For a long time, reverse mortgages were viewed by most clients and advisors as an expensive, complex and risky tool that put homeowners in danger of “losing the house.” They were often peddled on TV during cut-rate advertising hours using retired actors (Fred Thompson, Henry Winkler, Tom Selleck, etc.).
But recent changes to reverse mortgage programs and the application process, and the tightening of some rules by the Federal Housing Administration and the Consumer Financial Protection Bureau, may mean more protection for all parties involved. You and your clients should be aware of the unique properties of reverse mortgages and how they can help homeowners in good times and bad, and also what to look out for when shopping for one.
How they work
Reverse mortgages allow homeowners with a significant amount of home equity to borrow against that equity, without having to pay it back (at least, in the traditional sense).
The loans are available to borrowers who are over age 62. Married couples can qualify if at least one member is at least that age. Only primary residences, condos and certain manufactured homes are eligible. Multiplexes with four or fewer units may qualify as well, as long as the owners/borrowers use one of the units as their primary residence.
The most common form of reverse mortgage is known as a “Home Equity Conversion Mortgage” or “HECM.” These loans are federally insured but are obtained via private financial institutions, such as banks or credit unions.
How clients qualify
Getting a reverse mortgage is usually easier than getting a traditional mortgage, home equity loan or home equity line of credit. But, applicants still have to jump through a few hoops. Along with the aforementioned home equity, applicants must also have enough income or assets to pay for future maintenance, property taxes and other ongoing basic expenses. Although applicants don’t have to endure a traditional loan application process based on their credit scores and histories, they do have to undergo a financial “assessment” to verify their assets and liabilities and determine if the borrowers’ current financial situation is sustainable for the foreseeable future. The home in question must also be in reasonably good shape, and any urgent major repairs must be completed before the homeowner can receive the net reverse mortgage proceeds. Finally, would-be HECM borrowers are required to get a more in-depth education about their situation from an approved reverse mortgage counselor who is independent from the private lender.
The amount of money available depends on several factors, including the borrower’s age, the value and location of the home, the amount of accumulated home equity, current interest rates, interest rate type chosen (fixed or adjustable) and the method in which the borrower chooses to receive the funds (i.e., a lump sum or monthly payments).
For instance, the calculator at ReverseMortgage.org says if a 65-year-old couple living in Phoenix has a paid-for home worth $300,000, after getting approval they could get a gross lump sum of $162,600. After origination fees, mortgage insurance and “other closing costs,” they would net about $153,949 to eventually use as they wish. However, under the recently revised rules, the couple would be initially limited to using just $88,909 of the approved amount. After a year has elapsed, they could get the remaining available money.
This same couple could instead choose to get a monthly payment of $783, and that payment would continue as long as they remain in the home. Finally, they could also request a line of credit that only accrues interest when the borrowers actually tap the available amount in the future, and only on the money borrowed. The borrowers can even request a combination of several of these payment methods.
How is the loan repaid?
The homeowner (or their heirs) can repay the reverse mortgage and accumulated interest at any time. But the loan doesn’t necessarily have to be repaid by the borrowers within a certain time frame—if ever. Instead, the loan only has to be repaid when the homeowners leave the home, either through death or by moving to a different primary residence.
If the homeowners or heirs decide they don’t want to repay the loan, the home will be sold. If the net selling price is greater than what is owed on the reverse mortgage, the homeowners (or their heirs) receive the net difference. But if the home sales proceeds are less than the amount borrowed, the proceeds go first to the lender, along with any extra amount from the Department of Housing and Urban Development (HUD) needed to make the lender whole. The homeowners and their heirs would owe nothing.
And, HECM borrowers always have the option of repaying 95 percent of the home’s appraised value at that particular time, which would remove the lien and cancel the reverse mortgage.
Despite the many surprising advantages of reverse mortgages, there are some negatives that clients should consider.
First, there are those fees mentioned above. The amount will vary from one lender to another, but borrowers should expect to pay several thousand dollars in origination fees, mortgage insurance premiums and closing costs. True, those expenses can be taken from the proceeds of the reverse mortgage, but that will mean there is a sizable gap right from the beginning between how much clients receive from the reverse mortgage and the amount borrowed.
If the original borrowers either die or move out and can’t afford to buy the house or pay back the loan, then the home and proceeds won’t be part of the inherited estate. Any family members living with the original borrowers will have to find a new place to live.
Perhaps most importantly, the reverse mortgage loan balance may increase faster than the home’s value rises, which could erode the remaining home equity while the borrowers remain in the home, leaving little or nothing for the borrowers or their heirs. But the same may happen if the clients have to sell the home and move into an apartment or (worse yet) back in with the kids.
Kevin McKinley is principal/owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of Make Your Kid a Millionaire (Simon & Schuster).