Benefiting from the New Reverse Mortgages

Reverse mortgages received several changes in the last six months or so. The changes make the mortgages more attractive in general and, unlike in the past, they can make some sense for relatively short-term cash needs.

In a reverse mortgage, the homeowner with little or no mortgage on his home receives a loan. The loan can be a lump sum of cash, a line of credit, or a stream of payments over time similar to an annuity. The loan isn’t paid until the homeowner is no longer using the house as a principal residence. The lender is paid from the sale proceeds. When the home sells for less than the loan balance, the lender loses money. When the home sells for more than the loan balance, the homeowner or his heirs receive the excess.

Most reverse mortgages are made under a federal program known as Home Equity Conversion Mortgage (HECM) under which the Federal Housing Administration insures the lender against losses. Under the standard HECM the FHA will insure mortgages only until to a certain amount (currently $625,500). If you want to borrow more and have a home valuable enough to support the loan, you use a lender who will make a private reverse mortgage without an FHA guarantee. To quality a borrower must be at least 62 years old, meet with a qualified counselor, and have paid off all or most of the previous mortgages on the home.

The main criticism of reverse mortgages is the level of fees and expenses. There usually is an origination fee charged by the lender, a mortgage insurance premium charged by the FHA, monthly servicing fees, and of course interest. There also are the usual appraisal, inspection, and title search fees. No payments are due from the borrower until the home is sold. All the fees can be rolled into the loan balance.

The amount you receive depends on your age, and the older you are the more you can borrow. The borrower estimates your life expectancy and lends enough so the principal plus interest and expenses won’t exceed a maximum percentage of the home’s value by the end of your life expectancy.

The recent changes came from both the FHA and private lenders.

Reverse mortgages are the few new mortgages that are attractive to investors in the securitized mortgage market. To generate more mortgages, lenders are reducing or waiving their origination fees and monthly service fees. This reduces the cost and increases the amount you can borrow. The savings can be substantial. Standard origination fees are 2% of the first $200,000 of a home’s value and 1% above that until a maximum fee of $6,000 is incurred. Total upfront fees on a reverse mortgage can total 5% of a home’s value.

In the other change, the FHA introduced a new type of HECM called the Saver. Under a Saver, lenders reduce their fees by about 40%. In addition, the FHA reduces its mortgage insurance premium to 0.01%. On a standard HECM the premium usually is 1.25% to 2.0% of the home’s value and is the largest upfront expense. The interest rate on a Saver is a fixed fee of 1.25% plus a variable fee, recently under 3%.

The trade off is the maximum loan under a Saver is less, typically 80% to 90% of the limit under a standard HECM.

My traditional advice is to consider a reverse mortgage as a last resort. Don’t use one before your late 70s, or you won’t borrow enough to justify the expenses. Borrow only for essentials, not to enhance your income by taking vacations or making gifts to the grandchildren. And don’t fall for scams in which you are urged to take out a reverse mortgage to buy an annuity or make another investment.

The new Saver can make a reverse mortgage attractive in a few other situations.

Let’s say you planned to sell your home soon and move to something smaller. Because of the current market, you can’t sell at a reasonable price. You don’t want to start using your investment portfolio for spending yet and believe your investments will earn more than the cost of a Saver. So, you take a Saver against your home and use the proceeds to pay living expenses. You hope that in a few years the local housing market will recover so you can sell the home at a good price, pay off the Saver, and maybe have some money left over.

This strategy can work because the Saver’s fees are less than for a standard HECM and probably are less than for a home equity line of credit.

These unconventional uses of Savers are for those who don’t plan to hold their homes for the long term. Savers right now generally have higher interest rates than traditional HECMs. For short-term loans of a few years it makes sense to pay the higher interest rate in return for the lower fees. But for longer-term loans, paying the lower interest rate will result in lower costs.

You can find more about reverse mortgages (including the latest on the Saver mortgage) and about reverse mortgage counselors at www.hud.gov.

RW February 2011.