In February 2003, we discussed a mortgage product that was gaining favor in the marketplace – the reverse mortgage. Although the product had been available since 1961, only 18,079 such loans were filed in the U.S. government’s fiscal year 2003 and, while projections for 2005 were that 70,000 such mortgages would be originated, it wasn’t until 2006 that the 70,000 mark was exceeded. Only 107,558 such mortgages were originated in 2007.
What is a reverse mortgage?
In the late 1980s, the United States Department of Housing and Urban Development created a program known as the Home Equity Conversion Mortgage (HECM). Simply put, the idea of a HECM is to allow senior citizens access to the equity in their home. The reason they may need access to that equity is not material, but could include the need to meet monthly living expenses, obtain investment capital, cover extraordinary medical expenses, or other needs as well. The reason is not generally important in the underwriting process.
In a reverse mortgage, the lender will advance the borrower funds, either as a lump sum, in monthly payments, or as a line of credit. The amount available to the borrower is based on the borrower’s age, home value and condition, and interest rates. The borrower is not required to repay the loan as long as he, she, or they reside in and own the residence. The loan is also federally-insured.
Given the current mortgage woes, it might be comforting to know that a lender cannot take your home away from you as long as you continue to live in the home, keep the taxes and insurance current, and do not owe more than the home’s value.
How does one qualify for an HECM?
To qualify for an HECM, you must be 62 years of age or older; own the structure to be mortgaged outright, or have a remaining mortgage balance that can be paid off with the HECM. Additionally, the house must be your principal residence and in good repair. The property must also be either a single family dwelling or a two-to-four unit building in which you live.
Are there any drawbacks to an HECM?
There are some drawbacks to this “too good to be true” scenario. First, don’t expect to get all of your home’s value out in cash. The only way a lender will get repaid is by the disposition of the home or a refinancing when you give the home up (by moving out of it or at death). For this reason, the lender will give you only a portion of the home’s value. For example, a 62 year-old with a home valued at $350,000 can expect to get approximately $110,000 up front for the home. If you are 75 years-old, you could possibly get an up front amount of approximately $132,000.
A second drawback is the cost of an HECM. In the preceding examples, the fees were approximately 9% of the loan amount and the 62 year-old was required to pay $12,000 in mortgage insurance. This far exceeds the normal fees charged for conventional loans.
If you take out an HECM, you should expect to remain in the home for five years or longer in order to make the payment of fees worthwhile. This may seem like a no-brainer, but you may wish to consider where you expect your family to be during that time and whether you think your current living conditions are compatible with your future goals. Moving not only means moving to a new house; it also might mean moving to a nursing home or assisted living facility.
One final drawback, while real, is not one that should weigh heavily on you. You need to realize that your heirs may object to you entering into a reverse mortgage because this could adversely impact their inheritance. The home is yours, of course, and not theirs, so make sure you do what is right for you.
Are there any advantages to an HECM?
As previously discussed, the proceeds of an HECM can be utilized for any number of purposes, including obtaining investment funds. Since you don’t have to repay the debt as long as you live in your home, HECM proceeds could be a source of investment funds. Let’s take the previous example of our 62 year-old. After receiving the proceeds, she put the funds in a solid investment that is expected to earn 12% over the next 10 years. Assuming the home appreciates at a rate of 4% over the next 10 years, here is what she will have:
|Investment value assuming tax-free Growth
|Tax on net gain
|Net asset value after tax
This is just an example and, unless you can afford to lose $109,000, this is probably not a good option in most cases. A more likely scenario is utilizing the reverse mortgage proceeds to supplement your current retirement income or make urgently needed repairs on your home. At any rate, the prime advantage of a reverse mortgage is that it provides you a way to cash out on your home equity without risking the loss of your home.
Is an HECM for you?
HECM’s are complex products. For that reason, you should only deal with reputable lenders and shun anyone who does not subscribe to all HUD-approved standards. One of those standards is that you receive counseling prior to entering into this kind of mortgage product. You can also ask the lender if they are members of the National Reverse Mortgage Lenders Association, which has strong ethical guidelines for its members.
In recent years, many predatory lenders have targeted unsuspecting seniors. Check out the credentials of the lender you choose before you delve into an HECM. A good place to start checking is at www.hud.gov – the website of the U.S. Department of Housing and Urban Development.
As more Americans live longer, the need for cash to support their lifestyles increases. If you have a fully paid or very low-debt home, one source of funds may be a reverse mortgage. Growing in popularity, this debt instrument, which is typically government insured, can provide you an extra measure of comfort in retirement, but you must enter into it in a careful way. If you think a reverse mortgage could be for you, give us a call. Let us help you evaluate your options before you put your home on the line.
Have a great March.