Finding a reverse mortgage is the easy part

About 90% of all reverse mortgages are provided through a Federal Housing Administration program called HECM, short for Home Equity Conversion Mortgage. The rest can be “proprietary” loans from private lenders that tend to charge higher fees, or loans from state and local programs that may attach strings to how the money can be used (like for home repairs or paying off overdue property taxes). Virtually all seniors should stick with FHA-approved lenders that offer HECMs.

Qualifying for a HECM reverse mortgage is fairly straightforward. You need to be 62 or older; have either no mortgage, or just a small balance; live in the property as your principal residence; and not be delinquent on any federal debt like taxes or student loans. If you still owe money on your first mortgage, you can pay that off when you take out the reverse mortgage.

You’re also required to meet with an approved counselor for at least an hour to discuss the risks and obligations of a reverse mortgage. Call the U.S. Department of Housing and Urban Development—the FHA is part of HUD— toll-free at 800-569-4287 for the name of a counseling agency.

One of the key things a counselor will explain is that unlike a conventional mortgage, which you pay down every month until it reaches zero, a reverse mortgage’s balance grows over time. Remember, you’re not bringing down the principal by making monthly payments. The mounting debt generally isn’t paid back until you die, sell the house, or move out permanently. That ever-ballooning balance is a big reason why this type of loan should be held out as a last resort for homeowners who can’t access cash any other way.

Adding up the considerable costs

For cash-poor but house-rich seniors, a reverse mortgage sounds dreamy until you start tallying the bill. Third-party closing costs—think appraisal, title search and insurance, inspections, recording fees, credit checks, mortgage taxes, and the like—quickly snowball. Add to those fees for origination, mortgage insurance premiums (MIPs), and loan servicing. While this money doesn’t come out of your pocket immediately because it’s rolled into your loan, it does come due eventually—and with a vengeance, thanks to compounding interest.

Consider the following scenario outlined by AARP: A 75-year-old borrower living in a $250,000 home qualifies for an FHA reverse mortgage of $135,484, and takes $67,742 at closing with a 7% interest rate. By the time she’s 87, she’d owe a total of $203,771. That includes the initial loan amount ($67,742), closing costs ($12,000), MIPs ($7,933), monthly service charges ($5,040), and interest ($111,056).

Uncle Sam is trying to keep reverse mortgage costs in check. Federal law sets origination fees at 2% of the first $200,000 plus 1% of any additional amount; the maximum payment tops out at $6,000. The maximum loan amount was raised temporarily—until the end of 2009—to $625,500. Even with reduced fees, though, it’s an expensive path to cash, making alternatives like home equity lines of credit, or HELOCs, worth exploring.

Making a definitive decision is hard

Despite the expense, some homeowners opt for a reverse mortgage for good reason. Mortgage insurance guarantees that you’ll never be forced to repay the loan if you remain in your home. Additionally, the total debt will never exceed the property’s value—even if you live a very long time, or your home doesn’t grow in value or, worse, declines. It’s also easier to qualify for a reverse mortgage than other types of home-equity loans that carry stringent income and employment requirements.

A typical misunderstanding about a reverse mortgage is that in exchange for the loan, the bank owns or will own your home. False. You’ll always retain title. When you pass away, your heirs can if they choose repay the loan from their own reserves or refinance, thereby keeping your property in the family. Banks aren’t interested in owning real estate; they want their money back so they can lend it to someone else. Otherwise the house must be sold and the reverse mortgage repaid from the proceeds. Heirs get to pocket whatever is left over.

It’s impossible to know 100% whether a reverse mortgage is right for you. If you’re retired, in financial need, and have substantial equity in your home, then it’s a viable way to generate cash. Unknowns are the biggest complication. Leaving your home permanently due to, say, illness soon after taking out a reverse mortgage is costly. You will be forced to repay all of those up-front charges without enjoying the benefits. You’re ultimately gambling that you’ll remain in your home long enough, perhaps five years or more, to make the costs worthwhile. Consider your current health and family history for clues to your longevity.