Reverse Mortgage Update: Pros and Cons

By 2030, one in five Americans will be 65 or older. Among today’s retirees, 87 percent say they want to stay in their current home and community as they age. It’s easy to imagine those numbers will increase by 2030. Soon, nearly every retiree in America will want to live out their elder years at home – but will that be possible?

Whether you stay in your own home or not, the Center for Retirement Research at Boston College estimates that more than half of new retirees may be unable to maintain their pre-retirement standard of living. But for those who own their homes outright, or at least nearly so, there is a way that can help.

The Department of Housing and Urban Development offers a U.S.-insured Home Equity Conversion Mortgage (HECM) program to homeowners age 62 and older. This program provides money to seniors via a reverse mortgage, enabling them to convert their home equity into cash while they remain in their homes.

What makes HECM reverse mortgages unique among all those too-great-to-be-true deals you hear about is that, by law, this program protects homeowners against abuses found in contract disclosures that take advantage of participants, as well as investors who fund HECM reverse mortgages.

In addition, every borrower must be counseled by an independent expert before submitting an application to a lender – so the homeowner has the opportunity, if not the obligation, to ask every question imaginable to understand how the mortgage will work in his or her particular situation. Note, however, that HUD rules prevent counselors from advising borrowers about specific product features such as draw options and the relative competitiveness of each lender’s price. And, unfortunately, one of the things that hampers this industry is that there is no widely available data to compare lender pricing.

Here’s an overview of ways a senior homeowner can take advantage of the HECM program:

• If seniors who retire still have a mortgage balance on their home, they can convert the mortgage into an HECM reverse mortgage to eliminate payments altogether.
• Upon closing on the reverse mortgage, the homeowner can opt to take out cash at a fixed rate or withdraw a larger amount over a year with an adjustable rate.
• Seniors can supplement their income by drawing a “tenure” monthly payment that lasts as long as they reside in their house.
• Seniors can draw a “term” monthly payment for a specified period from a HECM reverse mortgage to supplement their income for a limited period, such as to delay Social Security to maximize its benefit.
• Seniors can use their current home equity to establish an HECM-based line of credit as a backstop for their asset-based retirement income, which is subject to market conditions or could even be exhausted because they outlive the income.
• Seniors can draw upon their HECM credit line to stabilize their income when other income sources drop, then pay it back when other those other sources rebound.
• Seniors can even use the proceeds of an HECM reverse mortgage to partially fund the purchase of another house by liquidating the asset that they already own.

Drawbacks

Be aware that if HECM borrowers don’t pay their property taxes or homeowners insurance, or don’t keep up the maintenance, their property can be foreclosed just as if it were a standard mortgage.

However, the difference between a foreclosed HECM versus standard mortgage is that the borrower does not have to make monthly payments; the home is subject to foreclosure only if they do not pay the taxes and insurance. Otherwise, the home is theirs until they die or move out of the house permanently.

The HECM offers a variety of different cash options, including upfront cash, monthly payments, a credit line, or some combination thereof. The amount available will depend on the homeowner’s age, the appraised value of their home, and prices charged by the lender.

Typical Loan Expenses

According to the U.S. Department of Housing and Urban Development, the typical reverse mortgage loan origination fee is 2 percent of the first $200,000 of the home’s value and 1 percent of the remaining balance, for a total cap of $6,000.

Borrowers are expected to pay an initial mortgage insurance premium, which is generally 2.5 percent of the home’s value, plus an additional $1,000 or more for a variety of expenses such as appraisal fees and title insurance. Going forward, the borrower may have to pay interest charges and ongoing mortgage insurance premiums.

If the upfront costs are too much of a burden or if the homeowner wishes to keep the property within the family, another option is for one or more adult children of the owner to finance a private reverse mortgage. In this scenario, the loan is secured by a deed of trust and payout options can be worked out between the owner and lender.

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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