Save Your Retirement
With a Reverse Mortgage

Dec. 22, 2003 -- Retirees may not like reverse mortgages. But they will learn to love them.

One glance at these loans, and you will likely suffer severe sticker shock. Reverse mortgages, which allow those aged 62 and up to borrow against their home's value without making any repayments during their lifetime, are pretty darn expensive. Nonetheless, I would advise boning up on the topic, for one simple reason: These things are going to be huge.

Today, reverse mortgages are a modest business. Consider the Home Equity Conversion Mortgage, which accounts for an estimated 90% of all reverse mortgages. In the 12 months ended September, there were only 18,097 HECM loans originated. Still, that 18,097 represented a 39% increase from a year earlier, and I suspect the number will skyrocket in the decades ahead.

The fact is, a reverse mortgage may be the only way cash-strapped baby boomers can salvage their retirement dreams. Older boomers, those born between 1946 and 1955, had a median household net worth of just $146,050 in 2001, according to an analysis of Federal Reserve data by AARP, the Washington group for seniors. Half of this net worth was accounted for by savings accounts, mutual funds and other financial assets. The other half? That would be home equity.

Claire Toth, a financial planner in Summit, N.J., is no fan of reverse mortgages. Before you consider one of these loans, Ms. Toth advises first trading down to a smaller place. That will free up home equity that can then be spent, while also reducing maintenance costs, property taxes, utilities and possibly homeowner's insurance.

But maybe you can't trade down, because your home is already pretty small, or maybe you still need the cash from a reverse mortgage, even after moving to a smaller place. "The fees are just exorbitant," Ms. Toth warns. "But if you don't have any other choice, you don't have any other choice."

Costs aside, reverse mortgages seem like a decent product. As long as you don't move or sell your house, the loan doesn't have to be repaid until after your death. At that point, the amount owed, including accrued interest, can't exceed your home's value.

Money received from a reverse mortgage is tax-free. How much can you get? If you are older, if interest rates are low or if your house is appraised at a high value, you can typically get a larger loan.

The loan size, however, also depends on the product you choose. Currently, there are five varieties of reverse mortgage on offer. The two types of HECM loans, which differ in the way they calculate their interest rate, are both federally insured. This insurance protects the lender against loss, should the reverse-mortgage balance be greater than the home's value when the homeowner dies or permanently moves out.

Thanks to this mortgage insurance, HECM loans have the steepest upfront costs. But the interest rate is relatively low and you can typically borrow a larger percentage of your home's value. To get a handle on costs, try the reverse-mortgage calculator at the National Reverse Mortgage Lenders Association's Web site.

Suppose you are age 75 and own a $280,000 home in central New Jersey. According to the calculator, you would be eligible to borrow $198,800 using a HECM loan. But after deducting $19,617 in closing costs and a set-aside for service fees, the cash available shrinks to $179,183. With a HECM loan, you can take this cash as a lump sum, a line of credit or monthly income, or some combination thereof.

There are lower closing costs on the three other types of reverse mortgage, Fannie Mae's Home Keeper and Financial Freedom's two Cash Account products. The reason: There's no insurance involved. But because these other loans aren't federally insured, you probably won't be able to borrow as much of your home's value.

As always, there's an exception. HECM loans are currently capped at $154,896 to $280,749, depending on where you live. As a result, if your home is worth more than, say, $500,000, you may be able to borrow more with the Cash Account offered by Financial Freedom of Irvine, Calif., a subsidiary of Lehman Brothers and the country's largest reverse-mortgage lender.

Financial Freedom's new Zero Point Cash Account is especially intriguing, because it has no origination fee and limits most other closing costs to a maximum $3,500. The Cash Account is only available as a credit line. If you take the zero-point option, you have to draw down 75% of your credit line right away.

That ensures that Financial Freedom will earn a decent amount of interest, thus allowing it to waive the origination fee, explains James Mahoney, Financial Freedom's chief executive. The Cash Account's interest rate, which fluctuates along with short-term rates, is around 6% today, compared with 4% for a conventional adjustable-rate mortgage.

Feeling a little sticker shock? As the reverse-mortgage market matures, there's a chance we will see a decline in both closing costs and also the interest rate relative to conventional mortgages. But reverse mortgages probably won't ever be as cheap as conventional mortgages.

Because of the costs, I can't get wildly excited about today's reverse mortgages. But I get even less excited by the idea of seniors scrimping and saving unnecessarily. Need a reverse mortgage to put the shine back on your golden years? Yeah, I'd probably go for it.

-- Mr. Clements writes the Getting Going column for The Wall Street Journal Online. WSJ.com subscribers can view past columns in the Getting Going archives.

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