Changing World of Reverse Mortgages

There have been big changes in reverse mortgages in the last year. Unlike many areas of real estate and home financing, there is some good news. If you are an older homeowner looking for a steady source of income or a lump sum of cash, consider a reverse mortgage. But beware of the potential pitfalls before making this move.

There are two broad types of reverse mortgages. There are those insured by the Federal Housing Administration and those that are not. Statistics are not readily available for the noninsured reverse mortgages, but there has been steady growth in the number of insured reverse mortgages. Over 115,000 insured reverse mortgages were closed in 2008, and the number has continued to grow into 2009. Only 43,131 loans were closed in 2005.

Reverse mortgages are simple in concept. A homeowner receives a lump sum, regular payments, or a line of credit. This is a loan secured by the home and does not have to be repaid until the homeowner either dies or sells the house. The lender is repaid from the proceeds of selling the home. If sale proceeds exceed what is due on the loan, the excess goes to the homeowner or beneficiaries designated by the homeowner. If the sale price is less than the amount due, the lender suffers a loss or, with an insured mortgage, the FHA does.

There were two big pieces of good news from FHA and Congress.

First, there now is one national limit on the value of FHA-insured reverse mortgages of $417,000. Previously, limits were imposed regionally based on median home values in an area and were adjusted annually. The top limit was $362,790.

The FHA also reduced the maximum fees lenders can impose on insured loans. Origination fees are limited to 2% of the initial $200,000 of the lending limit and 1% on any additional balance. In any case there is a maximum origination fee of $6,000.

Not all the news is good. There was a booming supply of non-insured reverse mortgages. The non-insured loans tended to carry lower fees than insured loans. Several of the firms fueling that growth have disappeared, including Countrywide Financial and IndyMac. The reduction in this market means homeowners have fewer options when they want loans above the FHA limit. The good news from this change is at least some of the non-insured loans were generated by high pressure sales tactics that put people into inappropriate loans. That source of pressure is gone.

A homeowner must spend time with an FHA-approved counselor before taking out an insured reverse mortgage, and there are good reasons for that.

Reverse mortgages are expensive, more expensive than traditional mortgages. Total fees, in addition to the origination fee mentioned above, can be $15,000 and more (ranging from 2% to 7% of the home’s value). There also are interest charges on the loan. The loans are expensive because lenders likely won’t receive any cash for years, and lenders are taking a risk on Life Expectancy. They lose money (or the FHA loses money on insured loans) when the homeowner lives beyond the life expectancy.

The fees can be paid from the loan amount, at the borrower’s option. That saves the homeowner cash now. The disadvantage is the fees become part of the loan, and interest also is charged on that amount.

The amount of home equity you can borrow is limited. The interest on the unpaid loan accumulates over your lifetime. The lender estimates what the principal, interest, and fees will compound to over your life expectancy. Profit is factored in. Adding all that means you can borrow much less than your home equity. The older you are, the greater the percentage of your equity that can be borrowed.

The interest rate usually is variable, but some loans now offer fixed rates. The interest compounds as long as the loan is outstanding. Since the loan is not repaid until the owner leaves the home, the lender does not know how long that will be.
During the loan period, the borrower is owner of the home and is responsible for maintenance, taxes, and insurance.

There are several traditional uses of reverse mortgages (also called home equity conversion mortgages or loans).

Someone on a fixed income might have seen inflation push his or her cost of living above current income. That person can take a lump sum as a reverse mortgage and invest it. Withdrawals from that account make up the difference between other income and living expenses.

A retired homeowner might have sufficient income to pay for regular living expenses but might need cash for major expenses. The expenses might be home maintenance and repairs, or there might be uninsured medical expenses. Perhaps a major item, such as a car, needs to be replaced. Any of these expenses can be paid for with a reverse mortgage without touching the nest egg or current income.

An older person with different types of debts might consolidate and pay them off with a reverse mortgage. That frees up income to pay for living expenses instead of debts.

In recent years, there apparently have been new uses of reverse mortgages. The loans were taken at younger ages to pay for vacations, buy televisions or other furnishings, buy nicer cars, or even make gifts to children or grandchildren. Wealthier homeowners were using the loans to help purchase second homes or even make investments. In some cases, lenders that also sold financial products convinced people to take out reverse mortgages to buy life insurance, annuities, and other products.

Some people plan to use a reverse mortgage line of credit as a substitute for long-term care insurance. That is one way to pay for long-term care if it is needed, but keep in mind that reverse mortgages are expensive and much less than 100% of your equity will be available to pay for long-term care this way.

These newer uses apparently were encouraged by loan brokers trying to generate more loans.

I long have recommended that reverse mortgages be considered one of the last resorts for cash. The loans are expensive, and you will be able to borrow a fraction of home equity. The older you are the more you can borrow. The younger you are, the more of your equity that will go to fees and interest.

Traditionally, the typical reverse mortgage borrower was a woman in her late seventies. That is changing. The average age of a reverse mortgage borrower has dropped to 73 years from 76 years in 2000. That could be a sign of economic distress or it could be people are using the loans in some of those new ways.

Do not take a reverse mortgages unless you likely will be in the home for several years at least. The fees are high and not worth paying for only a short time. It would be cheaper to sell your home a few years early or try another source of cash.

Fees might be lower on a lump sum loan than on an annuity or line of credit loan, and they might be a lower percentage of the home’s value on more expensive homes. As on other types of loans, lenders often will trade lower expenses for a higher interest rate.

As with any financial product, you should shop around. There generally are trade offs between fees, interest rates, and the maximum loan amount. Insured loans, for example, tend to have higher fees and lower interest rates than non-insured loans.

Comparing the trade offs in the available products can be tough. Don’t count on the FHA-approved counselor for strong guidance. The counselors do not give advice. Their only role is to be sure you understand the mortgage, especially the types of fees. Most counseling sessions last one hour or less. More information is available from the Department of Housing and Urban Development at www.hud.gov.

RW August 2009.