The reverse mortgage market was roiled over the summer. But there’s no reason for panic. Those who already have reverse mortgages won’t be affected, and those who want them in the future should have adequate options, perhaps more options than before. There are more changes on the way, however, and these will affect those who want the loans.
A reverse mortgage is a tool for someone who is over age 62 and has a lot of home equity he or she wants to tap. The loan can be taken as a lump sum, line of credit, or monthly payment. Monthly payments aren’t made on the loans. Instead, interest and fees accumulate, and the debt is paid from the sale proceeds after the borrower no longer uses the home as a principal residence. The homeowner is responsible for all repairs, maintenance, taxes, and insurance during the term of the mortgage.
Most reverse mortgages are insured by Federal Housing Administration.
The first big news was that two of the largest reverse mortgage lenders, Wells Fargo and Bank of America, withdrew from the business. They announced they would continue to service existing reverse mortgages but wouldn’t accept applications for new loans.
The banks gave different reasons for withdrawing from the market. But the real reasons probably are different from those they stated. The products are a tiny percentage of their businesses and growing slowly. The banks’ resources were better used elsewhere. Also, borrowers are starting to default on reverse mortgages, and the banks don’t want the reputation and headline risk of foreclosing on elderly borrowers who don’t own much other than their homes.
The largest reverse mortgage lender now is MetLife Bank. It says it likes the market and is planning to increase its share. In addition, there are a number of smaller lenders accepting reverse mortgage applications. In fact, the change could be good for borrowers. With the major banks no longer dominating the market, borrowers might be able to find better deals by shopping around.
There are other changes on the way for reverse mortgages.
In September the maximum loan that will be insured by the FHA is set to decline from $625,500 to $417,000, unless Congress acts.
Another change: The amount that can be borrowed is likely to fall a bit as new actuarial tables with longer life expectancies are introduced. The lenders determine the maximum amount that can be borrowed by considering several factors. The likely interest rate (most reverse mortgages are variable interest loans), the initial and annual expenses, and the home’s likely value at the end of the mortgage are key factors. The life expectancy of the borrower is also important. The home won’t be sold to pay the loan and the compounded interest and expenses until the homeowner passes away or moves out of the home. If the homeowner lives a long time, the home might be worth less than the amount due on the loan.
To reduce the probability of this, the lenders update their life expectancy data. The life expectancies are due to be increased in September.
Another likely change is increased use of credit reviews of applicants. Traditionally, lenders don’t worry about the cash flow of reverse mortgage borrowers because the home’s value backs the loan. Recently, the effects of the financial crisis caused some borrowers to have trouble paying their property taxes and insurance. Some analysts expect more borrowers to have these problems in the next few years. That’s probably why Bank of America and Wells Fargo exited the market.
The FHA also is concerned about the potential for such defaults. Soon there will be new regulations that require lenders of insured reverse mortgages to review an applicant’s ability to pay taxes and other bills in addition to the value of the home.
I’ve long advised that a reverse mortgage is a last resort. It is primarily by people who are least in their late seventies and don’t have other resources available. A reverse mortgage is a very expensive way to borrow. The upfront expenses can total 5% of the home’s value.
Many people probably are better off selling the home and downsizing, but a number of them don’t want to leave their homes. They should consider a reverse mortgage. You also shouldn’t seek a reverse mortgage unless it’s realistic that you’ll be able to stay in the home for a number of years, because the initial costs of the loan are high. There’s little advantage to taking out the loan if your health or other factors make it likely you’ll be leaving the home in a few years.
An exception is when you take a new type of loan called a Saver. Lenders reduce their fees by about 40%. In addition, the FHA reduces its mortgage insurance premium to 0.01%. On a standard loan 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 reverse mortgage.
Once you’ve decided to consider a reverse mortgage, shop around among as many lenders as you can find. Earlier in 2011 reverse mortgage lenders were waiving origination fees and monthly servicing fees. This is likely to continue as lenders seek to earn the business the big banks deserted.
You’re required to receive counseling from an approved counselor before being considered for a federally-guaranteed loan. Don’t leave the counseling session until you understand the loans, their costs, and how to analyze proposals from different lenders. Of course, be sure you’ll have enough income or savings to pay your insurance, taxes, and other expenses for an indefinite period.
RW September 2011.