January/February 2009

Reverse Mortgages: A Quick Financial Fix?
By Athan Bezaitis, MA
Aging Well
Vol. 2 No. 1 P. 28

This innovative loan product generates funds for cash-strapped elders, but experts agree reverse mortgages aren’t for everyone.

Reverse mortgages are a touchy subject. Intended as a monetary tool to help Americans over the age of 62 age in place, the loan releases home equity to cover expenses. Proceeds can be used to pay bills or provide in-home care. Nevertheless, critics are quick to point out the drawbacks, including high up-front costs, a complicated loan structure that can be difficult to understand, and devaluation of the owner’s property that affects what’s left for heirs.
 
For some older Americans, the money provides a windfall to maintain a standard of living within the home that may otherwise be impossible. Other reverse mortgage candidates may be better served with alternative funding choices, such as selling the home, taking out a home equity loan or equity line of credit, using the home as a rental property, or moving to alternative living facilities. The decision should be based on the homeowner’s circumstances and desires.

Before considering a reverse mortgage, it’s critical for the older adult to understand exactly how the loan works, the financial repercussions when the homeowner moves out or dies, and what other options are available.
 
What Is a Reverse Mortgage?
A reverse mortgage is a loan available to American homeowners aged 62 and older that doesn’t have to be repaid until the borrower permanently moves out, sells the home, or dies.

“The product was designed to provide a source of funding for older people to stay in their homes,” says Patricia Kauker, CSA, vice president of reverse mortgages at WSFS Bank in Hockessin, DE. “As the population ages and our economy struggles, expenses such as utility bills, homeowners insurance, and taxes are going up at a faster rate than Social Security and pension incomes. In the early stages, reverse mortgages were thought of as a needs-based product. Now we see more people looking at these loans as part of their overall retirement financial planning.”

Evidence supports Kauker’s claim. In October, Peter R. Orszag, director of the Congressional Budget Office, reported that American retirement plans have lost as much as $2 trillion in the past 15 months. With such staggering losses of revenue intended to be used as income for later life, reverse mortgages are reportedly among few areas of growth within the mortgage industry. In fiscal year 2008, the National Reverse Mortgage Lenders Association reported 112,100 home equity conversion mortgages (HECMs), which are reverse mortgages insured by the Federal Housing Administration (FHA). This total surpassed the record loan volume for 2007, according to U.S. Department of Housing and Urban Development (HUD) data. The lenders association reports that HECMs account for more than 90% of reverse mortgages in the United States.

In 2006, the first nationally representative survey of reverse mortgage shoppers conducted by the AARP Public Policy Institute found that 93% of borrowers reported their reverse mortgages have had a largely positive effect on their lives. However, the report also cited excessive initial loan costs and limited consumer confidence and knowledge. To protect borrowers and ensure the loan complexities are understood, applicants must seek third-party financial counseling from a HUD-approved source. The AARP study concluded that the FHA’s Home Equity Conversion Mortgage Program “has successfully created the foundation for the financial infrastructure of the reverse mortgage industry.”

But although the lure of a loan with long deferred payments may be tempting to cash-strapped elders, reverse mortgages are not always the best option for those who qualify.

Conventional Mortgages vs. Reverse Mortgages
While both reverse mortgages and forward mortgages (the type of loan typically used to buy a home) create debt against the home and affect equity in it, they differ in two distinct ways. First, with a reverse mortgage, the borrower does not have to make monthly payments. Second, no income is needed to qualify for a reverse mortgage.

A traditional mortgage is a falling-debt, rising-equity loan in which the lender considers income levels to determine how much the borrower can pay back each month. The homeowner then pays a monthly amortized amount to the lender to increase equity in the property. Over time, the loan balance decreases and the equity increases until the loan is paid off.

With a reverse mortgage, payments have the opposite effect, making it a rising-debt, falling-equity loan. Where a forward mortgage uses income to repay debt and build equity, a reverse mortgage decreases equity in the home and adds to the overall debt. If the value of the home rapidly increases, equity can also increase in a reverse mortgage, although this scenario is uncommon.

“One of the biggest complaints about FHA-backed reverse mortgages when compared to traditional mortgages is the up-front fees,” Kauker says. These charges include a 2% mortgage insurance premium that goes directly to HUD to ensure the loan on behalf of the lender and borrower. Other closing costs include title insurance, appraisal fees, recording fees, attorney or agent fees, and a credit report fee that is required even though the product is not contingent on credit. Also included is an origination fee, which, depending on the value of the property, is 2% of the first $200,000 and then 1% on the remainder, with a cap of $6,000.

As part of the Homeownership Act of 2008, HUD recently approved a single national loan limit of $417,000 (up to as much as $625,500 in high cost areas) for HECM reverse mortgages. Previously, the lenders association Web site reports, the HECM program assigned different lending limits by county, ranging from $200,160 in rural areas to $362,790 in the highest home value areas. The higher lending limit, according to Darryl Hicks, associate director of National Reverse Mortgage Lenders Association, “will enable borrowers to obtain a greater benefit if their home value is higher than the previous HUD limit.”

When comparing total costs of a reverse mortgage with a traditional home mortgage, Hicks says, reverse mortgages really are not all that different over the full span of the loan. “With a reverse mortgage, the up-front costs may appear high; that’s because the closing fees are transparent. It is the most transparent mortgage product out there when it comes to showing costs. A lot of the costs that you pay with a regular mortgage, such as a 30-year loan, have fees spread over a longer period of time. With a reverse mortgage, a lot of those costs are front loaded because our clientele are seniors. They may not live for 15 to 30 years to make those payments,” he explains.

Reverse Mortgages on the Rise
According to figures from the lenders association, reverse mortgages have seen a steady uptrend each year since 2001. Loan production has grown from 43,131 in fiscal year 2005 to 76,351 in fiscal year 2006 before climbing to 107,558 in 2007.

Other types of nongovernment-insured reverse mortgages provide a private sector alternative to HECMs. These so-called jumbo loans have higher lending limits than the $417,000 maximum recently established by the federal government with the Homeownership Act.

“If I live in a million dollar home, I’m not going to get as much money from a HECM as from a jumbo reverse mortgage,” says Hicks. “The problem is that, with the exception of one agency in New York City, there are no jumbo loans out there. The meltdown in the financial market has driven the product out for the time being. But they will be back.”
Hicks expects the growth of reverse mortgages to accelerate as seniors look for additional sources of income. Several new provisions of the Homeownership Act, in addition to the increased lending limit, will broaden the market for reverse mortgages while making them more attractive, he says.

Reverse Mortgage Eligibility
To qualify for a reverse mortgage, all owners listed on the home’s title must be aged 62 or older and must occupy the home as their principal residence for the majority of the year. The property must be a single-family or a two- to four-unit dwelling. Townhomes, detached homes, condominium units, and some manufactured homes are also eligible.

The borrower’s age, the current interest rate, and the appraised value of the home determine the amount of money available to the borrower. According to HUD, “Generally, the more valuable your home is, the older you are, and the lower the interest, the more you can borrow.”

While some fixed-rate HECMs are now available, most borrowers choose adjustable interest rates on reverse mortgage loans. HECM program regulations require that lenders offer an annually adjustable rate tied to the current one-year U.S. Treasury Secretary rate, according to AARP’s Web site. An HECM lender may also offer a lower rate that is adjusted each month, tied to the one-year treasury rate with a 10-percentage-point cap over the life of the loan.

Other considerations determining the amount of a reverse mortgage loan are based on whether the payment is taken as a single lump sum, as a monthly cash advance known as a tenure, as a term payment, as a credit line account, or as a combination of these payment methods. Lump sum payment provides instant cash but requires the highest interest fees. Purchasers of reverse mortgages most commonly choose a credit line. A monthly tenure payment is a guaranteed amount over the borrower’s life span, while a term payment provides equal payments for a selected period of months.

“The monthly tenure payments last for as long as there is a borrower still residing in the property, even if there is no equity left in the property and even if you live longer than expected,” Kauker says. “If the borrower has requested monthly payments in excess of the tenure option, the payments would stop once the requested term is over.”

Once the reverse mortgage deal is closed, with the proceeds, the borrower is required to satisfy any existing liens or repay any money owed on the home. The homeowner remains responsible for property taxes, homeowner’s insurance, home repairs, and utilities. According to the Centers for Medicare & Medicaid Services Web site, funds received from a reverse mortgage count toward the borrower’s income. This may affect eligibility for Medicaid or other state assistance programs.

Paying Off a Reverse Mortgage
The death of the last surviving borrower, the sale of the home, or the resident’s move into another dwelling such as a long-term care facility for 12 consecutive months triggers the payment of a reverse mortgage. The loan is usually paid off with the earnings from the sale of the house. If the borrower has died, the heirs of the homeowner’s estate can refinance the property. “If the family wants to keep the property, it repays the loan plus accrued interest,” says Neal E. Cutler, PhD, executive director of the Center on Aging of the Motion Picture and Television Fund in Woodland Hills, CA. “Alternatively, when the house is sold, any net proceeds beyond repayment to the bank are retained by the borrower’s estate.”

Unlike a traditional mortgage, the balance of the loan cannot exceed the value of the home when it’s sold. If the sum of the loan plus the accrued interest becomes greater than the market value of the house, the mortgage insurance premium covers the lender’s loss. “The risk to the lender is that the loan balance could some day exceed the value of the property. That risk is mitigated by the FHA mortgage insurance, which will pay the lender if there is a shortfall,” Kauker says.

When payment is triggered, borrowers are never personally obligated to repay a debt greater than the value of the property. The technical term for this cap on debt is a nonrecourse loan, meaning the lender has no legal recourse to anything other than the value of the home when the loan is paid off.

Reverse Mortgage Candidates
Many elders are “cash poor but equity rich,” says Cutler. “This means they may have substantial equity in their paid-up mortgage but a relatively small monthly cash flow from Social Security, pension, and investments.” For older adults who are asset rich, especially those who have paid off their home loans, a reverse mortgage could provide a welcome source of income, he says.

In fact, according to Kauker, the typical reverse mortgage client is “retired, possibly with a part-time job. Typically, they have some savings, not a tremendous amount,” she says. “I’ve seen more seniors coming to us with debt recently than I’ve seen in the past. Others want to help pay for their grandchildren’s college tuition. Some want to help their adult children with their financial obligations or to do things like purchase a boat or a mobile home—things they didn’t have the money for before.”

“Many consumers use the reverse mortgage to pay off a remaining home mortgage, thereby reducing monthly expenditures. They can also be used for necessities such as increasing copayments for healthcare; meeting the costs of prescription drugs under Medicare Part D, especially if one falls into the ‘doughnut hole’; repairing their homes; and as a protection against emergency expenses,” says Jon Pynoos, PhD, a professor at the University of Southern California, Davis School of Gerontology. Rather than using it as a monthly flow of income or a lump sum payment, he says, most opt to use it as a line of credit, using the money as they need it.

“A reverse mortgage is right for someone who doesn’t have any other options for meeting their financial objectives,” says Norma P. Garcia, senior attorney with the U.S. Consumers Union. “They don’t worry too much about leaving assets for an heir. Ideally, their luck will hold out so that they will not have to leave their home within a short time after taking out the loan. That is the big gamble. The longer you stay in the house, the better it is for the borrower.”
 
Abuses in the Reverse Mortgage Industry
At the Consumers Union, Garcia has received reports of abuses within the reverse mortgage industry. She recalls several stories from adult children whose parents had taken out reverse mortgages only to learn they suffered from dementia at the time the documents were signed. In another case, she recalls a daughter who discovered her mother had signed a document that allowed the lender to share in the appreciation of the property. When the home was sold, the bank received a portion of the proceeds.

“People of a certain age may have vulnerabilities. We are dealing with a complex subject here, so there is a potential for misunderstanding and abuse,” Garcia says. “The Consumers Union wants to see credit available to people of all ages, but we don’t see reverse mortgages as a silver bullet for this age group because the loan is not for everyone.”

Kauker expresses concern about the reputation of reverse mortgage lenders, many of whom have in mind the best intentions for their clients. “We have a lot of good lenders who have been doing good work. We are in this industry because we believe in the product. We are now faced with subprime lenders getting into this business. Our senior customers are an easy target, and we’re faced with people getting into the market for the wrong reasons,” she says.

As a consumer advocate, Garcia calls for even greater regulation. “We cannot count on voluntary ethics to police the marketplace,” she says. “Our financial meltdown is an example of this. Regulation and legislation that incorporates sound business practices create a safety net for consumers, and it puts the lending industry on notice of what is expected in the marketplace. In turn, it gives consumers confidence knowing there are protections in place that relate to these products. And it helps the lenders because the bad actors are being policed and weeded out of the industry.

“People should be going in with their eyes open,” adds Garcia. “If I had the choice of an interest-free loan from a city or county to install grab bars and make my home wheelchair accessible, I would go for the cheaper option over the reverse mortgage if it is available. But a lot of people don’t know these options exist and are left with a reverse mortgage as the only option. Do your homework before you sign on the dotted line.”

— Athan Bezaitis, MA, is a freelance writer based in southern California.

Five Questions Clients Should Ask before Considering a Reverse Mortgage
1. Does a client really need a reverse mortgage? If a client wants to take a dream vacation, a reverse mortgage is a very expensive way to pay for it. Investing money from these loans is an especially bad idea because the loan is likely to cost more than investors could safely earn. If anyone is trying to sell your client something and recommending use of a reverse mortgage to pay for it, that’s generally a good sign that he or she doesn’t need it and shouldn’t be buying it.

2. Can your client afford a reverse mortgage? These loans are very expensive, and the amount clients owe grows larger every month. The younger clients are when they take out a reverse mortgage, the more compound interest will grow and the more they will owe. On the other hand, due to high up-front costs, these loans can be especially costly if clients sell and move just a few years after taking the loan.

3. Can clients afford to start using up their home equity now? The more clients use it now, the less they’ll have later when they may need it more, such as to pay for future emergencies, healthcare needs, or everyday living expenses. This is of particular concern if needs suddenly increase or income doesn’t keep pace with inflation. Equity may be needed to pay for home repairs or assisted living expenses.

4. Are there less costly options? Are there other financial resources available? If not, and if clients could make the monthly repayments on a home equity loan or a home equity line of credit, these alternatives are much less costly than a reverse mortgage. Many state and local governments offer low-cost loans for paying property taxes or making home repairs. Have clients considered the costs and benefits of selling the home and moving to a less expensive one?

5. Do clients fully understand how these loans work? Reverse mortgages are quite different from any other loans, and the risks to borrowers are unique. Before considering one, clients should do the homework carefully and thoroughly.

— Source: AARP