Are your retired parents facing an unexpected expense for medical care or essential home improvements? Is your widowed mother unable to make ends meet with just her Social Security payments and the income on some modest investments? Homeowners age 62 and older can convert a portion of their existing home equity into cash to meet such needs by obtaining a reverse mortgage.

Although the first reverse mortgage was written in the early 1960s, relatively few lenders offered them until the Federal Housing Administration initiated the Home Equity Conversion Mortgage (or HECM) program in 1988. Over a half million reverse mortgages have been written since the FHA program began, and a new HECM product introduced in late 2010 may lead to renewed interest in the program.

An FHA reverse mortgage is a relatively simple financing device, tailored to the needs of the growing elderly population. Homeowners who meet the minimum age criteria and have little or no balance remaining on a conventional mortgage can obtain a reverse mortgage regardless of their income or credit history. FHA formulas determine the maximum amount of a loan secured by a reverse mortgage, based on the age of the homeowner(s), the current interest rate, and the appraised value of the home. The homeowner selects the method by which he or she will receive the proceeds of the reverse mortgage; choices include a lump sum payment, equal monthly payments over a fixed period, or a line of credit.

The unique aspect of a reverse mortgage is the way in which the loan is retired. The homeowner makes no payments after receiving the proceeds of the loan; the entire amount is repaid once the last homeowner/borrower no longer uses the house as his or her principal residence. While there is not necessarily a “typical” case, it is likely that many homeowners who obtain a reverse mortgage will continue to live in the mortgaged property until they die or have to move to a long-term care facility. The lender is then repaid from the proceeds of the sale of the home; if the sale generates more than the payoff amount, the residual goes to the estate of the homeowner. However, if the proceeds are less than the balance due on the loan, the FHA covers the gap, not the estate of the homeowner/borrower. This is true even if there are other assets available in the estate that could be applied to the balance of the mortgage loan.

The homeowner retains responsibility for payment of property taxes, insurance premiums, and maintenance expenses on the mortgaged property as long as he or she uses it as the principal place of residence. The homeowner must also pay all of the usual closing costs (origination fees, service fees, appraisal and title search expenses) as well as an up-front mortgage insurance premium of 2% on the standard FHA reverse mortgage. In addition, over the life of the loan, the homeowner will pay an annual mortgage premium of 1.25% on a standard reverse mortgage.

These very substantial insurance costs, which are typically paid from the proceeds of the loan, have been the greatest drawback of the original HECM program.  Because the mortgage insurance requirement results in a substantial depletion of the homeowner’s equity over and above the value of the loan, many older homeowners have considered a reverse mortgage only as a last resort.  To address this concern, the FHA launched a second reverse mortgage program, known as the HECM Saver, in October 2010. In essence, the Saver is a lower up-front mortgage insurance premium (.01% of the home value, rather than 2%) coupled with a lower maximum loan amount. This modified reverse mortgage program is likely to spark new interest in the FHA reverse mortgage program among older Americans who find themselves in financial distress.