The case for Reverse Mortgages
This last month I had a reader who wrote in and asked what my opinion was of reverse mortgages. She was worried that she would be signing the house away to the “bank” and lose all her equity. That is actually a very common misconception. I have been doing reverse mortgages for several years now, and a lot has changed for the better. So let’s take a closer look and see if we can clear up any additional misunderstandings.
In 2013 and again in 2015, FHA/HUD made several changes to the “Home Equity Conversion Mortgage” (HECM) or reverse mortgage, to make it safer for consumers. The first government insured reverse mortgages were created in 1989. So they have had plenty of experience with this product since then. One of the big issues addressed, was with regard to the presence of a “non-borrowing spouse”. The minimum age to qualify for a reverse mortgage is 62 years old. So what FHA discovered was that many reverse mortgages had been made to the first spouse who turned 62, leaving their younger partner off of the loan in order to qualify. The problem occurred when the qualifying spouse passed. Since their partner wasn’t covered by the guaranty, they were forced to refinance a much higher balanced loan at that point, sell, or otherwise be forced to leave their home. Under the new rules, a non-borrowing spouse’s age must be considered. That change effectively eliminates this malady from ever happening again.
One of the other ways many elderly people ended up losing their home, was by their failure to make tax and insurance payments successfully. In response to this, FHA instituted a rule requiring a financial analysis be done, to determine the borrowers’ ability to meet these needs. If it is determined that there is not enough residual income to make these payments, then the lender must set up and fund a “Life Expectancy Set Aside” account, or LESA. This set aside is required before any additional equity can be accessed. And in the cases where there is not enough equity to fund the set aside, cash may be required at closing to make up the difference.
Another draw back that many elderly ran into was the high costs associated with the reverse mortgages. The form of mortgage insurance used by the FHA to insure the solvency of this program is expensive. However this too has seen substantial improvement. In 2014 FHA made the following changes - “HUD charges an initial MIP of 0.50 percent (0.50%) of the Maximum Claim Amount (MCA) when the mortgagor’s Initial Disbursement Limit or the Borrower’s Advance is 60% or less of the Principal Limit. HUD charges an initial MIP of 2.50 percent (2.50%) of the MCA when a mortgagor’s Initial Disbursement Limit or the Borrower’s Advance is greater than 60% of the available Principal Limit.” So with the advent of the new line of credit option, many folks can wait until after closing to make any withdrawals. And in this way they avoid the higher mortgage insurance factor. Likewise, many loan officers like myself have products and pricing available such that we can cover some or all of the closing costs – including the mortgage insurance premium. You just need to shop thoroughly and make sure you are working with the right person.
However let’s be very clear here - these loans are NOT for everyone. This is not the type of loan you want to take out, when you are planning to move inside of the next 5 years. It is also not a great idea for consumers who have difficulty managing money. By that I mean, having access to a large lump sum of money can be intoxicating and merely postpone the inevitable outcome of losing one’s home, due to long standing behavioral issues. However, reverse mortgages have some really great new attributes that can substantially enhance your income and quality of life in retirement!
The newest feature offered under the HECM program is the line of credit option. To demonstrate, let’s take a hypothetical borrower we will call Bob. Let’s say Bob & Mary own a home worth $350K. He is the younger of the two at 85 years old. They are in good health, and owe $150K currently. The current mortgage payment is $1645. They get Social Security between them of approximately $30K year, or $2500 per month. Lastly, they have $50K left in what remains of a retirement nest egg, and have $400 per month in pharmacy bills. Taking all this into consideration, you can see that Bob & Mary are living off of $455 per month for food and utilities. Any surprises have to be funded by tapping into their nest egg. If they sell the house to get their equity out, they still have to find a new place to live and wouldn’t qualify for the current payment they have. Enter the reverse mortgage. The reverse mortgage removes the $1645 payment, giving them $2100 per month to spend as they like. In addition, they elected the line of credit which turned out to be slightly over $71K. In addition, the unused portion of this line of credit grows at a start rate of 4.93% per year. Try getting that on a CD in a bank! LOL. If the rate on the adjustable rate reverse mortgage goes up – the growth rate on their line of credit grows by an equal increase. And now their nest egg is preserved, which made them and their financial planner very happy!