Verdict – Good or Bad for You?
On the surface, the HECM (home equity conversion mortgage or Reverse Mortgage) appears to be more attractive than it actually is, in my opinion. The lenders of these mortgages are pretty stingy with their money. For example, a male borrower aged 75 can gain access to only 61.4% of the home’s market value according to current tables. This means that a home valued at $500,000 would yield $307,000 in proceeds. Today’s 75-year-old male could very well live to age 95. If he stretched that money out evenly over those 20 years, the per-year payout is about $15,000 – not much in today’s economy.
But you should not make a final decision about whether it is good or bad for you based on the information in this short post. Fortunately, you are required to receive counseling from a Certified Reverse Mortgage Professional to start the application process. Hopefully, though, this may give you enough to decide if you should take that next step.
Do These Scenarios Sound Familiar?
- You would like to make a transition – downsize, upsize, move to a better neighborhood or active adult community or a more accessible home. However, you are waiting to get the right price so you can pay cash for the new home and avoid mortgage payments.
- A loved one is about to lose a home to foreclosure. His fixed income hasn’t kept up with the cost of living and mortgage payments are unaffordable.
- You can’t move from a declining neighborhood because the sale proceeds from the current home won’t be enough to buy in a better area.
- Your family is struggling to find a way for an elderly relative to stay safely in a long-time home. Her income isn’t enough to pay for in-home help.
- You would like to buy a second home, but don’t want the financial drain of mortgage payments.
If so, you might want to explore reverse mortgages. There have been so many TV commercials about this choice lately that it almost seems shady. However, I want to make you aware of the possibilities. I also want to guide you to the proper finance professionals so that you can make sure this is a sound and safe choice for you.
The Home Equity Conversion Mortgage
Reverse mortgages, or home equity conversion mortgages (HECM), convert home equity into cash. Like a forward mortgage, the borrower’s home secures the loan. They are called reverse mortgages because money paid in by the homeowners over the years plus value appreciation is paid back to the homeowners. You keep the title and continue to live in the home.
Reverse mortgages amortize negatively. The payments the borrower receives add to the balance owed at the end of the loan. Interest accrues at a fixed or adjustable rate. But the borrower will never owe more than the property is worth, nor can the lender seek access to other assets. The lender places a lien on the property. But if the borrower lives in and maintains the home, there is never any repayment obligation.
Events that trigger repayment include:
- a move to another home as the principal residence or permanent absence (12 months or more)
- a specified maturity date
- death of the last surviving homeowner
- sale of the property
- failure to pay taxes and insurance or make repairs
The borrower may pay off the loan through sale of the property or prepayment at any time without penalty.
The FHA is the Leading Provider of Reverse Mortgages
The FHA insures about 90 percent of reverse mortgages. It also sets standards and policies for the loans, collects data on trends, and monitors lenders. Responding to concerns about costs, FHA merged the application and paperwork for HECM sell-and-purchase into one transaction.
What Can a Reverse Mortgage Do?
A reverse mortgage can:
- Supplement Social Security, pension income or public aid benefits.
- Postpone drawing Social Security benefits thus increasing the monthly benefit.
- Provide an income the borrower cannot outlive.
- Stop mortgage payments.
- Prevent foreclosure.
- Pay for in-home care, medical expenses, and long-term care insurance.
- Prepare a home for aging in place.
- Pay off credit cards, debts, and existing mortgage balances.
- Buy a second home or a new home.
- Upsize, downsize, move to an active community, or move closer to the family.
Types of Reverse Mortgages
HECM for Refinance
The HECM for refinancing enhances the quality of life by increasing cash flow. The payout can be monthly, as needed, lump sum, or a combination of methods.
HECM for Purchase
The HECM for Purchase gives a lump sum for the purchase of a home.
HECM Line of Credit
A reverse mortgage line of credit allows the borrower to draw funds from the equity in the home as needed. The reverse mortgage line of credit maintains a growth rate that allows the borrower to tap into more equity without needing to refinance.
The amount gained through the growth rate is nontaxable income. If there is a mortgage balance on a property, however, the remaining mortgage balance must be paid off before the reverse mortgage takes effect.
Which is Best – Fixed or Adjustable Rate?
You need to consider whether to take a fixed or adjustable rate loan. You should compare the cost of the mortgage and availability of funds for a line of credit to a lump sum with a fixed rate as well as which will be the most cost-effective for achieving a specific goal. An HECM counselor can offer printouts, called TALCs, showing annual and total costs and payouts for all options.
The fixed-rate HECM offers a predictable interest rate and higher loan amounts. HECMs for Purchase (H4P) are loans that require the borrower to take the funds and pay interest on the entire amount. H4P loans are usually fixed rate but can be adjustable rate as well. Some borrowers may have the finances to take this choice and obtain a line of credit for their new home.
Depending on the state and program guidelines a lump sum payout could disqualify the borrower for public benefits, such as Medicaid. The borrower should consult their financial advisor, CPA, or elder law attorney before selecting this possibility. The interest rate of an adjustable-rate HECM will determine whether the total loan amount will offer more, the same, or less than a fixed-rate of the loan. HECM adjustable-rate loans can have various payout options such as a lump sum, monthly or annual withdrawal, or a combination thereof.
Total Annual Loan Cost (TALC)
The total annual loan cost (TALC) statement shows the complete loan cost over a period. Unlike an annual percentage rate (APR) disclosure, the TALC factors in time and value appreciation. The longer a borrower lives and the lower the appreciation rate, the more likely the balance will surpass the value of the home. This results in a bargain for the borrower. However, if appreciation is high and the borrower lives in the residence for a short time the true cost of the loan can be high.
You can ask the HECM counselor or lender for TALC rate comparisons for various stages of the loan, rates, and loan types. This request should precede the loan application. The comparison page, TALC, and amortization schedule are supplied again at application. Two limitations on the usefulness of a TALC are:
- It does not take into consideration the added value in a growing line of credit.
- The calculations are based on the life expectancy of one homeowner.
The Most Common Reverse Mortgage Alternative
You should compare a reverse mortgage to selling the home and using the proceeds to rent or buy a home. Factors to compare include:
- Quality of life
- Net sale proceeds
- Cost to buy or rent a new home or live in a congregate or assisted-living community
- Availability of alternative income-producing investments, potential earnings, and ability to manage the investment
- Availability of community-based support services and public benefits
Summary of Reverse Mortgage Benefits
Tapping built-up equity
The main benefit of a reverse mortgage is allowing a homeowner to tap the built-up equity in the home by receiving immediate cash, lifetime payments, or a line of credit.
Tenure payments give a monthly income that will continue even if the homeowner outlives the actuarial life-expectancy tables. Homeowners can live in the comfort and privacy of their own homes and with the security of stable income.
Neither the homeowner nor the heirs will ever owe more than the home is worth, even if the home value declines or payouts exceed the value. The lender cannot seek other assets to make up for a shortfall. If the homeowner or heirs try to sell the property in an arm’s length (not to a relative) sale and the proceeds fall short, the remaining mortgage balance is excused. Mortgage insurance compensates the lender for a shortfall.
The IRS does not consider money borrowed through a reverse mortgage taxable income.
When Is a Reverse Mortgage Not a Good Idea?
In general, if the potential borrower is planning to move in one year or less, it may not be advisable. The scenarios below offer examples of when it would not be in the best interest of the borrower to obtain a reverse mortgage.
Low equity or property value
When a homeowner does not have much equity in the property – less than 40 percent – or the property value is low. In this case, the amount available through an HECM will likely be insufficient to offset the costs. You need to figure out whether this option is the best course of action to meet your financial needs.
Substantial other assets
But using other large assets may involve fees, taxes, and penalties. It is often better to use the equity in the home than it is to spend down other assets.
Short-term, small financial needs, no compelling need
HECM costs outweigh the benefits if the borrower’s needs are short-term or modest. It is usually not the best choice for someone who will likely need nursing home care soon.
Obviously, the HECM is not meant for flipping properties. The costs associated with reverse mortgages are high. It is not “free” money. Don’t consider an HECM if you don’t have a compelling need to draw out the equity.
High-risk, low-return investments
This is not a good idea when the proceeds are intended for a high-risk investment or one with a lower rate of return than that paid on the line of credit. To achieve an advantage, the investment rate of return must exceed the growth rate on the line of credit.
Purchase an annuity
Using the loan proceeds to buy an annuity is generally not allowed. You need to gather information to decide whether either the HECM or an annuity is the best course of action to meet your financial needs.
Paying for nursing home care, buying into a continuing care community, buying new homes not ready for occupancy
Because of the residency requirement, a reverse mortgage cannot be used to buy into a CCRC or pay for a nursing home stay of more than 12 months. An exception is made when one spouse continues to live in the home. The payout from a reverse mortgage could, however, be used to pay for long-term care insurance. This could cover a future nursing home stay. Newly constructed homes are eligible if occupied within 60 days.
If you have used a reverse mortgage, your feedback about your experience with it would be appreciated.