Reverse Mortgage Question

I have been reading about reverse mortgages. With falling home values, how can a lender possibly know their risk with providing a reverse mortgage when they don’t know what the home will be worth once the borrower dies?

I'm pretty sure they take advantage of you in general and under value the property so much that it would be tough for them to lose unless a tsunami came through and you didn't have insurance for that.

Why wouldn't someone with that much equity just take out a HELOC with the longest draw period you can find and then refi the HELOC before you have to start repaying P+I and just keep paying interest the whole time.

The banks don't know whether the home value will decrease or rise. They play the odds. However, the beginning vlaue for calculation purposes is "fair market" and is not devalued. In fact, banks that had written reverse mortages prior to the real estate collapse are really getting hurt by them and the homeowner is the winner thusfar.

Yet, the lump sum equivalent that the bank will put into motion is discounted from the fair market estimate. So, a house that has a fair market value of $200,000 may allow a $140,000 lump sum never to be paid back prior to the occupants death. The amount owed to the bank can never exceed the original $200,000 appraisal though. In other words, there is a cap on the debt regardless of interest rates, makret conditions, etc.

Much like a lifetime income annuity, reverse mortgages can also pay a guaranteed income stream for life regardless how long the recipient lives. Thus, the longer you live and receive payments, the better the deal. It is no coincidence that the $140,000 lump sum mentioned earlier would buy a commercial lifetime annuity that equals the monthly payout of a reverse mortage of the same size.

HELOCs do not shelter the homeowner from these risks at all. Although they are more flexible and COULD be cheaper in the short term, lack of refinancing options as one ages (mortality tables) and interest rate fluctuations, you could end up paying more in the end without the guarantees of the lifetime income and debt cap that a reverse mortage provides. The other disadvantage of a HELOC is of course...the payments. The payment requirement alone hinders the maximum guaranteed income you can receive from the equity in your home.

To sum it up, over the long term a reverse mortgage offers more guarantees, higher income and a debt cap.

Over the short course, the HELOC would likely be a better option.

Neither option is the best for everyone, the idea being that we should prepare for our retirements that enable us to live as we desire without tapping equity. Unfortunately, given the economy and the corresponding crushing blow to marginal retirement accounts, we may see reverse mortages become more popular with banks, and more attractive to consumers.

I understand that this recent housing bubble bursting is the first time in U.S. history that housing values have fallen. Prior to that this new turn of events, I could understand how the lender risk with a reverse mortgage could be assessed. The only uncertainty would be how long the borrower would live, and I suppose they have actuarial data that can establish that average risk to the lender. But now, with drastically falling home values and shifting government policies, I cannot see how a lender can possibly know that what they pay out will be covered by what they can sell the house for in 20-30 years.

As I understand it, a borrower can either take a lump sum of equity up front at the time of the loan origination, or take it in monthly payments. However, the duration of payments is set at a specific limit. So the payments can end even though the borrower can stay in the house until he or she dies. If the equity is taken up front as a lump sum, I guess the interest for the whole term would all be deducted from that lump sum.

I had a HELOC that I originated in 2004 with a $125,000 line of credit. About a month ago the lender suspended the remaining $73,000 of credit because my house has lost 30% of its value since 2004. They won't even answer my letter now. I will never get another HELOC.