Reverse mortgages have been around for nearly 20 years, but it wasn’t until the current financial crisis that they caught on. Seniors are turning to these loans to tap the equity in their homes and generate tax free income to help them ride out hard times.

For Frank and Carol Rider, a reverse mortgage is providing a cushion, giving their investments time to recover from the bear market. The Riders, both in their early seventies, borrowed about $200,000 against their home in New Mexico. They used the money to pay off their traditional mortgage and to take $1,500 a month for the next 20 years to supplement their pensions and Social Security benefits. “We’re trying to maintain our lifestyle,” says Frank, noting that he and Carol travel extensively year round.

For Luther and Peggy Combs, their reverse mortgage is a lifeline that saved their home from foreclosure. The Combses, both in their early sixties, had high hopes for a comfortable life when they moved from Chicago to central Florida a few years ago. But Luther lost his job when the economy soured, and the couple found themselves deeply in debt. Although they had to use every penny of their home equity to pay off their bills, the reverse mortgage wiped out their monthly house payments and made it easier for them to sleep at night.

You can take it with you. A reverse mortgage can be a good option for people who want to relocate or move to a smaller home but who don’t want to sink all their cash into a new house or who may not qualify for a traditional mortgage. In the past, the only way they could take out a reverse mortgage was to stay put. But new rules that took effect in January allow seniors to use a reverse mortgage to buy a new home.

Say you own a house in Massachusetts worth $500,000 and you want to buy a $400,000 house in Florida. If you were to sell your house and pay cash for your new home, you’d have just $100,000 left to add to your savings. But now you can take out a reverse mortgage on the new home. For example, if you took a $100,000 reverse mortgage on the Florida house, you’d have twice the amount left $200,000 to add to your savings.

How it works. You must be at least age 62 to take out a reverse mortgage. Plus, your house (current or future) must be your primary residence, and your mortgage must be either paid off or have a small balance. Unlike a traditional loan, there are no income or credit score requirements, and you may use the money as you wish,

The older you are, the higher the appraised value of your home (up to the maximum federal loan limit) and the lower the interest rate, the greater the amount you can borrow. As part of the economic stimulus package, Congress raised the reverse mortgage loan limit to $625,500 through the end of 2009. After that, the lending limit reverts to $417,000, unless Congress intervenes.

As a rough rule of thumb, a 65 year old might be able to borrow up to 35% of a home’s value, says Eric Bachman, founder of Golden Gateway Financial, a reverse mortgage lender in Oakland, Cal. The percentage rises to 45% for a 75 year old, and 55% for an 85 year old. (To get a personalized estimate of how much you can borrow, go to www.goldengateway.com.)

You can take your payment as a lump sum, a monthly cash payout, a line of credit held in reserve or a combination of all three. No repayment is due until the last homeowner moves out or dies, at which point the home can be sold to pay off the debt. The loan repayment can never exceed the home’s market value (even if it declines), absolving your heirs of any liability.

High fees. Your personal “bailout plan” won’t come cheap. You’ll pay the usual closing costs, plus loan servicing fees, an origination fee of up to $6,000 and interest over the life of the loan. But what makes a reverse mortgage really costly is an initial insurance premium equal to 2% of the home’s value (up to the reverse mortgage loan limit) plus 0.5% per month of the mortgage balance. (The Federal Housing Administration insurance protects you and the lender if your home value declines and ensures that you won’t owe money if the loan balance exceeds the home’s value.)

On a $200,000 loan, the upfront costs could exceed $20,000, says Jeff Lewis, chairman of Generation Mortgage, in Atlanta. So a reverse mortgage makes sense only if you plan to stay in your house for several years. But if you do, now could be a golden opportunity for owners of high priced homes. Interest rates are at historic lows and loan limits may never be as generous, boosting potential payouts, And, says Lewis, “Once you lock in a reverse mortgage, declining home values don’t matter.”

Interesting thought, but here is how I see it: Those people thought that their house was not just a place to live but that it was also the goose laying golden eggs. Well, the goose died, and the eggs were made of fool’s gold (“Obama’s plan to stop foreclosures,” Cover story, News, Feb. 19).

Then there are the people who purchased a home that they could not possibly afford with risky mortgages. These people likely were hoping (or planning) on a goose coming with their house as well. They were going to be rich beyond their dreams.

Now these people are in dire straits, and I’m being told that I should foot the bill for their poor judgment. I do not believe that I should reward or support those who make poor choices.

At the other end of the spectrum are the people who are now selling or losing their homes because they have lost their jobs in part due to the ripple of effect of those who were careless. These people have my sympathy. But there is no knight in shining armor to rescue them.

Kati Litten
Fresno

What about PMI?

One subject that I have not heard in discussions on the housing crisis is why private mortgage insurance (PMI) isn’t paying for these defaulted home loans.

I am sure that most of these foreclosed homes were bought with a down payment of less than 20%, which would require PMI. With PMI, the banks and mortgage companies should have most of their losses covered. Did these banks take the PMI payments, put them in their pockets and not buy the insurance? Wouldn’t that be considered fraud?

With PMI, the homeowner should be able to walk away from a home with no obligation and the lender would be protected. Isn’t that what the PMI was for?

Jim Sfakianos
Pensacola Beach, Fla.

The home equity line of credit fueled thousands of extreme kitchen makeovers during the real estate boom. But the housing bust and the credit crisis stopped the HELOC party with a vengeance: Tens of thousands of homeowners had their lines cut or frozen, and most lenders stopped issuing new ones altogether.

But don’t give up on the HELOC yet. As housing prices and the economy begin to stabilize, it’s coming back. Many lenders are writing lines again, says MortgageBot, a company that processes real estate loans, albeit half as many as it did during the boom days. True, HELOCs are no longer the screaming deal they once were. Lenders used to offer the lines for half a percentage point below the prime rate (currently 3.25%), but now the cheapest you’re likely to find is prime plus a point or so. Most lines also have a floor, or the lowest possible rate they can go, of about 4%.

That said, if you have more than 20% equity in your home, a line of credit can still be a relatively cheap way to borrow and it’s a far better source of emergency cash than your credit card. “Think of a HELOC as a belt and suspenders,” says Oakland money manager Marjorie Bennett. To make sure you get the most out of it, follow the rules below.

Don’t Borrow The Max

The days when banks would lend you 100% or more of the value of your home are long gone, of course. Most lenders won’t approve a line that brings your total housing debt to more than 80% of your home’s value, and you’ll need a minimum 740 credit score to get that much.

But there are good reasons to borrow less. Depending where you live, you probably can’t rely on a rising real estate market to knock down your housing debt. You should aim to keep your total monthly debt payments at no more than a third of your take home pay. Keep in mind that as the economy recovers, HELOC rates will rise too, so borrow only what you could keep up with if rates jump, says financial adviser Don Whalen of Alpharetta, Ga. If you were to take out a $75,000 HELOC today, for example, you’d owe $344 a month in interest; if rates rise a couple of percentage points the monthly tab will jump to $469.

Use It The Right Way

By now you almost certainly know that using your home equity line for frivolities like vacation packages and plasma screens is asking for trouble. Other traditional uses may or may not still make sense:

Home improvements. Tapping your HELOC to fund necessary projects like a roof replacement is still worthwhile: You can deduct interest on up to $1 million when you use HELOC funds to improve a first or second home, which in turn sharply lowers the real cost of the loan. Renovations that won’t necessarily pay for themselves, like a media room or a deluxe kitchen? Take a pass.

Car loans. At a 7.3% rate, a three year new car loan costs a lot more than a line of credit. A HELOC can be a good substitute as long as you expect to pay it back within a few years. You may be able to write off the interest. Though the rules are complicated, in general you can deduct interest on a HELOC for up to $100,000 of non home related uses.

Student loans. Max out government backed Stafford and PLUS loans first. The interest on these loans is usually tax deductible, and they often offer flexible repayment plans. But if you have to take a private loan, a HELOC can be a cheaper alternative.

Small business. Entrepreneurs have long used HELOCs as easy business lines of credit to smooth out bumpy income. Steer clear of that unless you’re confident the business is solid, says Newtown, Pa., financial adviser Jonathan Heller.

Make Sure You Keep It

If you’re going to use a HELOC as an emergency fund, you have to make sure your line isn’t pulled out from under you. Most banks have stopped freezing existing HELOCs, but that could happen if real estate values drop in your neighborhood. Your best defense is to use your line regularly, even if you take out just $500 at a time. Even during the worst of the credit crisis, issuers weren’t freezing or closing HELOCs that were in use as long as the homeowners weren’t underwater, says financial adviser Kevin Reardon of Brookfield, Wis.

If you think you’ll need to use your HELOC in a few months and are concerned that it could get chopped, borrow the funds now and park them in an FDIC insured account to keep them safe. Then start paying the loan back ASAP.