers to buy investments like deferred annuities with the proceeds of their loans. The new law prohibits lenders from requiring borrowers to buy investments or insurance products as a condition of being approved for the loan. You should never ever take out a reverse mortgage to buy investments; to get the kinds of returns that would cover the interest on the loan, you would need to take on a level of risk that's unacceptable when your home equity is at stake.