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FHA Reverse Mortgages Come Lock, Stock & Barrel

A new perk could potentially boost the size of reverse mortgage loans. An interest rate lock, now available on mortgages approved by the Federal Housing Administration (FHA)—about 90% of the reverse mortgage market—lets borrowers pin down an interest rate when applying for a loan. Until now, you risked a higher-than-expected interest rate on closing day—and, as a result, a reduced loan amount.

If you're 62 or older and have paid off most of your home loan, a home equity conversion mortgage—more commonly known as a reverse mortgage—lets you "reverse" the mortgage process. Instead of making monthly payments on your home, you sell your house to a lender in exchange for a lump sum, monthly payments, or, most commonly, an equity line of credit.

The loan needn't be paid back until you sell your house, vacate it for longer than a year, or die. Then, you or your estate repays the loan's principal and interest. Should your house sell for less than the borrowed amount, the bank eats the loss.

How do interest rates affect how much you borrow? They're one of the factors lenders consider—along with your age, and the value and location of your home—in determining a maximum loan amount. Rates for FHA reverse mortgages are based on the yield of the 10-year U.S. Treasury security, with an average 1% margin. Even a mild rate increase can affect the size of the loan.

Consider a 76-year-old man with a house valued at $500,000. He was approved to tap $315,548 in equity based on a 4.37% interest rate. But if rates rose a quarter percentage point—to 4.62%—before closing and he hadn't locked in the lower rate, he'd qualify for only $305,162, or $10,386 less, according to the National Reverse Mortgage Lenders Association.

The lock, which lenders must provide free of charge, is a no-lose proposition when you close within 60 days of filing your application, explains a report from the Department of Housing and Urban Development (HUD), which provides FHA-approved loans. That's how long your rate is guaranteed. If interest rates drop before closing, you can opt for the new lower rate.

HUD approved the reverse mortgage lock in March 2003, but it wasn't implemented until recently because lenders needed time to adjust the loan process and wanted reassurance that Fannie Mae, the government-sponsored agency that invests in mortgages, would buy locked home equity conversion loans.

Although Congress created reverse mortgages in 1989 to offer cash-strapped seniors access to steady, tax-free income, today the loans are being used to finance retirement luxuries such as second homes, vacations, and even personal aircraft. But are they for everyone? Consider these factors:

Is a reverse loan worth the cost if you borrow only a small amount? For minor borrowing, this may be a very expensive way to go, with origination fees, appraisal costs, closing costs, and mortgage-servicing charges accounting for a significant chunk of your loan balance. Moreover, because the house must ultimately be sold to repay the debt, you or your estate will also eventually have to pay home-sale closing costs. Fees vary widely from one provider to the next, so making accurate comparisons can be difficult.

Will you be disqualified for state funding? While proceeds from your loan won't affect your eligibility for Social Security or Medicare, the money could keep you from receiving benefits from programs such as Medicaid or Aid for Dependent Children. You may be able to get around this problem if you select a monthly payment schedule, then spend your check during the month you receive it.

How much equity can you really tap? Lenders won't let you borrow against the full value of your home. You may only be able to tap as little as 60% of your home equity with an FHA-insured loan. But non-FHA reverse mortgages—available from Fannie Mae and Financial Freedom Senior Funding Corp., a lender in Irvine, California—have higher lending limits. No matter which program you choose, however, you'll always lose some of your equity to fees.

If all of this sounds complicated, the good news is you don't have to make a decision in the dark. To get an FHA-approved reverse mortgage loan, you're required to meet with a HUD-approved certified housing counselor, who helps determine whether the loan makes sense, how much you need, and the payment arrangement that works for you. Contact HUD at 800-569-4287 for more information about counseling agencies and FHA-approved lenders. And while Fannie Mae and Financial Freedom don't force applicants to meet with a counselor, they do require applicants to review extensive literature on reverse mortgages.

With today's booming real estate prices, your home may be worth far more than ever before. Unlocking your equity with a reverse mortgage could make sense, particularly now that you can lock in your interest rate.

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