Reverse Mortgages Revisited
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. What Is A Reverse Mortgage?
2. How Reverse Mortgages Work
3. Evaluating The Various Types of Loans
4. Pros And Cons of Reverse Mortgages
5. Conclusions And Resources
In the investment industry, we often talk about seniors who are “house-rich but cash-poor,” in that they own their home, but do not have enough money for regular monthly expenses such as food and medicine. However, a relatively new financial transaction known as a “reverse mortgage” allows elderly homeowners to unlock the equity in their home without all of the hassles and ongoing payments of a traditional home equity loan.
Since I last wrote about this subject in March of last year, I have continued to see an expanding interest in this type of transaction. It is estimated that over 43,000 homeowners took advantage of the reverse mortgage option in 2005, up from only 150 in 1990. As the Baby Boomers start to retire in a few years, I look for this number to increase dramatically.
References to reverse mortgages in the financial media, newspapers, e-mail solicitations and even in television ads have increased as well. Just recently, I saw a TV ad for a reverse mortgage provider featuring veteran actor James Garner. Interestingly enough, some ads do not target the elderly themselves, but rather their children who may be part of what is known as the “sandwich generation,” or persons who simultaneously have to put kids through college and care for elderly parents.
With the costs of elder care continuing to rise, the availability of reverse mortgages may be an important planning tool for seniors and caregivers alike. Best of all, this transaction is not limited to the poor, so even wealthy retirees can use the reverse mortgage transaction as part of their financial planning process.
In this week’s E-Letter, I’ll revisit the basics of reverse mortgages, where they may be useful, and their possible drawbacks. Please note that it is impossible to completely cover a topic as big as reverse mortgages in the short space of this E-Letter. However, I will attempt to hit the high points, and then provide a list of resources later on that provide more information on this innovative idea.
Before I begin, you should be aware that I am not active in the reverse mortgage business, nor am I affiliated with any lender or mortgage broker. This information is the culmination of my own research on reverse mortgages and is designed solely to make you aware of this new financial planning tool.
What Is A Reverse Mortgage?
A reverse mortgage is simply a non-recourse loan against property collateralized by the principal residence of the borrower(s). A reverse mortgage allows homeowners to access part of their home equity and use it for immediate cash needs or to create an income stream for as long as they live. All reverse mortgage loans are adjustable-rate loans, but they also have interest rate caps to protect the homeowner.
The name “reverse mortgage” is very appropriate since it is essentially the opposite of a traditional mortgage. Instead of a decreasing loan over time, the reverse mortgage creates an increasing loan amount. Instead of monthly payments going to a mortgage company, in a reverse mortgage, the monthly payments come from the mortgage company to the homeowner.
Most important is that reverse mortgage loans are non-recourse, in that their only collateral is the home. If the reverse mortgage loan balance exceeds the value of the home at maturity, the lending institution cannot look to the homeowner’s estate for payment of the difference.
Before reverse mortgages became available, the only way to cash out home equity was to sell the home and have to move out, or borrow against it and create an outgoing monthly payment liability – and that’s IF a retired homeowner could even qualify for a loan. With a reverse mortgage there is no traditional credit scoring to qualify, homeowners continue to occupy and hold title to their home, and no periodic payments are required.
Reverse mortgages are very flexible when it comes to payment options. A homeowner may select monthly payments for life or over a certain number of years, a lump-sum or a combination of the two. In most states, a line of credit is also available, so that the loan only grows as the homeowner draws upon the line. In fact, this option is the one chosen most often by homeowners.
There are no restrictions on how the proceeds from a reverse mortgage can be used, which could be both a blessing and a curse. Proceeds might be used to pay off a first mortgage on the property, do needed repairs, provide supplemental income or purchase long-term care insurance. It could also be given to charities or family members, or invested for the future. However, you should be careful of any charity, investment or insurance promoters who want you to enter into a reverse mortgage for the sole purpose of giving them the money. More about that later on.
Fortunately, homeowners considering most types of reverse mortgages are required to attend a consumer education session with an independent counselor approved by HUD or Fannie Mae. During these sessions, counselors explain the legal and financial consequences of the reverse mortgage, and any other options that may be available. The goal is to make sure the homeowner completely understands the entire transaction as well as the obligations of the loan agreement.
The loan is paid back when the homeowners no longer occupy the home. This can come about as the result of the death of the homeowners, sale of the home, or if the homeowners cease to occupy the home for a period of twelve months. However, since the homeowners retain title to the property, there is no requirement that it be sold to pay off the note. Heirs may use proceeds from a life insurance policy to pay the loan balance and retain ownership of the family residence.
To qualify for a reverse mortgage, a person must be at least 62 years of age. If married, both spouses must be at least age 62. While a person must obviously own a home before being eligible for this type of transaction, the home must also be the primary residence. Second homes generally do not qualify for a reverse mortgage.
To qualify, the home must be in good repair and the homeowner must continue to pay property taxes, homeowner insurance, and repair the property as necessary. No credit check or scoring can be used to qualify the homeowner for a reverse mortgage. There are also no employment or minimum income requirements, and no medical qualifications for a reverse mortgage.
In most cases, homeowners already own their homes free and clear of any mortgage debt. However, a reverse mortgage can be obtained on a home with an existing mortgage with the provision that a sufficient amount of the reverse mortgage proceeds be used to pay off the existing mortgage. While this reduces the amount of money available to the homeowner, it frees up the monthly payment formerly being used to fund mortgage payments.
Unlike first mortgages that usually fund a set percentage of a home’s appraised value, the percentage of equity available through a reverse mortgage can vary greatly even on homes with similar values. The amount of a reverse mortgage loan is based on a calculation taking into consideration the following variables:
1. The age of the homeowner (or youngest co-owner);
Thus, older homeowners tend to get larger payouts than younger homeowners, and payouts assuming lower interest rates are larger than those assuming higher interest rates. Almost all reverse mortgages are adjustable rate loans. The interest rate applicable to the most popular reverse mortgage product is calculated by adding an allowable margin (or spread) to the current one-year Treasury bill rate, plus an additional 0.5% for insurance. The amount of the spread can vary from lender to lender, so it pays to do some shopping around.
There’s no doubt that the period of historically low interest rates in the early 2000s is a big reason that reverse mortgages gained so much popularity so quickly. Even though rates have risen since then, the genie is now out of the bottle and reverse mortgage transactions have continued to be popular even as interest rates have risen.
As a general rule, reverse mortgage transactions are much more expensive than traditional forward mortgages, especially in the short-term. Costs are proportional to the value of the home and consist of the lender’s fee, closing costs, and insurance fee on federally insured transactions. In addition, monthly service fees are either charged up-front or accrue during the life of the loan.
While many of these fees can be funded from the loan proceeds, it is still important to shop around to make sure you are getting the best deal. Lenders are required to disclose all costs in a Total Annual Loan Cost (TALC) disclosure. These TALC disclosures are useful in comparing one type of reverse mortgage to another, or even comparing competing lenders.
As noted previously, before any type of reverse mortgage can be funded homeowners are required to attend a counseling session conducted by an independent HUD-approved counselor that is not affiliated with the lender. This meeting is usually required to be face-to-face, but can be conducted over the phone in certain situations.
Types of Reverse Mortgages
The primary types of reverse mortgages include both government sponsored and privately sponsored products. Each type of reverse mortgage has its own set of criteria that might make it the best choice, depending upon the homeowner’s situation.
The most popular type of reverse mortgage is known as the Home Equity Conversion Mortgage (HECM), administered by the Department of Housing and Urban Development (HUD). The amount of the loan is based upon the lesser of the appraised value of the home or the maximum FHA loan guarantee for the homeowner’s local area.
Currently, the overall maximum value is $362,790, but this applies only to certain parts of the country. In Travis County, Texas, where I live, the maximum home value is only $200,160. To see what the applicable maximum is in your area, refer to the FHA loan limit website at https://entp.hud.gov/idapp/html/hicostlook.cfm.
To remedy this regional disparity, the US House of Representatives recently passed the Expanding American Homeownership Act of 2006 (H.R. 5121), which creates a single national loan limit for the HECM tied to the conforming Freddie Mac loan limit (currently $417,000). This uniform loan limit would allow homeowners to access a larger reverse mortgage, and thus provide a larger monthly payment or credit line. The bill has now been sent to the Senate where it has been referred to committee.
It is important to note that the maximum loan limit does not mean that you cannot do a reverse mortgage on a home with greater value, just that the home value for purposes of calculating the maximum HECM loan will be limited to the applicable maximum value. Thus, if your home is worth more than the applicable FHA maximum, your loan will based on the lower amount. If your home is worth less than the applicable maximum, then the loan will be based on the actual appraised value of the property.
In light of escalating home values in recent years, it is apparent that the HECM loan could restrict the maximum reverse mortgage available on a higher-value property. In such cases, a second type of reverse mortgage may be more suitable. The Home Keeper Mortgage is designed for homes with higher values and is sponsored by Fannie Mae (the Federal National Mortgage Association), a shareholder-owned corporation that buys mortgage loans. In fact, Fannie Mae buys all reverse mortgage loans, whether they are HECM or Home Keeper.
The major difference between the HECM and the Home Keeper is that the Home Keeper is based on a higher property value that is applicable nationwide, rather than varying by county and state. The maximum home value under the Home Keeper is $417,000, more than double the Travis County, Texas maximum under a HECM loan. Thus, for some high-end homeowners, the Home Keeper may provide a greater benefit.
Keep in mind, however, that the calculation factors for Home Keeper loans are more conservative than for HECM loans. As a result, the Home Keeper often results in a lower lump sum or monthly payment than the HECM on homes at or below the FHA maximum. In addition, if you choose to access your home’s value through a line of credit, the credit line actually grows larger at a stated rate of interest in an HECM, where it does not grow at all under a Home Keeper mortgage.
For some homeowners, even the $417,000 maximum limit under the Home Keeper reverse mortgage is too restrictive. Homeowners whose homes may have values into the millions of dollars have other options through other private reverse mortgages sponsored and backed by various non-governmental financial institutions. One such loan is the Cash Account sponsored by Financial Freedom Senior Funding Corporation, a subsidiary of IndyMac Bank. This particular proprietary loan has virtually no maximum home value or loan limit.
As a general rule, the HECM product usually offers the lowest cost, highest benefit, and greatest amount of flexibility for the homeowner. For this reason, the HECM accounts for over 80% of all reverse mortgage transactions.
Is This Product Really Necessary?
As one who continues to be alarmed at the level of public and private debt in our country, I was skeptical at first of this innovative new way to access home equity. After all, we continually hear about record debt levels, and are exposed to ever-more creative ways found by lenders to access the last little bit of home equity. I wondered whether reverse mortgages just might be the straw of debt that breaks the camel’s back.
However, after looking at the demographics, I think the reverse mortgage is not just another way to increase consumer debt, but is a useful tool for those seniors who can benefit from it. As we all know, the American population is continuing to age. As of 2005, there were over 36 million people age 65 or over in the US, and this is expected to almost double to 71.5 million by the year 2030. Over two million people per year turn age 65, and this pace will also increase in the years to come.
Those age 65 can expect to live another 18+ years according to recent predictions, and this is likely to continue to get longer as medical science continues to improve. The result of this extended life expectancy is that many retirees are living far longer than they expected to and planned for. It’s not that they didn’t plan for retirement; many simply didn’t consider the prospect of living to age 85 or older instead of age 75.
There is also significant statistical data showing that many seniors do have homes that could be a source of additional income. It is estimated that there are approximately 21 million senior homeowners with $2.1 trillion in home equity, and recent statistical studies by the Federal Reserve have shown that home equity is typically the largest component of a senior’s assets. As other assets are exhausted, the availability of a reverse mortgage might mean the difference between poverty and a comfortable retirement.
Advantages Of Reverse Mortgages
According to an AARP survey, about 80% of seniors expressed the desire to “age in place.” In other words, they wanted to be able to stay in their existing homes and neighborhoods throughout their golden years. As I see it, this is a primary advantage of reverse mortgages, in that they allow homeowners to continue to live in familiar surroundings while supplementing their income at the same time.
Reverse mortgages also impart another benefit to seniors, and that is the ability to remain independent. In many cases, dependence upon family is not so much a matter of health as it is of money. Even if some homeowners could retain their residences without a reverse mortgage, they might depend upon family members for other expenses. The reverse mortgage can help qualifying seniors retire in dignity by maintaining their financial independence.
Of course, these are not the only two advantages of reverse mortgages. Other important advantages include the following:
1. According to the American Bar Association, proceeds of a reverse mortgage should flow tax-free to the homeowner. However, mortgage interest is not deductible over the life of the loan, since it is accruing and not currently being paid. Upon repayment of the loan, the mortgage interest may become deductible at that time. Homeowners considering a reverse mortgage should always consult their tax counsel to determine how this transaction will affect not only their current tax status, but also the tax status of their estate after death.
2. Proceeds of a reverse mortgage can be used for virtually any legal purpose. While much of this article has focused on using reverse mortgage proceeds to provide necessities, they can also be used for travel, investments, long-term care or other insurance benefits, helping with educational costs for grandchildren, buying a vacation home, charitable gifts, etc., etc. The list of potential uses for the proceeds is only limited by the imagination of the homeowner.
3. There are multiple payment options under most types of reverse mortgages including lump-sum, line of credit and monthly payments for life. In addition, the transactions are so flexible that seniors can usually choose a combination of payment options, and modify their elections later on within limits. If homeowners elect to receive monthly payments for life, they cannot outlive the income, even if the amount of the loan eventually exceeds the value of the home.
4. Unlike other options for accessing home equity, there is no traditional credit scoring or income requirement to qualify for a reverse mortgage. Virtually any homeowner age 62 or over is a candidate for this transaction.
5. Mandatory counseling assures that seniors get full disclosure. In fact, it is estimated that homeowners will sign their name dozens of times during a loan closing, with many of the documents being required disclosures to assure homeowners fully understand the transaction.
6. Reverse mortgage loans do not have to be repaid until homeowners no longer occupy the residence, and this is usually after the homeowner’s death. In cases where both spouses are on the title, repayment is not required until the death of the last spouse. There is no requirement that the home securing the loan be sold at maturity. Heirs can use funds from other sources to pay off the loan and retain the residence.
7. In most cases, the reverse mortgage proceeds will not affect regular Medicare or Social Security benefits.
8. Best of all, even if the market value of the home drops in the future, there is no recourse to the homeowner’s estate or heirs if the loan balance exceeds the home’s value at maturity.
Obviously, the above list of advantages is not exhaustive, but it does show how the reverse mortgage transaction can truly be a godsend to seniors with insufficient income, as well as for caregivers faced with ever-increasing costs of providing for their loved ones.
Possible Disadvantages Of Reverse Mortgages
While there are many advantages to a reverse mortgage transaction, they are clearly not for everyone. Homeowners who live in regions of the country where home values have skyrocketed may not be able to access the same percentage of their home equity as someone living where home values have not risen as much.
Even though there is no requirement that the home be sold to repay the loan, logic dictates that in many cases this will be the only option available. In those situations, the family will be required to either purchase the home themselves, or give up the sentimental value of the family home. In such situations, homeowners may be torn between economic necessity and emotional issues.
Another potential disadvantage is that reverse mortgages are a form of debt, and many of today’s seniors are very averse to debt. They grew up in a generation that saved up for major purchases and only incurred debt to buy something as large as a home. And when the home was paid off, some even had a mortgage-burning ceremony that signified an end to debt. The reverse mortgage representatives I have spoken with indicate that this debt aversion is sometimes the biggest obstacle in the senior’s mind when it comes down to committing to a reverse mortgage.
As noted above, the reverse mortgage must be paid off upon death of the borrower or after the borrower has not lived in the home for a period of 12 months. This could be a disadvantage if an elderly person has an accident and has to be placed in a nursing home while recovering. Even if the borrower fully intends to return to his or her home, if the recovery period exceeds 12 months, the reverse mortgage contract could become due.
Reverse mortgage loan proceeds might potentially affect other public benefits that homeowners may receive. While regular Social Security and Medicare benefits are not affected, other programs such as Medicaid and Supplemental Security Income (SSI) might be in certain situations and under certain payment options. To determine the impact of a reverse mortgage on other public benefit programs, homeowners should consult their local Area Agency on Aging. To locate you local Agency, call 1-800-677-1116 or go to http://www.eldercare.gov on the Internet.
As discussed earlier, reverse mortgage loans can be relatively expensive in the short-term. While up-front costs average out the longer the loan goes, they can be quite expensive if the homeowner chooses to sell the home shortly after obtaining a reverse mortgage. The general rule of thumb is if a homeowner plans to move out of a home within five years, reverse mortgages are usually not a viable option.
I noted above that one of the advantages of a reverse mortgage is the ability to use the proceeds for virtually any legal reason. Most of us think of this transaction being used to pay for needed home repairs, medical bills or retirement income. However, this advantage can be turned into a disadvantage if the borrower’s home equity is wasted on frivolous spending. While vacations, boats or other luxuries are nice, spending home equity on these non-essential items may return to haunt elderly homeowners if they are faced with large medical or long-term care expenses later on in life.
Finally, as with any program with the potential to put money in the pockets of the elderly, scam artists are sure to follow. While the requirement for independent counseling and the large number of disclosures might deter some villains, I suspect that others are busily planning bogus investments and charities that will seek to take advantage of seniors by using reverse mortgages.
I especially fear for those at or near retirement who have failed to save enough money to have a comfortable retirement. Such individuals may be susceptible to investment scheme promoters who promise huge returns with no risk. Remember, if an investment opportunity sounds too good to be true, it usually is.
Other scams involve organizations that attempt to get seniors to hire them to access a reverse mortgage lender. There are many free sources of information available on reverse mortgages so it should not ever be necessary to pay anyone just to introduce you to counseling organizations or participating lenders. Refer to the Resources section below for some of these free sources of information.
Even in light of some potential disadvantages, I think the reverse mortgage is a very useful financial planning option for many seniors. I have written in the past about how many people have failed to save sufficiently for their retirement. That, coupled with the reduction in the number of guaranteed employer pension plans, means that more and more seniors will be depending upon Social Security for a major part of their retirement income.
Another good thing about reverse mortgages is the involvement of both HUD and Fannie Mae. These entities help to assure the safety of the transaction as well as the non-recourse facet that is so important. Most homeowners who have already entered into these transactions are obviously pleased. According to a recent survey conducted by Fannie Mae, over 80% of all homeowners who obtained a reverse mortgage indicated that they were satisfied with the results of the transaction.
Therefore, it appears likely that the reverse mortgage movement is going to continue to grow as Baby Boomers reach retirement. Reverse mortgage transactions are already growing at a healthy pace, which is almost sure to continue as word about these transactions spreads.
As with many financial and estate planning issues, it is important to do your homework before entering into a reverse mortgage transaction. I have listed below a number of resources that you should consult before seeking out a lending institution.
I think it is also important to involve family members in making the decision to pursue a reverse mortgage. This is especially true since there are likely to be emotional attachments to the “old homestead” that are better to be addressed before the transaction is done. However, in situations where economics trump emotions, the reverse mortgage can provide needed cash that would have otherwise been locked up in the home.
As always, feel free to share this information with anyone you feel it would benefit.
Very best regards,
Gary D. Halbert
AARP reverse mortgage website: http://www.aarp.org/money/revmort/
Reverse mortgage informative booklet provided by AARP:
Reverse mortgage loan calculator: http://rmaarp.edthosting.com/
NationalCenter for Home Equity Conversion Mortgage: http://www.reverse.org/
National Reverse Mortgage Loan Association: http://www.reversemortgage.org/
Contact the Dept. of Housing and Urban Development (HUD)at 1-888-466-3487 to obtain free information and a referral to a HUD-approved housing counseling agency.
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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert, Mike Posey (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.