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Although reverse mortgages have been around for nearly 20 years, until recently, there was little interest in these expensive and complicated products that are often considered financial-planning tools of last resort. Most seniors with reverse mortgages use the money to supplement retirement income or increase discretionary income to pay for property taxes, homeowners-insurance premiums, home repairs, in-home health care or medical expenses. Lenders and advocates agree that the most common misconception about reverse mortgages is that the bank can take your house, leaving you and your heirs in the lurch. Reverse-mortgage payments don't count toward the threshold for determining whether Social Security payments are subject to income tax. To take a reverse mortgage, you must at least 62 years old, your house must be your primary residence, and your mortgage must be paid off or have a small balance. Lenders have begun to introduce jumbo loans for more-expensive homes, but the credit crunch has thinned out the number of lenders.

ALTHOUGH REVERSE MORTGAGES HAVE BEEN around for nearly 20 years, until recently, there was little interest in these expensive and complicated products that are often considered financial-planning tools of last resort. But that is starting to change. Two-thirds of the nearly 350,000 reverse mortgages made to date were taken out within the past three years, and one-third of those were issued in 2007 alone. Structured properly, a reverse mortgage can be a lifesaver for cash-strapped seniors like Sheila Clancy.

Clancy, a widow, needed extra income after her husband, Ed, died, but she didn't want to sell her home in Sarasota, FIa., where they had raised their seven children. It wasn't easy providing for such a large brood on Ed's schoolteacher salary, and there wasn't much left over to save for retirement. Sheila gave up her job to take care of Ed when he got sick. So when he died in 2004, Sheila, then 63, barely scraped by. She started collecting Social security benefits and survivor benefits from Ed's small pension (the pension checks will end next year), but making ends meet wasn't easy, particularly with a mortgage payment of $1,900 a month.

In 2005, Clancy decided to take a reverse mortgage that allows her to tap her home's equity as needed without incurring a monthly payment. Based on her home's appraised value of $210,000, she qualified for a loan that allowed her to pay off the balance of her first mortgage, cover $15,000 in upfront costs, take a lump-sum payout of $49,000 (some of which she used to repair her roof) and have a $47,000 line of credit. Bottom line: Clancy says the reverse mortgage gave her peace of mind.

Most seniors with reverse mortgages use the money to supplement retirement income or increase discretionary income to pay for property taxes, homeowners-insurance premiums, home repairs, in-home health care or medical expenses. So far, it's a small group. Since the introduction of federally backed home equity conversion mortgages, or HECMs, in 1989, only 1% of all eligible seniors have signed up for these loans, which account for the vast majority of the market.

NONASTYSURPRISES

LENDERS AND ADVOCATES, INCLUDING AARP AND the U.S. Department of Housing, agree that the most common misconception about reverse mortgages is that the bank can take your house, leaving you and your heirs in the lurch. But a reverse mortgage must be repaid only when you sell the house, when you die (or the last surviving borrower dies), or when you reside elsewhere for a year or longer. Then you or your heirs must repay the lender from the proceeds of the home's sale.

If the proceeds exceed what you owe, you walk away with the remaining equity. But the lender can't come after you or your heirs if the home sells for less than you owe or if your lifetime payments exceed the initial loan limit. However, to protect the lender against that possibility, borrowers must pay a mortgage-insurance premium.

Because there are no loan payments to potentially fall behind on, you can never lose the home to foreclosure. And because HECMs are federally guaranteed, if the lender fails, the federal government takes over the loan and continues to fund it. The lender does have the right to call the loan if you fail to pay your property taxes or homeowners insurance, or if you don't maintain the property.

Reverse-mortgage payments don't count toward the threshold for determining whether Social security payments are subject to income tax. But if you are receiving Medicaid, Supplemental Security Income or other public assistance, reverse-mortgage payments could affect your eligibility.

HOW THEY WORK

TO TAKE A REVERSE MORTGAGE, YOU MUST BE AT least 62 years old, your house must be your primary residence, and your mortgage must be paid off or have a small balance. The older you are, the higher the appraised value of your home and the lower the initial interest rate, the higher the initial loan limit for which you'll qualify (see the box on page 103). A single borrower will qualify for a higher initial limit than a couple of the same age. That's because couples are statistically likely to live longer, increasing the risk to the lender that the payout will exceed the value of the house.

With an HECM, you can take a lump sum upfront, a line of credit, a monthly payment for a fixed period of time (term) or for the life of the loan (tenure), or some combination of these. You can change your selection at any time for a $20 fee. Interest is typically a variable rate, but lenders have also begun to introduce reverse mortgages with a slightly higher, fixed rate. The fixed rate works best for borrowers who will take a large lump sum right off the bat, as most borrowers do. Those who take monthly payments or occasional withdrawals against the line of credit will do better with a variable rate.

With an HECM loan, the appraised value is capped at your county's median home value, up to a maximum of $200,160 in most nonmetro areas and $362,790 in many urban areas. Fannie Mac's Home Keeper program caps the allowable property value at $417,000. Pending Federal Housing Administration legislation may raise maximum limits on home value. Meanwhile, if your home appraises above the caps, you can borrow up to the allowable limit.

Lenders have begun to introduce jumbo loans for more-expensive homes, but the credit crunch has thinned out the number of lenders. Jumbo loans aren't backed by the federal government and don't enjoy the same protection against loss, so such loans tend to be more expensive than HECMs and offer lower initial loan limits. As a rule of thumb, says Craig Corn, co-president of EverBank Reverse Mortgage, HECMs will provide more cash than jumbos for homes valued at less than $500,000.

SMART STRATEGIES

IF YOU DECIDE THAT A REVERSE MORTGAGE IS A good option for you, take only what you need up front and reserve the rest for monthly payments or withdrawals against a line of credit, says Meg Burns, director of the FHA's Office of Single-Family Program Development at HUD. If you take a lump sum you don't need, you'll run up unnecessary interest charges. Plus, the line of credit on an HECM (but not on Fannie Mac's Home Keeper or jumbo products) will grow over time.

AARP gives this example of how the math works: Say you set aside $100,000 of your initial loan limit in a credit line and you withdraw $20,000, on which interest accrues at a rate of 6% annually. Your available credit (now $80,000) will grow by the same rate, so a year later you can borrow up to $84,800 (6% ? $80,000 = $4,800). Burns says the rate of growth on the credit line is likely to be higher than you could get on any conservative investment in which you might otherwise stash lump-sum money. (That's another reason an HECM with a smaller credit line may pay out more over time than a jumbo loan.)

SHOULD YOU TAKE ONE?

A RECENT AARP STUDY ON REVERSE MORTGAGES shows that a 74-year-old borrower living in a $300,000 house could expect to pay about $15,000 in upfront costs on an HECM, including the origination fee, mortgage-insurance premium and closing costs, plus another $15,000 in monthly insurance premiums and servicing fees over the life of the loan.

Because of the steep upfront costs, it does not make sense to take a reverse mortgage if you don't expect to keep your home at least five years, says Sarasota financial planner Joe Downs. If you have substantial income and assets, it's almost always less expensive to tap them than to take a reverse mortgage, says Don Redfoot, of AARP. If you need a relatively small amount of money-say, $30,000 for home modifications-it's almost certainly cheaper to take a home-equity line of credit. Or your state or municipality may offer a lower-cost reverse mortgage specifically for home improvement (visit www.hecmresources.org and click on "Alternatives").

Just like any other loan, the longer the term, the higher the costs (see the box at right). But the interest that you pay isn't taxdeductible until the loan is paid off. That bolsters the case made by many financial planners that a reverse mortgage is a planning tool of last resort. Still, says Downs, it does work for the right people. "If your life is made better for ten to 15 years by making the mortgage payment go away, then it can be a good product," he says. "I'm a firm believer in that bumper sticker that says, Tm spending my children's inheritance.' "

SHOP AROUND

FEDERAL LAW REQUIRES YOU TO CONSULT WITH A HUD-approved counselor, in person or over the phone, before you can apply for a federally insured loan. If you visit a lender first, the law requires that you be given a list of at least five counseling agencies. But HUD's Burns suggests that you seek counseling before talking with a lender. Expect to spend about an hour learning the details of reverse mortgages. "If you get 15 minutes of counseling over the phone, you probably haven't gotten the whole story," she says. And if a counselor pushes you to work with a particular lender, or vice versa, look elsewhere for advice and service.

Also beware of additional sales pitches. A recent AARP survey showed that 9% of all prospective borrowers were invited to buy other financial products with their payout money. Most experts agree that's never a wise course because you'll get hit with upfront costs twice.

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Where to shop for a reverse mortgage

Among the biggest reverse-mortgage lenders are Wells Fargo, Financial Freedom, Countrywide, Bank of America and EverBank. Before you call lenders, get up to speed using the resources listed on their Web sites. Also take a look at www.aarp .org/money/revmort (click on "basics" to read the guide "Home Made Money"), www.fanniemae.com (search "reverse mortgage" to read "Money From Home" and find lenders by state) and www.hud.gov.

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THE WHOLE STORY

An insider's guide to reverse mortgages

When you shop for a reverse mortgage, lenders must give you the total annual loan cost (TALC), the equivalent of an annual percentage rate. But that doesn't reflect how your pattern of withdrawals will affect your total cost or the equity when the loan ends.

AARP has developed a model that lets counselors and lenders give you a customized analysis. Golden Gateway Financial, a reverse-mortgage broker, has an online calculator that uses AARP's model to let you compare loans. At www .goldengateway.com, click on "Do the math." Input your age, estimated home value and zip code (to determine whether your home's value exceeds the Federal Housing Administration limit for your area). The program generates your loan options, which you can sort by loan limit or by interest rate.

The table below summarizes the results for a homeowner in northern Virginia whose home is worth $350,000 and who has a $50,000 mortgage balance. It assumes an upfront withdrawal of $50,000 to pay off the mortgage. We ran the numbers two ways: with a loan term of 20 years for a 62year-old and ten years for a 72-year-old.

* Interest. Most lenders charge a variable rate based on the one-year Constant Maturity Treasury or LIBOR index plus a margin of one to oneand-a-half percentage points. In March, lenders at Golden Gateway offered rates ranging from 4.86% to 5.55%. The loan used in the example had an initial rate of 5.28%.

* Initial loan limit. This is based on your age (or that of the youngest co-borrower), the value of your home and its location (see the accompanying article). The older the borrower, the higher the limit.

* Maximum monthly payment. This amount depends on how much you initially withdraw as a lump sum or reserve for a line of credit. In our example, the younger buyer qualifies for a much lower monthly payout.

* Total cost. In addition to interest, the lender can currently charge up to 2% of the home's value (or the FHA limit, whichever is less) for the origination fee. Lenders can also charge for such things as an appraisal and title search. Plus, you'll pay a monthly servicing fee of $30 to $35.

TIP//Take only that you need up front as a lump sum and reserve the rest for monthly payments or withdrawals against a line of credit.

For the federally insured home equity conversion mortgage, you'll pay mortgage insurance of 2% of your home's value upfront, plus 0.5% added to the interest rate on your loan.

* Equity remaining. This is the amount of equity you're projected to have left at the loan's end. In the table, the younger borrower's remaining equity is only slightly lower because we assumed 4% per year annual homevalue appreciation-the historical average.