By Betty Meredith, CFA®, CFP®, CRC®
For the average mid-market American, home equity is their largest household asset. As retirement counselors, we need to understand options for helping retired clients appropriately use their home equity if their economic situation requires it, such as selling their home/downsizing if access to their equity isn’t feasible, or alternatives if they desire to “age in place.” In this article we cover the basics of reverse mortgages, how the reverse mortgage market is changing due to the Great Recession, and how those changes are affecting many older homeowners who seek an improved quality of life or need funds for unexpected emergencies.
A reverse mortgage is a loan for homeowners at least age 62 where equity in the home can be used to create a tax-free stream of payments, a lump sum payment, or a credit line, while allowing the homeowner to continue living in the home. A reverse mortgage creates a debt secured by a lien on the property which increases as funds are withdrawn, therefore reducing the homeowners’ equity. Assuming the retiree stays in the home until passing away, any equity remaining after repaying the reverse mortgage will pass to the retiree’s beneficiaries or estate. The loan is also terminated if the homeowner(s) live(s) for more than one continuous year elsewhere (such as in a nursing home), or if the home is sold.
There are over 2,200 private lenders currently who offer reverse mortgages. HUD (U.S. Department of Housing and Urban Development, the federal government agency which oversees home mortgage lending practices) and the FHA (Federal Housing Authority) are not direct lenders, but they maintain a list of federally insured, approved lenders. The only reverse mortgage insured by the U.S. Federal Government is called a Home Equity Conversion Mortgage (HECM) program, and is only available through an FHA approved lender.
The amount that can be borrowed depends on the following:
- The age of the youngest borrower (if a couple)
- The value of the home or the county limit, and
- The expected average interest rate on the reverse mortgage.
Most all types of homes qualify; some condos, townhomes and mobile homes may be eligible as well. The home must be owned free and clear of all liens or be paid off once the proceeds of reverse mortgage are applied. Currently, there are no credit scoring or income requirements to qualify for a reverse mortgage.
What are the options for reverse mortgages?
In 2010, the FHA introduced the HECM Saver option, an upfront less-expensive
reverse mortgage likely to have a slightly higher interest rate. Saver borrowers pay substantially less in upfront mortgage insurance premium fees (0.01% vs. 2.0% for the FHA’s HECM Standard option) in exchange for a principal lending limit reduction of 10-18%, which leaves more equity in the home and reduces the overall financial risk associated with the loan. For example, on a $280,000 home, using the HECM Saver option means the upfront premium is just $28 versus a $5,600 upfront fee for an HECM Standard reverse mortgage. However, the Saver homeowner might only be able to borrow $144,015 versus $176,243 for a standard HECM.1
For either HECM Standard or Saver reverse mortgages, borrowers pay an ongoing 1.25% per year FHA mortgage insurance premium on the outstanding loan balance. The FHA insures HECM loans to protect lenders against loss if amounts withdrawn exceed remaining equity when the property is sold. FHA insurance also ensures payment to the borrowers in the event the lender is unable or unwilling to make payments.2
Several options for receiving funds tax-free are:
- Credit line for emergencies
- Monthly payments
- Lump sum distribution
- Any combination of the above
It is best to originate a fixed-rate reverse mortgage in a low interest-rate environment like we have now to minimize the effect of compounded interest on the amount of the loan to be paid off upon termination.
When and how are funds repaid?
The loan is not due as long as at least one homeowner lives in the home as their primary residence, maintains the home, and keeps taxes and insurance coverage current. If the title to the home is only in one spouse’s name, the other spouse should be added onto the title before securing a reverse mortgage. Even if the surviving spouse is still living in the home, if a surviving spouse’s name is not on title, the reverse mortgage will become due and the home will need to be sold if the titled homeowner dies.
Once a homeowner has passed, their estate has approximately six months to repay the balance and keep the home or sell the home to repay the balance. All remaining equity belongs to the estate – not the lender. If the sale of the home is not enough to pay off the reverse mortgage, the lender must take a loss and request reimbursement from the FHA. No other assets are affected by a reverse mortgage unless heirs choose to pay off the loan to retain the home. For example, investments, second homes, cars, and other valuable possessions cannot be taken from the estate to pay off the reverse mortgage balance.
To learn more about the taxation of reverse mortgages, see this article from the Journal of Financial Planning.
Benefits of using a reverse mortgage:
- Funds received are tax-free.
- Allows a homeowner to stay in the home.
- Doesn’t require an income requirement or minimum credit score, though income, assets, monthly living expenses, and credit history may be verified.
- Repayment is not due for as long as the homeowner lives in the home and meets requirements for maintenance and paying property taxes and insurance.
- Funds must be used to pay off small existing mortgages (only one lien is allowed on the property).
- Interest rates are lower than on traditional mortgages and home equity loans because the loan is federally guaranteed.
- Heirs can choose to sell the home, keeping any remaining equity after the balance of the reverse mortgage is paid off, or pay off the loan using other funds and keep the home. For example, assume that when a homeowner
passes the reverse mortgage balance was $50,000. If the estate sells the house for $250,000, the lender gets $50,000 and the estate inherits $200,000.
- If the home is underwater, the total repayment due is limited to the amount of the proceeds of sale.
Since there are many factors to consider before deciding whether a reverse mortgage is the right move, the FHA requires homeowners to participate in a consumer information session. (As a strong proponent of educated decision-making, I see this requirement as a benefit.) Given by a HUD-approved HECM counselor, homeowners can make more informed decisions about program eligibility requirements, potential financial outcomes, and alternatives to using a reverse mortgage and repaying the loan. A 2006 AARP study3 found that 75% of homeowners interested enough to complete the counseling process, to be screened for eligibility and given an estimate of loan amounts, then became reverse mortgage borrowers.
Drawbacks of using a reverse mortgage:
- Fees for reverse mortgages are the same as traditional FHA mortgages but have an additional required insurance cost.
- The initial mortgage insurance premium (MIP) is 2% of the property value up to the HUD property value limit for the HEMC Standard option and .01% for the Saver option. The initial MIP is charged at closing on the lesser of the appraised value of the home, the FHA HECM mortgage limit of $625,500 or the sale price. In addition over the life of the loan, a fee of 1.25% of the mortgage balance will be paid every year.
The FHA mortgage insurance guarantees:
- The homeowner cannot “outlive” the reverse mortgage.
- The homeowner and heirs will not be personally liable if the balance of the loan exceeds the value of the home at the time of sale.
- Homeowners will have access to the principal of the loan when desired; in other words, the lender cannot back out or call the loan at a later date if the lender becomes financially troubled (the FHA takes over the loan).
- A lender can charge an HECM origination fee up to $2,500 as compensation for processing the loan if the home is valued at less than $125,000. For homes of more than $125,000 in value, lenders can charge 2% on the first $200,000 of the home value plus 1% of the amount over $200,000, up to a total cap of $6,000. Because of this large fixed origination fee, reverse mortgages are not appropriate for lesser value homes.
- Closing costs (fixed costs in addition to the lender origination fees) will also be a higher percentage of the home’s equity on lesser-valued homes compared to the same loan on a higher-priced home, therefore lessening
the financial sense of using a reverse mortgage. Appraisal, title, and notary
closing costs totaling $1,000 represent 0.56% of a $175,000 home. However, the same closing costs on an $80,000 home represent 1.25% of the home’s value. If homeowners with low-value homes need help postponing property taxes or making needed home improvements, they can find out more about local “single purpose”options offered by their city, county or state through the Area Agencies on Aging (AAAs) by visiting www.eldercare.gov or calling 1-800-677-1116 to defer taxes until the home is sold before pursuing an HECM.
- Social Security and Medicare benefits are not affected by reverse mortgage payments, but Medicaid and other needs-based government assistance can
be if monthly funds withdrawn surpass the program’s income limits. Retirement counselors need to be aware that receipt of reverse mortgage payments can disqualify a person from important Medicaid long-term care benefits.
Since the potential need is huge, what is the state of the reverse
mortgage market today?
Almost 75% of the 660,000 reverse mortgages that have been made since 1989 have been made in the last five years.4 However, the rate of reverse mortgages has declined substantially over the last two years, falling 35% to 72,748 in 2010, compared to 111,924 originated in 2009.5 The decline is being driven by:
- The drop in home prices which resulted in the loss of home equity,
making a large segment of potential borrowers ineligible for reverse mortgages as they are now not able to borrow enough to pay off their primary mortgage and have enough funds left over for their cash needs. A January, 2011 New York Fed research report6 states, “When home prices began to fall in 2007, owners’ equity in household real estate began to fall rapidly from almost $13.5 trillion in 1Q 2006 to a little under $5.3 trillion in 1Q 2009, a decline in total home equity of over 60%. At the end of 2009 owner’s equity was estimated at $6.3 trillion, still more than 50% below its 2006 peak.”
- The exit of Fannie Mae from the adjustable rate reverse mortgage market in 2010.
- Fixed-rate mortgage-backed securities issued by Ginnie Mae, an arm of HUD, requiring the borrower to withdraw the full loan limit at closing. These types of loans shot up from 3% to 70% of HECM loans after Fannie Mae pulled out. However, the number of HECM reverse mortgages declined over 30% from 2009 to 20107 as many people don’t want to be forced to withdraw the entire loan at once and pay interest right away on a large amount they don’t currently need.
- Lenders are experiencing an increase in the number of loans in technical default as homeowners fall behind on property taxes homeowner’s insurance, both of which are required to avoid foreclosure.
So how well are reverse mortgages meeting the needs of the
At a time when there is an increased need for options to access home equity to meet retirement needs, all the above is leading to a shakeout in the number of reverse mortgage providers. There are now only 2,222 active lenders, down 30% from 2010.8 Wells Fargo and Bank of America, the two lenders with the largest volume, pulled out of the reverse mortgage market in 2011. Wells Fargo cited their decision was based on the fact that as a reverse more originator they are not allowed to decline anyone, and their lack of success in negotiating with HUD to find an alternative solution.
In terms of other bad news, in 2010 MetLife withdrew from the long-term care market, John Hancock closed its employer-based long-term care product to new enrollments, and the CLASS Act long-term care program (part of the Affordable Care Act) was cancelled in 2011.
It seems we’re moving in the wrong direction. Mid-market retirees are now more than ever left on their own to insure their retirement.
Betty Meredith, CFA®, CFP®, CRC® is the Director of Education and Research for International Foundation for Retirement Education (InFRE), and Managing Member of the Int’l Retirement Resource Center, LLC.
1Assumes a fixed-rate reverse mortgage and a 78-year old homeowner that lives in Macomb County, Michigan 48015, with a home that has an estimated value of $280,000. Age is calculated as if the loan closing date is Friday, March 9th, 2012. http://rmc.ibisreverse.com/default_nrmla.aspx.
2 U.S. Department of Housing and Urban Development. http://www.hud.gov/offices/hsg/sfh/hecm/hecm–df.cfm
3 Donald L. Redfoot, Ken Scholen, and S. Kathi Brown, Reverse Mortgages: Niche Product or Mainstream Solution? AARP Public Policy Institute Report #2007-22, 2007.
4 How Recent Changes in Reverse Mortgages Impact Older Homeowners, AARP
Public Policy Institute, Fact Sheet 211, February 2011.
5 How Recent Changes in Reverse Mortgages Impact Older Homeowners, AARP Public Policy Institute, Fact Sheet 211, February 2011.
6 Household Debt and Saving during the 2007 Recession, NY Federal Reserve,
7 Reverse Mortgage Insight, http://www.rminsight.net/reverseiq-newsletter/2011/01/a-merry-year-end-for-lenders-retail-leaders-december-2010/
8 Reverse Mortgage Insight, http://www.rminsight.net/reverseiq-newsletter/2011/01/a-merry-year-end-for-lenders-retail-leaders-december-2010/
©2011, Betty Meredith. All rights reserved.