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What Is A Reverse Mortgage?

Many homeowners, upon reaching their retirement years, find themselves "house rich" and "cash poor". They find it difficult to live on a fixed income based primarily of Social Security. Meanwhile, they may have tens or hundreds of thousands of dollars in home equity.

Because of their age, they may find it hard to refinance, to pull out their equity. After all, once a person reaches retirement age, the chances of living another 30 years to pay off a mortgage becomes less likely. And rising medical bills would incur even greater risk of non-payment of any new mortgage. So, banks understandably shy away from home equity loans for the elders among us.

A "reverse mortgage" solves those problems. Briefly, a lender would pay the homeowner a monthly payment (or even a large lump sum) based on his or her equity, effectively paying down (reducing) the equity. This provides the elder homeowner with additional income to supplement his or her Social Security. And the lender would hold a growing lien on the property, which can grow up to a certain point - normally only a certain percentage of the equity at the time the reverse mortgage is initiated.

The lender is protected by virtue of the right to effect a sale of the property upon the homeowners demise, and collecting the amount they paid out, plus accrued interest.

If there are heirs who want the home, they can inherit it by paying the lender his due.

History

Lenders, guided and regulated by HUD (Housing & Urban Development), began offering reverse mortgages in 1987 in a pilot program. But the reverse mortgage originated in 1985, in the mind of entrepreneur and real estate investing icon Bill Vaughn.

Mr. Vaughn had been a real estate investor for 15 years, and was already credited with developing many of today's "flipping" strategies in the early 1970's, long before people like Carleton Sheets or Robert Allen ever took to late night television, when in 1985 he encountered a sad situation with an elderly friend, who was having a very hard time meeting his rising medical costs from age-related illnesses. Banks would not even consider a home loan, even with Bill as a co-signer. Mr. Vaughn devised a plan that he dubbed the "Golden Years" project. In this first reverse mortgage, his friend would receive a monthly cash payment from Mr. Vaughn. The amount was determined according to a) the value of the equity in the home, and b) life expectancy (from a chart obtained from his life insurance agent). Mr. Vaughn agreed to make that monthly payment regardless of how long his friend lived. In return, his friend would leave the home to Mr. Vaughn, free and clear, when he passed away, with a stipulation that if the friends' heirs wanted to keep the home, they would pay Mr. Vaughn the full amount he had paid to the homeowner, plus any and all accrued interest.

That is how the "reverse mortgage" originated. In 1987, HUD took an interest in the strategy and started a pilot program that is called Home Equity Conversion Mortgage (HECM).

The market for reverse mortgages is relatively small - about 1% as of this writing, but growing annually. As the "baby boomers" reach retirement, the number is expected to increase dramatically over the next 20 years.

This page brought to you by the American Success Institute, Manchester NH
© 2008