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In comparing these two loan products, there are several factors to consider. For some, the option Arm would be like a ticking time bomb – it is only a matter of time before the low monthly mortgage payment would be replaced by a large monthly payment. If the senior does not have an abundance of income and wants to stay in their home for many years to come, then the option ARM would be a poor choice. On the other hand, the reverse mortgage carries the guarantee of no mortgage payments for as long as the homeowner lives in the home.

Qualifying for the reverse mortgage is much easier than qualifying for the option ARM. The reverse mortgage does not require any income, assets (other than home equity) or minimum credit score. The option ARM does require those items, even if they only must be “stated” on the forms by the borrower. Caution: never consider lying about the amount of income or assets. Despite what an eager broker might say, such an action carries potential loan-fraud consequences.

Coming up, Part 5

This is part 4 and the last post of this series.

Perhaps the senior is making ends meet, but would be borrowing on their credit cards, or from their kids, or depleting precious savings for other significant expenses such as home repairs or medical bills. In that case, a reverse mortgage home equity line of credit would provide the financial security of knowing that the funds are there when they are needed. Remember that with reverse mortgage line of credit, the money simply sits in home equity and does not begin accruing interest until it is used. Once a draw is made, there is no burden of payments or risk of rising interest rates pushing the payments sky-high as with a traditional home equity line of credit.

On the other end of the spectrum are the well-off and financially savvy. Their investment portfolios perform well and provide all the income that they need. These seniors know the power of leveraged investments and compounding returns. They might take out a reverse mortgage and invest the money where they know that they can get a rate of return that is greater than the interest rate on the reverse mortgage. Borrowing money at 6% to get a return of 8% or more makes sense every time.

The wealthy use the reverse mortgage as a prudent estate planning tool. By accessing their home equity, they are able to begin transferring more of their wealth to their heirs. Such a strategy gives them direct control over how their money is distributed, allows them to enjoy the giving process, and can dramatically reduce the estate tax burden.

A reverse mortgage should be considered by all homeowners over age 62. While not for everyone, it is a powerful financial tool that should not be dismissed without understanding how it could apply to each senior’s individual situation.

Since the inception of the reverse mortgage program by HUD, only an adjustable interest rate has been available – at least until last year. With recent news stories spreading fear about the danger of adjustable rate mortgages, many seniors have understandably been more than a little gun-shy of the reverse mortgage with an adjustable rate.

But just in this last year, a new fixed-rate reverse mortgage has been introduced. The rate is locked at the drawing of the final loan documents and remains fixed for the life of the loan. With rates as low as 5.5% this year, a fixed rate reverse mortgage sounds like an attractive option. But, as with most new things, it comes with a few caveats.

The fixed rate reverse mortgage requires that the senior homeowner take out the money that they qualify for as a lump sum. No credit line, term or tenure income payment is available. For those that have a large mortgage to payoff, or for those who have plans for the money, this disadvantage is the sleeves out of their vest. But for this reverse mortgage for seniors who owe little or nothing on their homes and just want a little additional monthly spending money, the lump sum requirement has some real tradeoffs.

If they are required to take out all of the money at once, then interest will begin accruing on the full loan amount from the first day. But with the adjustable rate reverse mortgage, they could get a monthly income check whose amount is added to the mortgage balance when the check is deposited. This would keep the balance of the reverse mortgage lower over the long run, allowing less interest to accrue and leaving the senior or their heirs more home equity down the road.

The fixed rate reverse mortgage may be a good idea for some seniors. For those who think that an adjustable rate will, over time, average out to be higher than the currently-available fixed rate, it may be a good choice. Those who choose the fixed rate reverse mortgage must also have a good use for the lump sum of cash that they will receive, so that they do not needlessly accrue interest on their loan.

Refinance and Pull Cash Out
Another alternative may be to pull cash out of your home equity with a traditional mortgage. Why not? Perhaps you should. But first make sure that you fully understand what you're getting and the risks, versus a reverse mortgage.

The two traditional home loan options are the Home Equity Line of Credit (HELOC) and Cash-Out Refinance (CO-REFI). These are loans that are probably offered by every bank in town and are often advertised on their windows. The main difference between the CO-REFI provides you with a one-time lump sum of money and the HELOC gives you much less money, but (like a credit card) you can take out money and put it back in whenever you wish. Some people use these home equity loans to help finance their lifestyle.

So what are the problems for people 62 and older with these loans? The first is that you must qualify for both of them. The qualifying criteria, which determine your interest rate and amount of money that you can get, are all of the following: (1) your credit history and rating; (2) monthly income and amount of cash already in your bank accounts; (3) equity in the home. Now compare those qualifying requirements to those for a reverse mortgage: homeowner's age, location and equity in the home. Now that's more like it!

To get a reasonable amount of money from a traditional mortgage you must have a large enough income (or bank account) to make the required payments for the term of the loan - which is 30 years in some cases. This is why you've heard the saying: "banks only loan money to people who don't need it." In most cases (excepting the reverse mortgage), that's true. If you need the money, you may not qualify for very much. And the less money you get, the quicker you'll run out of it as you spend it on loan payments and your other expenses.

Which brings us to the second and potentially bigger problem: if you're getting a traditional mortgage to help cover expenses, you are using loan proceeds to make the payments. That's called borrowing from Peter to pay Paul - or perhaps more accurately, borrowing from Peter to pay Peter!

In the case of a HELOC, as you use up the money from the loan, your payments will increase sharply. With the CO-REFI, you're paying interest on the FULL amount of the mortgage the month after you take out the loan. So what happens, with either forward mortgage, when you use up all the money and can no longer make the payments? You will be forced to sell your home- or the bank will foreclose and take your house. That's a bit of a dangerous downward spiral, don't you think?

Worse yet, most HELOC's (and many CO-REFI's) have adjustable interest rates. Adjustable rate means adjustable payment. As interest rates rise, your monthly loan payments can rise dramatically. Which brings us back to that dangerous downward spiral.

Stay tuned for more on this topic tomorrow!