For
ourselves, or for our parents, reverse mortgages can be an important
part of our
financial planning. Much
has been written about reverse mortgages, but this article by Gary Halbert is
one of the best resources I have found in addressing this opportunity. This article
first appeared in Gary's Investors Insight newsletter. For additional information,
you can visit his website at www.InvestorsInsight.com
or contact Gary at GaryHalbert@InvestorsInsight.com.
Reverse
Mortgages Offer New Hope For Seniors
by Gary D. Halbert
March 15, 20051.
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. Resources Introduction
In the investment industry,
we often talk about seniors who are “house-rich but cash-poor,” in that
they have a home, but do not have enough money for regular monthly expenses such
as food and medicine. In many cases, family members are required to pitch in and
help with their parents’ finances because, as the old saying goes, “you
can’t eat your house.” Well,
that old saying may no longer be true. A relatively new financial transaction
known as a “reverse mortgage” has been gaining popularity lately, and
offers seniors the ability to free up their home equity in a way that does not
require immediate repayment like a home equity loan or line of credit. And this
transaction is not limited to the poor, with even wealthy retirees using the reverse
mortgage transaction as part of their financial planning process. We
are starting to see more and more references to reverse mortgages in the financial
media, newspapers, e-mail solicitations and even in television ads. Even so, it
is estimated that only 30% of all eligible homeowners are aware of reverse mortgages.
As the general population continues to get older, look for these ads to become
more prevalent. Interestingly
enough, many of these ads are not targeting the elderly themselves, but rather
children who may be part of what is known as the “sandwich generation,”
or persons who are simultaneously having 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. What
Is A Reverse Mortgage?
A
reverse mortgage is simply a non-recourse loan against property collateralized
by the principal residence of the borrowers. 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 holder 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. Previously,
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 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. Unfortunately, the line of
credit option is not yet available in Texas, where state law currently prohibits
this type of arrangement. 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. The
Basics
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 do not currently 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);
2. The value of the home;
and
3. The applicable interest rate. 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.
The current period of historically low interest rates is a big reason that reverse
mortgages have gained so much popularity in the last few years. However, now that
the genie is out of the bottle, I expect these transactions will continue to be
popular even as interest rates move higher. 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 who 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 $312,895, but this applies only to certain parts
of California. In Travis County, Texas, where I live, the maximum home value is
only $177,650, and this is the highest value in Texas. 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.
This 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 $359,650,
over 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 live outside of Texas and the credit line option
is chosen, 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 $359,650 maximum limit under the Home Keeper reverse
mortgage is too restrictive. Homeowners whose homes may have values into the millions
of dollars have a third option 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 Lehman Brothers Bank. This particular proprietary loan is geared
toward home values of $450,000 or more. 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 90% 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 2002, there were over 35 million people age 65 or over, and this is expected
to 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; they just didn’t include the prospect of living to age
85 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 over 21
million senior homeowners with $1.7 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 a recent AARP survey, 85% 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 not only affect 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 (except in Texas), 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, they 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. 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 the local Agency, call 1-800-677-1116
or go to http://www.eldercare.gov on the Internet. As
discussed earlier, reverse mortgage loans are 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
5 years, reverse mortgages are usually not a viable option. 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 in retirement who were hit hard by the recent bear market,
and who want to “make it all back.” These individuals are easy prey
for investment scam artists who promise the sky, but end up absconding with the
money. Just remember, if an investment sounds too good to be true, it usually
is. Conclusions
Even in light of some
potential disadvantages, I think the reverse mortgage is a financial planning
device whose time has come. 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.
I am also encouraged about
the possibilities of reverse mortgages because of 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 90% 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 70% year-over-year rate, which is pretty amazing considering that the industry
estimates that only 30% of seniors have ever heard of reverse mortgages. The continued
explosive growth of this market is almost guaranteed 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. Resources:
AARP
reverse mortgage website List
of reverse mortgage articles from AARP Reverse
mortgage informative booklet provided by AARP
Reverse
mortgage loan calculator National
Center for Home Equity Conversion Mortgage: National
Reverse Mortgage Loan Association
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