With life expectancies increasing and quality of life improving, reverse mortgages are something to be considered for those who can benefit from its use, but only after thoroughly understanding the ramifications of becoming a borrower.
Advertising for Home Equity Conversion Mortgages (HECM), commonly referred to as reverse mortgage (RM) loans, seems to be prevalent on almost every TV show. The ads seem to especially target the 62-and-older age demographic. The reason is that 62 is the minimum eligibility age to participating in this plan, which is underwritten by the US Department of Housing and Urban Development (HUD). A homeowner can access a portion of the equity value in their primary residence (excluding co-ops) with an ongoing income stream from an RM lender. Use Your Home to Stay at Home is the official booklet that describes the “ins and outs” of the HECM program. It’s an excellent reference guide for anyone contemplating an RM.
Conventional vs. Reverse Mortgage
Unlike a conventional home loan, where monthly or bi-weekly payments are paid by the borrower to the lender, an RM borrower (recipient) receives payments from the RM lender. Though it appears simple, these loans can be confusing to many. Be aware there are costs involved to have the RM instituted and important considerations which must be thoroughly understood before entering into this loan agreement.
On April 27, the HECM program implemented financial assessment criteria regarding how a homeowner can qualify for a reverse mortgage. Borrowers are required to demonstrate their ability to pay their property taxes and home insurance premiums and lenders must review borrower credit histories, credit reports, and additional documentation for accuracy and to ensure clients can meet this obligation. However, provisions exist in which borrowers meet the requirements, but must still opt for a set-aside to ensure they will meet their responsibilities.
An RM income stream may consist of a line of credit (HECM Saver), lump sum, term, or tenure payments to the borrower and each is specific as to how proceeds are received. In addition, important factors are considered in determining the eligible loan amount, such as age of borrower, available equity in primary home, etc. For some recipients, this may be an important source of tax-free income to help make ends meet, fix up their home or make necessary physical modifications, or pay for healthcare and other expenses. In reality, borrowers can spend the proceeds any way they wish.
Unfortunately, past problems with some unscrupulous lenders who took advantage of borrowers caused HUD to institute strict guidelines that must be followed before any transactions occur. Borrowers must consult with an approved lender and attend an HECM counseling session to be considered for an RM.
Pros and Cons of a Reverse Mortgage
The borrower must reside in their primary residence, continue to pay property taxes, and maintain homeowner’s insurance, although no monthly repayments are required. Upon the death of the borrower, a non-borrowing spouse may continue to reside in the home, but they must be at least age 62 and continue to pay the property tax and insurance. Otherwise, the lender can attempt to recoup the loan by selling the home. Importantly, the loan principal and usually a higher interest rate will continue to accrue until the loan is paid off.
The loan repayment may be accomplished by heirs who want to retain the property or upon the sale of the property to satisfy the outstanding loan due. Any money received by the lender in excess of the loan due is dispersed to the borrower or their survivors, per the terms of an existing will or applicable state law. Importantly, if the RM loan exceeds the value of the home when sold, the heirs are not personally responsible to make up the shortfall.
Fees to obtain an RM can be greater than other loan types, but for those who truly have limited options, an RM may be an important financial lifeline. If you are thinking of leaving your home as part of your estate plan to your heirs, you may need to rethink this option before taking out an RM. Chances are the amount of available cash after the loan is satisfied may render this option illogical. However, to those who need it most, the availability of an income stream may trump the desire to leave that inheritance. One important consideration is that many loans forbid borrowers from leaving their home for more than a year, something that could happen if you end up in a long-term healthcare facility. By not residing in your home, your loan could come due and payable, in effect may causing you to lose your home.
Reverse Mortgage May Have Other Uses
RM is often viewed as a source of cash flow for those individuals who need additional money to make ends meet. However, some financial advisors consider RM a method to expand estate planning opportunities. Consider an individual who has no heirs or does not want to bequeath their home. Being mindful that there are costs associated with obtaining an RM, other uses for an RM may include: delaying the receipt of Social Security and retirement fund proceeds, having access to a line of credit which continues to grow until used, replacing cash flows if interest rates or stock market returns go down, and more. You should thoroughly review and vet your prospects of staying in the home while accessing the home equity to determine if an RM may be appropriate for your specific parameters, financial needs, and goals.
Financial planning is often performed in stages: debt accumulation, debt reduction and asset accumulation, late asset accumulation and protection, spending in retirement, and asset distribution, i.e., gifting. RM may offer an additional piece of the financial puzzle, depending on how proactive and successful an individual has been with investing.
Is a Reverse Mortgage Right for You?
With life expectancies increasing and quality of life improving, reverse mortgages are something to be considered for those who can benefit from its use, but only after thoroughly understanding the ramifications of becoming a borrower. The rules and regulations for obtaining and maintaining an RM are myriad, with assorted caveats the borrower needs to be aware of before entering into this loan. A Certified Financial Planner can help guide and assist you with answering compelling questions and offer fiduciary advice with other financial decisions. The key is to be informed, share your concerns with those you trust and determine if an RM is right for you after comparing other financing options.
H. William Wolfson, DC, MS, MPASSM, CFP is an independent financial consultant and advisor. Dr. Wolfson is a member of the Financial Planning Association (FPA). He retired after 27 years of practice and remains active volunteering his time to the continued education and success of colleagues. Dr. Wolfson may be contacted for consultation at firstname.lastname@example.org and view all his published articles at https://www.linkedin.com/pub/h-william-bill-wolfson/14/a55/226.