Several big banks have abandoned reverse mortgages this year, some watchdog groups have maligned them and consumers have shied away from them. Nevertheless, now may be a good time to recommend them to clients.
Reverse mortgages let those who are older than 62 tap into the value of their homes, often their most valuable asset. And although home equity has been falling since its 2007 peak, the National Reverse Mortgage Lenders Association and RiskSpan, a consulting firm, estimate that, in the first quarter of this year, those older than 62 still had $3.2 trillion in equity.
Dennis Loxton, a CFP and regional vice president of the reverse mortgage division of First Century Bank in Gainesville, Ga., says that reverse mortgages are most commonly taken out by low- or middle-income people to retire mortgage debt, free up liquidity or to pay for health care costs. But he's also seeing more affluent clients use them as a planning tool to fund long-term care and supplemental life insurance. "Their investments have taken a big hit, and if they have needs that have to be addressed, they're looking to their house to fund it," he says.
TIME IS MONEY
Reverse mortgages are a niche product: Only a tiny percentage of eligible homeowners opt for them. But if they make sense for your client, it's a good idea to lock them in soon, for several reasons:
* The industry's biggest player by far, the Department of Housing and Urban Development, which insures reverse mortgages through the Federal Housing Administration, plans to decrease the loan's limit at the end of 2011 to $417,000 from $625,500.
* With property prices in certain parts of the country continuing to stagnate or fall, an FHA-insured reverse mortgage is one way to lock in a home's current value and protect its equity.
* A reverse mortgage can be a financial lifeline for laid-off pre-retirees who are having difficulty finding new jobs in a weak economy.
* The exit of large lenders like Wells Fargo, Bank of America, Financial Freedom and SunTrust Bank means the future of reverse mortgages is unclear.
Loan volume fell in 2009 and 2010 from a 2008 peak, and 2011 is expected to be another down year, according to Reverse Market Insight. Concerned about overexposure to risk, Ginnie Mae, which purchases reverse mortgage-backed securities, tightened standards for its issuers last month.
Well-publicized lawsuits also have shaken the industry. Last year, the Illinois attorney general sued two mortgage brokers for unfair and deceptive marketing practices, claiming they implied these loans were part of a government benefits program and did not need to be repaid.
This year, the AARP Foundation Litigation sued the U.S. Department of Housing and Urban Development, charging that a 2008 policy change illegally forced some spouses of deceased borrowers into foreclosure after their homes had fallen in value. (HUD has since changed the rule). It also sued Wells Fargo and Fannie Mae to enforce rules that will let spouses and heirs of deceased borrowers purchase family homes at appraised value.
While these headwinds are unlikely to cause the reverse mortgage industry to disappear, in the short run they will probably have a negative impact. Some experts predict the industry will consolidate into a few big players that will take a closer look at the ability of applicants to pay for property taxes, homeowners insurance and upkeep costs before they grant a loan. Fees - often already steep - could rise, as well.
HOW THEY WORK
Homeowners can get a federally insured reverse mortgage if they meet the 62-or-older age requirement, are not delinquent on any federal debt, use the home as a principal residence and own it free and clear, or can pay off the balance of the mortgage with the proceeds from the loan. Since the loan is based on the value of the home, borrowers don't have to meet conventional underwriting requirements for income or creditworthiness. However, because a reverse loan is complex, they must first go to counseling on the benefits and risks.
They can choose a fixed- or adjustable-rate loan. But those who choose a fixed rate must take a lump sum, and start paying interest on the entire amount immediately. That makes sense if the money is needed to pay big bills right away, but if borrowers invest the unused amount at a lower rate than they are paying for the loan - perhaps in a savings account - they would lose the difference.
Owners do not have to repay the mortgage as long as they occupy the home (although under certain circumstances, the loan also can be used to sell one home and simultaneously buy another, eliminating one set of closing costs). The proceeds are tax-free.
The loan must be paid, with interest, when the borrowers die, move or sell the property, or if they don't pay property taxes and homeowner's insurance, or maintain the home. Any money left after the loan is satisfied goes to the borrowers or their heirs.
Borrowers need not be in good health to get a reverse loan, and having one does not affect benefits from Social Security or Medicare. However, clients should know a reverse mortgage can put a borrower above the asset limit for receiving needs-based government benefits like Medicaid, says New York lawyer Ira Salzman, who specializes in elder care law.
While applying for needs-based programs could seem a remote possibility to clients, in fact, 63.6% of nursing home residents were covered by Medicaid in 2010, according to the American Health Care Association. Planners should also be aware that laws and eligibility requirements for needs-based programs vary from state to state, Salzman says.
PROS AND CONS
A reverse mortgage can serve many purposes. Al Rodriguez, president of lender Gold Star Mortgage Financial in Longwood, Fla., says one of his clients, a 77-year-old, took out a reverse mortgage to buy a home down the street for her daughter. "That's a good idea," he says, noting the mortgage-free daughter will now be near enough to care for her mother, reducing her expenses.
He was not so enthusiastic about a reverse mortgage another client wanted to take out. At 69, the client wanted to make sure money would be available for his 64-year-old wife, should he die and their monthly income drop. Those who need the proceeds from a reverse mortgage now are well advised to get it, but if the need is years away, it's better to wait, Rodriguez says. That's because the older an applicant is, the more he or she will be able to get in monthly income.
In addition to considering when the money is needed, clients should also know that reverse mortgages can be expensive, unless lenders agree to waive or absorb some of the costs. Borrowers seeking an FHA-insured home equity conversion mortgage (the FHA name for a reverse mortgage) may have to pay an origination fee of up to $2,500 if the home is appraised at less than $125,000. If it is worth more, lenders can charge a 2% origination fee on the first $200,000 of the home's value, plus 1% of the balance, up to a maximum of $6,000.
They also can be charged a separate mortgage insurance premium of 2%, plus closing costs. Over the life of the loan, they will also be charged an annual mortgage insurance premium equaling 1.25% of the mortgage balance.
These borrowers must also pay a monthly servicing fee of no more than $30 if the interest adjusts annually, and $35 if it adjusts monthly. The monthly fees may be added to the loan balance.
Those who opt for the popular Saver loan, which was introduced a year ago, only have to pay a mortgage insurance premium of 0.01%. However, they can only borrow about 80% to 90% as much as they could with a standard home equity conversion mortgage. They also will likely pay a slightly higher interest rate, according to reversemortgage.net.
The volume of Saver loans, although still comparatively low - 536 in August - has more than doubled since January. The loans were already about 10% of all new reverse mortgages in August, says John Lunde, president of Reverse Market Insight. What's more, the loans are likely to continue attracting younger borrowers seeking new financial strategies as they approach retirement, with the share of 62-year-old home equity conversion mortgage borrowers rising to 8% in 2010 from 4% in 2004, Lunde says (see "Getting Younger" chart below).
Although reverse mortgages can be a useful tool, planners should weigh them against other ways to raise cash. If a senior is older than 65, and just needs money for home repairs or improvements, planners should look into deferred payment loans offered by some state and local governments, according to the National Council on Aging, a nonprofit advocacy organization.
In contrast to reverse mortgages, these loans have low closing costs and no insurance premiums or origination fees. If interest is charged, it is minimal and simple, not compounded.
Another choice available in many areas is a property tax deferral loan. Both these loans work like reverse mortgages, in that they tap into existing home equity. Borrowers do not have to make payments on them as long as they continue to live in the home.
For homeowners who have not yet retired and need ready cash, a home-equity line of credit may be better than a reverse mortgage, Rodriguez says. It's important to do a side-by-side comparison of all of the costs; while total interest rates can be lower for home equity conversion mortgages, fees and closing costs are typically higher. Fortunately, the reverse mortgage variable rate is usually derived from the same indexes as those used for home equity lines of credit, making comparisons straightforward.
If adult children have the means, another option is a private reverse mortgage. "It especially makes sense if you have a property that you want to keep in the family," Loxton says.
Under such an arrangement, seniors don't have to meet any debt-to-loan ratio requirements or pay any fees. Instead, their children provide their parents with a monthly sum and cover the cost of the home's upkeep. In return, when the parents die and the house is sold, the children get compounded interest on the loan (since the parties are related, the applicable federal rate must be charged), plus the principal and what they spent on maintenance. Moreover, they will get a stepped-up basis on the home, eliminating capital gains taxes.
The potential downside for seniors is that their children could have a financial reversal at any time and no longer be able to fund the loan. For the children, the risk is that the house could fall in value, so that they eventually wind up spending more than they get back.
But these risks can be mitigated if all parties agree in advance to sell the home if the market value falls below the total amount that the children invested. As with all intrafamily arrangements, it's crucial to have a lawyer prepare the documents to prevent misunderstandings or lawsuits, Salzman says.
There are also other ways for seniors to use their home to improve cash flow. They can move to a smaller, less expensive apartment and rent out their home; live in the home while leasing out the basement or a room (assuming local ordinances allow it); or sell the home to a relative or investor who will let them rent it back.
Home equity may not be what it was at the housing market's peak. But with smart planning, it can still be tapped via reverse mortgages to help fund a client's retirement.
June Fletcher is the author of House Poor and writes the weekly online House Talk column for The Wall Street Journal.