Reverse mortgages -- a way for seniors to tap into their home equity without having to make monthly payments -- have become a mainstream retirement-planning option in recent years. Despite some drawbacks, for many retirees, a wisely chosen reverse mortgage has helped fund a comfortable, active retirement when savings and pensions alone weren't sufficient.

But recently, the reverse-mortgage picture has gotten very complicated.

Consider: The conventional wisdom around reverse mortgages has long been that retirees should wait as long as possible before taking one. There are two reasons for this:

  • Reverse mortgages usually have an actuarial component, meaning that the lender looks at your likely remaining life expectancy when deciding how much to lend you. The older you are, the better your chances of getting more money. More money is good.
  • Historically, houses have appreciated over time, so that (according to the conventional wisdom) the longer you wait, the more equity you'll have. The more equity you have, the more money you can get.

You see the problem, don't you? (If not, read that second bullet point again. It'll come to you.)

Yes, reverse mortgages are yet another area to take a hit from the declining housing market. Not only are reverse-mortgage lenders such as IndyMac Bancorp (NYSE:IMB) and Wachovia (NYSE:WB) reeling from the housing crisis (and tightening up their lending standards across the board accordingly), but also for those on the borrowing side of the equation, you probably have less home equity than you did a year or two ago.

To be clear, reverse mortgages aren't the real cause of banks' pain. The most popular type of reverse mortgage -- the home-equity conversion mortgage -- is guaranteed by the Federal Housing Administration (FHA) and widely available through major national players such as Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC). And although Fannie Mae (NYSE:FNM) and a few other lenders offer custom products that aren't backed by the FHA, the problems -- from the banks' perspective -- are elsewhere.

But that declining equity is a big problem for borrowers. According to a new study from reverse-mortgage broker Golden Gateway Financial, a 72-year-old potential borrower who owns a house that was worth $200,000 in January 2007 would be able to borrow about $17,000 less now -- roughly $126,000, versus $109,000 -- than he or she could have a year ago. Because the value of the home has fallen, the owner has already taken a hit of more than 14%.

Now, that's a nationwide average, and depending on where you live, your mileage will surely vary. But no matter where you are, odds are that your home equity has taken a sizeable hit over the past year. Mine certainly has.

That hit means less money for your retirement. And although I don't have a crystal ball, I don't see the housing market recovering to early 2007 levels any time soon. It may even get worse.

What to do?

Thinking it through
When a longstanding rule of thumb goes out the window because of a change in market conditions, the best thing to do is take a deep breath and apply some common sense.

Is this a bad time to take a reverse mortgage? Not if you need the money. Waiting for the market to recover could mean a lot of uncertainty -- you could wait six months or 10 years. But if you need the money immediately, and a reverse mortgage is the best fit for you, that's an excellent reason to take one now -- without losing sleep over the what-ifs.

Is waiting a few years to take a reverse mortgage a bad idea?  I can't predict whether your home equity will be lower in a few years, but I can predict that you'll be a few years older in a few years. And when you're a few years older, those actuaries will be likely to lend you a larger proportion of the home equity you do have. So based on what I do know, I say that if you can wait, wait.

What else should I know? A lot more -- these are complicated products with many traps for the unwary. If you're seriously thinking about a reverse mortgage, read Doug Short's dissections of the pros and cons in the February and December 2006 issues of the Fool's Rule Your Retirement newsletter. (It's a paid service, but a free trial gets you full access for 30 days with no obligation, so click with confidence.)

And while you're in the Rule Your Retirement archives, check out Robert Brokamp's article from last September on alternative ways to tap your home equity. One of them might be a better fit for you.