Reverse mortgages – also known as Home Equity Conversion Mortgages (HECMs) – have had a bad rap for many years.
Every morning, Monique wakes up feeling overwhelmed by all the financial changes that have hit since Chuck died. Her CPA keeps talking about a coming Widow’s tax, something about her now being a single filer.
And how will she afford the house with just one Social Security check, even if the mortgage is paid off? Or pay his medical bills? Of course, she and Chuck had planned, but they got the timing all wrong. What’s Plan B?
But while the rap is usually justified when HECMs are used recklessly – as a panicked, last-ditch solution – it is unjustified when used carefully and intelligently.
In fact, reverse mortgages can be used to complement a retirement plan or to minimize the impact of an unexpected life event. They can create liquidity out of that illiquid asset – a house – as part of an effective Plan B retirement strategy.
What are reverse mortgages?
Reverse mortgages are a type of home loan available to homeowners age 62 and older. The HECM program is administered by HUD (the Housing and Urban Development Department) and insured by the FHA (Federal Housing Administration).
Reverse mortgages are also available through some state and local governments, nonprofit organizations and lenders offering proprietary plans, but none of those are federally insured and can expose a borrower to unpleasant surprises. We will focus here on HECMs from FHA-approved lenders.
Like a traditional mortgage, a reverse mortgage uses the home as security for the loan, but borrowers don’t make monthly mortgage payments. (They must, however, pay property taxes, homeowners’ insurance, HOA fees and maintenance.)
Each month, the loan balance increases as interest and fees are added. As the loan balance goes up, the equity in the home goes down.
Borrowed money + interest + fees each month = rising loan balance
The homeowners (or their heirs) will eventually have to pay back the loan, often by selling the home or by purchasing it for cash at 95 percent of its appraised value when the loan comes due. As a non-recourse loan, the borrower (or estate) is not responsible for any repayment shortfalls.
Initial costs that cover fees and insurances can be high – including lender and HECM origination fees, plus third-party fees for appraisals, title searches, inspections, and so forth – and no clearinghouses exist for comparing offers from different lenders. Finding the best option requires a bit of legwork.
How new regulations have affected reverse mortgages
The federal government is making efforts to put the HECM program on more sustainable footing because of its importance to the financial health of seniors.
Upfront mortgage insurance premiums (MIPs) have been dropped to a flat 2 percent of the value of loan proceeds withdrawn initially. Annual MIPs have been lowered to 0.5 percent of the outstanding loan balance each year, to make the total compounding rate more competitive with traditional mortgages and home equity loans.
Lenders have been forced to become more competitive by having the interest rate floor lowered from 5 to 3 percent. And borrowers now have to undergo a more stringent financial assessment to ensure that reverse mortgages are being used responsibly.
Reverse mortgages’ undeserved bad rap
Most of the negative stories you hear about reverse mortgages reflect poor communication, insufficient research or lack of understanding of the terms and conditions.
(Having that vital clarity is another reason for sticking with lenders who function under the guidelines of HUD and the FHA.)
Among the horror stories:
• Children who don’t inherit the house, as expected. For some reason, their parents did not share the fact of having taken out a reverse mortgage.
• One spouse having to leave the house upon the death of the other spouse. While that used to occur when the surviving spouse was not a co-borrower, a 2013 court ruling created protections as long as certain conditions are met.
• Seniors losing the house for lack of maintenance. Borrowers are responsible for protecting the asset that secures the loan, and lenders keep a watchful eye. However, some cities and non-profits offer programs that help low-income seniors with the upkeep of the home.
Looking at reverse mortgages with strategic eyes
Many financial experts have started viewing reverse mortgages differently. For example, they look at a paid-off house as an asset, similar to a retirement portfolio. They see taking money out of the house as no different from spending down a portfolio.
As part of a strategic plan, reverse mortgages can improve someone’s “retirement sustainability and build a larger legacy to leave their heirs,” according to Dr. Wade Pfau, a renowned author and expert in reverse mortgages. Used correctly, the liquidity released from an illiquid asset is one component of an income stream.
For example, accessing such funds can mean not taking Social Security early (at 62), thereby not losing the advantage of full retirement (at 66-67) or even late retirement (at 70).
And in rising markets, portfolios can be left untouched – and allowed to grow – while living expenses are covered by funds from a reverse mortgage.
Such funds can figure into:
• beneficial Roth IRA conversions;
• the payment of long-term care premiums;
• funding home renovations that allow for aging in place;
• and countless other retirement strategies.
Strategies even exist whereby fluctuating interest rates can grow the value of the principal of a line of credit.
The key is to be very clear on all the costs and rules. Details on HECMs are available at HUD’s website [link to https://www.hud.gov/program_offices/housing/sfh/hecm/hecmabou ] But, to be sure you integrate a reverse mortgage strategically into your retirement planning, consider reaching out to a financial advisor.