Any advisor worth his or her proverbial salt is familiar with reverse mortgages, and how the unique arrangements can allow house-rich but cash-poor seniors to afford to remain in their primary residences.
But there is a lesser-known yet more-intriguing use of the financial tool: letting qualifying buyers purchase a home with a decent down payment, but no mortgage to pay off, and with no in-depth consideration of their income, assets, or credit situation.
Reverse Mortgage Refresher
The traditional use of a reverse mortgage (also known as a “Home Equity Conversion Mortgage,” or “HECM”) by Americans over the age of 62 is to tap equity they have accumulated in their primary residence.
The amount available depends on the homeowners’ ages, the value of their home and home equity, where they live, and the prevailing interest rates.
Homeowners in their 60s can get as much as two-thirds of the home’s equity back in the form of cash, a monthly check, or a line of credit. You can run some scenarios with the calculator available at tinyurl.com/revmort.
There is no mortgage application, but there could be a significant amount of fees charged to the borrower (or tacked on to the borrowed amount) once the reverse mortgage is approved.
Once the transaction is completed, the only meaningful future financial responsibility of the owner will be to pay for maintenance, upkeep, insurance, and property taxes.
There is no requirement that the reverse mortgage ever be paid off by the borrower. Instead, once the homeowner either dies or vacates the residence for twelve months, the lender sells the property in the open market.
The lender uses the sales proceeds to first pay off the borrowed amount (plus fees and accrued interest). Any remaining funds go to the homeowner or her estate.
If the lender eventually sells the home for less than the borrowed amount, the homeowner (or her estate) still owes nothing. The lender’s potential loss is usually covered by a government-sponsored insurance program.
A relatively new reverse mortgage
In 2009 the Department of Housing and Urban Development announced the “HECM for Purchase” program, designed to give seniors a chance to buy homes using reverse mortgages.
There are many reasons a recent retiree would want a new home, including the desire to move to a warmer climate, or closer to far-flung family members, or “right-sizing” to a home more appropriate for an owner of a certain age.
But the main attraction of using a reverse mortgage to purchase the place will often be financial.
First, it could be retirees without enough predictable income from Social Security or a pension to qualify for the more-stringent standards established by lenders today. Or those who are recently divorced or widowed, and don’t have quite the income or liquid assets they did when they were in a couple.
Another group of prospective users might be clients who have the lion’s share of their assets in tax-sheltered IRAs, and don’t wish to incur the income-tax hit associated with withdrawing funds to make a cash purchase, or monthly mortgage payment.
An even more common occurrence these days is a homeowner who hasn’t been able to sell their current primary residence, but is eager to purchase a new retirement home at today’s depressed prices.
Even would-be renters might prefer the certainty of using a reverse mortgage to purchase a permanent home, rather than signing up for a lifetime of monthly rent payments.
Finally, it might be a client wise enough to realize that using the reverse mortgage to purchase a home reduces the liquidity risk and exposure to the housing market that accompanies more traditional methods of home buying and financing.
Buying with a reverse mortgage
Let’s say a 65 year-old couple wants to buy a $350,000 home in Palm Beach, Florida, using a reverse mortgage to make the purchase.
According to the calculator available at allrmc.com, they would have to come with $139,730 of their own money—about 40% of the purchase price.
The total initial fees would be $12,680 which, when combined with the borrowed amount of $210,270, would bring the total of the loan to $222,950.
That amount will accrue at 4% annually (the current going rate) until both members of the couple die, or move out of the place for more than a year. Then the house is sold by the lender.
If the selling price is less than the balance owed, the couple will owe nothing. But if the sales proceeds exceed the balance owed when the house is sold, they (or their heirs) will receive the difference.
Where’s the downside?
The primary risk to using a reverse mortgage to buy a home is due to the interest that is accruing on the borrowed amount.
The longer the owners live and remain in the home, the more likely it is that the amount “owed” on the reverse mortgage will exceed the purchase price, eliminating whatever equity the owners established at the time of purchase.
Take the aforementioned couple buying the place in Palm Beach. If they stay in the place for twenty years, the calculator at allrmc.com says that by that time the loan balance will be about $635,656.
Even if the value of their home rises at, say, 3% per year for those twenty years, at that point it will be worth $637,454. If the couple then gives up the home to the lender, they will have lost the $139,730 they put up as the initial down payment.
Get more information
Whether clients are interested in using a reverse mortgage to remain in their current home or purchase a new one, they usually shouldn’t start by talking to a lender.
Instead, they should first find a HUD-approved counselor by going to tinyurl.com/hecminfo, or calling 800-569-4287. There may be a small fee for the session, but it can be waived for certain seniors.
And to make sure you know at least as much about reverse mortgages as your clients do, you should visit AARP’s comprehensive information site at aarp.org/revmort.