As she speaks, Cleo Dunn tends to a vibrant splash of red-and-white Asian lilies and peach-tinted geraniums surrounding the back patio of her house in Leawood, Kansas, where she's lived for two decades. The home, which she shared with her husband, Robert, until he died four years ago, has always been her pride-and her refuge. She vowed she'd never leave it, even after she was diagnosed with a rare spinal ailment that requires her to use a wheelchair. And, so far, she's been able to keep that promise, thanks to a Home Equity Conversion Mortgage (HECM), better known as a reverse mortgage. The $1,100 a month that Dunn receives from the loan—and will continue to collect until she dies or permanently leaves the home—not only allows her to stay put but pays for her prescriptions and the in-home aide who comes by each morning. "Without a reverse mortgage," says the 88-year-old Dunn, "it would have been impossible for me to stay here."

Dunn is one of a growing number of house-rich, cash-poor Americans 62 years of age and older who've discovered reverse mortgages, a unique financial tool that lets them tap the equity in their homes while they're still living in them. The longer Dunn receives the payments, the more equity she uses. But because the loan is protected by federally sponsored mortgage insurance, neither she nor her heirs will ever owe more than the value of the home. Should Dunn live long enough that the monthly payments exceed the value of her house, she doesn't have to worry. Only when she dies or moves out does the lender have to be repaid, most likely through the sale of the house.

If you aren't familiar with reverse mortgages, you'll almost certainly be hearing more about them as today's hot housing market and low interest rates continue to fuel their popularity. In 2001 only about 8,000 U.S. homeowners used a reverse mortgage; in 2004 the number jumped to about 47,000. And this year the National Reverse Mortgage Lenders Association expects the number to hit 60,000. HECM loans, the only reverse mortgages insured by the federal government, account for 90 percent of the market. Other types of reverse mortgages are usually administered by private companies and local or state governments.

'This cushion helps me supplement my erratic income.'

Ken Scholen, director of AARP's Reverse Mortgage Education Project, is among a chorus of consumer experts who agree that a reverse mortgage can be a good choice for many cash-strapped homeowners. But, he hastens to add, it's not for everyone. Even though interest on the actual loan itself is usually similar to interest charged on other mortgages, the up-front costs (origination fee, mortgage-insurance premium, closing costs, and service fees) can make it an expensive way to borrow money. "A reverse mortgage should be just one of many options a homeowner considers," says Scholen.

How It Works

The HECM type of reverse mortgage is offered by many of the same private lenders that provide regular, or forward, mortgages. The difference is that instead of your making payments to the lender, the lender makes payments (or a lump-sum payment) to you. Just as in a conventional, or forward, mortgage, a reverse mortgage lets you borrow money using your home as collateral. But with a conventional loan you make monthly payments to reduce the loan amount. With a reverse mortgage the loan amount and the interest it accrues over the life of the loan don't have to be paid back until you die or permanently leave the home. Anything left after the loan is paid is yours or your heirs', just as with a conventional loan. With a reverse mortgage, you still own your house; of course, the mortgage company has a lien on it—just as with a conventional mortgage. And you still pay insurance, taxes, and repairs.

You can take out a reverse mortgage even if your house isn't fully paid for. But you do have to have enough equity to make the deal cost-effective. This method served Virginia resident Ruth Hill well. The 63-year-old freelance journalist used a reverse mortgage to pay off her conventional loan, which had been costing her about $600 a month. "This cushion helps me supplement my sometimes erratic income," she says.

How to Qualify

To qualify for a reverse mortgage, you must be at least 62 years of age and own your home, and it must be your main residence. If you co-own your house with a spouse or partner, both of you must be 62 or older. Single-family houses, some manufactured homes, two- to four-family residences, and most townhouses and condos qualify for a reverse mortgage. Since you aren't making any payments, your current income or credit history does not matter, just as long as you haven't defaulted on a federally insured loan, such as a student loan.

The amount of money you qualify for depends on a mix of current interest rates, your home's location and value, your age, and, of course, the equity built up in the home. The more equity you have and the lower the interest rate and the older you are, the more money you can get. For example, a 62-year-old borrower who owns a $250,000 home would generally qualify for $132,700 from a reverse mortgage at September's interest rates; a 72-year-old who owned the same home would get about $154,500; an 82-year-old, about $178,600.

You can choose one of three ways to receive your reverse mortgage funds: in a lump sum, monthly payments, or a line of credit. The best choice depends on your needs. Let's take, for example, the 62-year-old borrower who's getting a reverse mortgage on her $250,000 house. She could take the $132,700 she qualified to receive in a lump sum. Or she could opt for monthly payments for a fixed period of time, say 10 years, which would give her about $1,470 each month. Or she might choose to take monthly payments for as long as she lives in her home and get about $740 a month. If she chooses to access her money through a line of credit, she can withdraw money as she needs it. The advantage here is that she doesn't pay interest on the credit line until she uses it. And, even better, the amount remaining available for her grows larger each month because of a built-in hedge against inflation that is included with this type of reverse mortgage payout.

What It Costs

Reverse mortgages come with competitive interest rates, but they also require significant up-front fees. "That's what makes them expensive," says Christian Sezenias, a reverse mortgage counselor with Novadebt, a nonprofit credit and HUD-approved housing counseling agency located in New Jersey. Consider our 82-year-old borrower. To get his $178,600, he'd have to pay about $13,700 in up-front fees—$5,000 for the lender's origination fee, $5,000 for mortgage insurance, and $3,700 for closing costs. He would also have another $4,460 deducted from his available loan amount to cover service fees. He doesn't have to pay any of these fees out of pocket, because they are added to the loan. And the interest he pays on the fees over the life of the loan fluctuates up or down depending on market conditions.

The fees' impact is stiffest early in the loan. If you plan to stay in your home for only the next two or three years, paying $13,000 or more in fees for a reverse mortgage can be a heavy price. But the longer you stay, the more the relative cost of the fees spreads out. That's the reason lenders and consumer advocates alike advise against getting a reverse mortgage if you're not planning to stay in your home.

For Your Protection

The Federal Housing Administration (FHA) requires that all HECM borrowers consult with an FHA-approved reverse mortgage counselor before they sign the final papers. The counselor is required to explain the costs and financial implications of the loan. "Because of this process," says Peter Bell, president of the National Reverse Mortgage Lenders Association, "there's a lot less room for misleading information from lenders."

Before taking out a reverse mortgage, consumers should consider any and all alternatives that would achieve the same purpose. For instance, there may be grants or low-cost loans available from local and state governments or nonprofit agencies to help you pay to fix up your house. You might also qualify for a new conventional forward mortgage or equity loan. Another option is to sell your house and move into a less expensive home. Say you sell your paid-for house for $500,000 and then buy a condo for $300,000. Even after paying real estate commissions, you could end up with about $150,000 tax- and interest-free money. And you'd still have the option of taking out a reverse mortgage on your new home later, if you should need it.

Regardless of how you choose to use your equity, deciding whether or not to get a reverse mortgage could be "one of the most important financial decisions you'll ever make," says Scholen. "So be sure it's the right one."

Mike Hudson, an award-winning journalist, specializes in personal finance and writes for the Los Angeles Times and other publications. He's based in Virginia.

Additional reporting: Holly Zimmerman