July 20, 2000

New wrinkle in reverse mortgages

By TOM KELLY
The Real Estate Advisor

If the up-front costs and low ceilings of reverse mortgages are the only reasons steering you away from tapping into your home’s equity, Washington Mutual Bank has inadvertently provided an alternative.

As of July 3, the Seattle-based thrift rubbed a new wrinkle into its “On the House” equity program, giving consumers the option of a first-mortgage lien in a traditional second-mortgage environment.

The bank, the nation’s fifth-largest mortgage lender and biggest thrift institution, rolled out its second-mortgage, credit-card program earlier this year.

The new setup means you can now draw on the equity in your home via the special credit card, yet get the advantages of first-mortgage interest rates (8-8.5 percent) and the tax advantages brought by mortgage interest deductions. In addition, unlike reverse mortgages, borrowers are not limited by age requirements and are able to access a greater percentage of the home’s actual value. The credit line can be reused as it is repaid.

The potential downside to the concept is that credit-crazy consumers could zip through thousands of dollars of their only asset in a heartbeat. And, once the equity is spent, homeowners would still have to make interest payments.

According to Pam Gavin, Washington Mutual vice-president for consumer product development, focus-group participants wanted the ease of a credit card yet deductibility of interest payments.

“If a customer has a very good rate on a first mortgage already in place, they can keep it and use On the House as a second mortgage,’’ Gavin said. “This is a flexible program. We can also pay off the underlying mortgage so that the customer can get the benefit of lower first-mortgage rates.’’

The concept of blending installment loans with standard home loans began in 1987, shortly after the Tax Reform Act of 1986 disallowed all installment debt interest (car, boat, credit card) to be tax deductible. All interest on a primary residence could be deducted without limit, but interest deductions on refinances made after Aug. 16, 1986, were limited to the original cost of the home, plus capital improvements.

Washington Mutual, in an effort to attract home-equity loan borrowers trying to maximize the tax curtailments of the new law, introduced “Owner’s Choice,” a personal line of credit secure by a first deed of trust for customers who purchased or refinanced their homes with at least a 20 percent down payment. As the loan was repaid, the borrower could pull the money back out – as much as 80 percent of the home’s value – at no cost through a credit line that may used for as long as the customer owns the home.

The 2000 version is “On the House,” wrapped in plastic and useable anywhere. Traditional reverse mortgages are loans that allow persons 62 years of age or older to tap into their equity by receiving monthly payments, a line of credit or a lump-sum payment. The loans began in 1989 and required a confidential meeting with an independent, FHA-approved counselor. They were once offered only through loans insured by the Federal Housing Administration and now are offered by other underwriters. The loans do not

have to be repaid as long as the home is the borrower's primary residence.

One of the most confusing fees involved in a reverse mortgage is the mortgage insurance premium. Seniors are usually flabbergasted when they find the amount is 2 percent of the appraised value of their home. Couple that cost with a loan origination fee and standard closing costs, and a borrower can easily spend $6,000 to borrow $319 a month for life.

Why, you ask, should a senior who owns her home free and clear have to pay for mortgage insurance? Unlike typical mortgage insurance that protects the lender if the borrower defaults, mortgage insurance on a

reverse mortgage ensures the borrower (or the borrower's estate) will never owe more than the value of the home. That means other assets will never be used to repay the mortgage if the home's value turns out to be less than the loan balance.

And, seniors also don't have to own the home free and clear.

Let's say you net $70,000 on the sale of your family home and use that amount as the down payment on a $120,000 retirement condo. You can take out a reverse mortgage for the $50,000 balance and not make a payment. However, if you live in the condo until you die (based on "actuarial life expectancy") your $70,000 will likely be used up by the interest charged on the $50,000.

If a homeowner 62 years of age or older has another asset to use as collateral for a loan, the costs involved typically are significantly lower than those incurred with a reverse mortgage.

For example, a person could "margin" a stock (borrow against its value) with a brokerage firm and pay no fee or monthly payments. Interest accrues on the loan but the borrower is not obligated to repay the debt

within a specific period. Interest on most margin accounts adjusts monthly as do many reverse mortgage loans. Some reverses adjust annually. The FHA reverses are indexed to the one-year Treasury Bill, and five payment options are usually available.

Washington Mutual has provided another option. However, every new program introduced is not for everybody. “On the House” will be great for those who do needcash quickly, don’t want to be locked into a reverse mortgage schedule and consistently repay their debt.

However, if you can’t repay your monthly credit cards, don’t shop until you drop by taking cash out of your home.

Previous columns:

• Referrals offer risks, rewards, 07-13-2000
• Vacation is no time for worrying about escrow, 07-06-2000
• AIRD will mean big changes for appraisers, 06-29-2000
• Rules vary on renting your cabin, 06-22-2000
• Credit: You really are just a number, 06-15-2000
• Reverse mortgages have come full circle, 06-08-2000
• Virtual home tours are a big hit, 06-01-2000
• HUD forced to police its own programs, 05-25-2000