What is a Reverse Mortgage?
A reverse mortgage is a type of home loan that lets you convert a portion of the equity in your house into cash.
With regular mortgages, borrowers make monthly payments to pay down the debt. With reverse mortgages, lenders pay borrowers and the debt increases over time. The loan isn’t settled until the borrower sells their home, moves out or dies.
The loan is then repaid or the home is sold to pay off the debt.
Owners must pay the property taxes and insurance costs and keep the house in good condition when they agree to a reverse mortgage. If they don’t – and many have fallen into that trap – the lender can foreclose.
Most reverse mortgages are insured by the Federal Housing Administration under a program known as the Home Equity Conversion Mortgage, or HECM.
The first reverse mortgage was written 1961 when Deering Savings & Loan in Portland, Maine, designed one to help a widow stay in her home after her husband’s death.
The program really took off in 1988 when Congress passed a bill giving the FHA authority to insure the loans. Activity peaked in 2008 with 115,000 loans, then the Great Recession cut that annual number almost in half.
The past few years have seen a turnaround. Reverse mortgages still only account for 1% of the $11.5 trillion in U.S. mortgages. But the number of eligible applicants – people over 62 – is expected to go from 46 million now to 98 million in 2060, according to 2017 statistics from the Department of Health and Human Services.
Reverse Mortgage Facts
The booming senior population – and some advertising spots by actor Tom Selleck – are part of the reason reverse mortgages are popular again.
When Selleck talks, people listen. Lately, the star of “Blue Bloods” and “Magnum P.I.” has been talking about reverse mortgages.
Don’t worry, he says in a commercial. Reverse mortgages can be an answer to your financial prayers.
“It’s not another way for banks to get your house,” Selleck says. “And it’s also not too good to be true.”
That’s easy to say when you have an estimated worth of $45 million like Selleck, but thousands of Americans who aren’t TV stars have different ideas.
The industry is steeped in promises, controversy and cautionary tales. If you’re considering getting a reverse mortgage, the best way to ensure a happy story is to educate yourself.
Business is booming at places like American Advisor Group, or AAG. The company that Selleck endorses has seen its revenue triple from $63 million in 2012 to $216 million in 2016.
So yes, when Selleck talks, people reverse mortgage.
But should they?
Who is a good candidate for a reverse mortgage?
If you own your home and don’t have much savings or need an infusion of cash, a reverse mortgage has some advantages.
One-third of U.S. households have nothing saved for retirement and the average amount saved among the remaining two-thirds was $73,200. That might get you through a few years of retirement, but it’s not enough to last through a long retirement.
A reverse mortgage can ease the strain on your monthly budget. Since most senior citizens live on a fixed income, it can supplement Social Security and help handle the inevitable mounting medical expenses.
Who is not a good candidate for a reverse mortgage?
A reverse mortgage is a questionable proposition if you have sufficient income to pay your bills or are willing to sell your home to tap into the equity. If that’s the case, it may make more sense to just sell it and downsize your home.
If your expenses temporarily jump, it makes more sense to try to weather the storm than take on an expensive loan.
A reverse mortgage is also not a great idea if you want to leave your home to your heirs. They can still inherit the home, but they’d have to pay a mortgage debt that has been mounting instead of dwindling.
Who is a terrible candidate for a reverse mortgage?
Anyone who blindly believes what they hear advertised shouldn’t be anywhere near the discussions on reverse mortgages.
The industry has something of a flim-flam reputation, and not without reason. The Consumer Finance Protection Bureau (CFPB) fined three companies a total of $790,000 in 2016 for alleged false claims.
It said they told borrowers they wouldn’t have to make monthly payments or face foreclosure, and didn’t tell them about the risks of failing to pay property taxes.
It wasn’t the first time the industry did things that would get it arrested on “Blue Bloods.” AAG was kicked out of Massachusetts in 2008 for allegedly marketing its product as a government benefit.
In 2015, the CFPB fined AAG $400,000 after it determined old ads featuring Fred Thompson wrongfully claimed consumers couldn’t lose their homes. A lot of people have. Many others ended up losing money with a reverse mortgage.
Social Security benefits can begin at 62, but waiting until full retirement age of 65 or 66 (depending on your birthday) will increase the size of your monthly check.
Reverse mortgages are often promoted as “bridge” to get you from 62 to 65, but a 2016 CFPB study found that bridge can be pretty rickety.
In general, the costs and risks of getting a reverse mortgage are greater than the cumulative increase in Social Security payouts that homeowners get by waiting until full retirement age to claim benefits.
The CFPB report said the by the time the average homeowner turns 69, a reverse mortgage costs $2,300 more than the gain in Social Security benefits.
“A reverse mortgage loan can help some older homeowners meet financial needs, but can also jeopardize their retirement if not used carefully,” CFPB Director Richard Cordray said. “For consumers whose main asset is their home, taking out a reverse mortgage to delay Social Security claiming may risk their financial security because the cost of the loan will likely be more than the benefit they gain.”
If that weren’t worrisome enough, HUD reported that more than 18% of reverse mortgages taken out from 2009 to June 2016 are expected to default because of unpaid taxes and insurance. That compares with fewer than 3% of federally-insured traditional mortgage loans that are seriously delinquent.
Almost 90,000 reverse mortgages are at least 12 months behind in payment of taxes and insurance and are expected to be foreclosed in 2017. That’s more than double the number in 2016.
Apparently, somebody forgot to put that in Fred Thompson’s script.
How Do You Qualify for a Reverse Mortgage?
The main requirement is you must be 62 years old. If your spouse is not that old, he or she cannot be on the title.
The property must be your primary residence. You have to go through consumer counseling so the government will know you at least theoretically understand the obligations you’re getting into.
You must have a lot of equity in your home. The exact figure depends on the lender, but it is almost always higher than 50%.
Lenders might look at other factors that come into play when you get a traditional loan, like your credit score and debt-to-income ratio (DTI). But the DTI is not typically considered in the qualification.
Neither is your credit score if you are getting a HECM loan, though if you have any outstanding debts like federal student loans you will not be approved.
The Veterans Administration doesn’t offer reverse mortgages. But you can use the VA to get a traditional loan to pay off a reverse mortgage.
Reverse Mortgage Process: How Do You Get One?
The first thing to do is shop for a lender. Many large banks have stopped writing reverse mortgages, though they are still available at smaller banks and credit unions.
There are also plenty of on-line lenders like One Reverse Mortgage, Liberty Equity Solutions and Home Point Financial Corp.
All mortgages have costs, but reverse mortgages can be pricey compared to traditional mortgages. Between the interest rate, origination fees, mortgage insurance, appraisal fees, title insurance fees and other closing costs, the total could be as high as $40,000.
That would eat up much of the equity a borrower has in their home. And the origination fee is based on the home’s value, which is usually much larger than the loan amount.
So it pays to shop around for the best deal. Once you have chosen a lender, the property is appraised to determine its market value. Most reverse mortgages are processed within 30-60 days. Borrowers can receive 50% to 66% of the value of their equity depending on their age and interest rate, which is generally about 5%.
Once the loan is approved, borrowers have four disbursement options – lump sum, monthly payments, credit line or a combination of the three.
What Happens When the Loan is due?
Usually, you call the coroner because the homeowner has died. The mortgage also comes due if the homeowner moves or sells the property, fails to pay taxes and insurance or doesn’t make needed repairs.
If you live in a reverse-mortgage home in Buffalo and decide to retire to Florida, you’ll have to sell the property. If it’s worth more than what it owed, you get to keep the difference.
That’s an iffy proposition given how the debt increases. That’s where the HECM’s mortgage insurance comes into play.
Reverse mortgages are known as “non-recourse” loans. That means you or your survivors will never owe more than what the home is worth. If that’s not worth enough to cover the balance of your loan, mortgage insurance pays the difference.
That has cost the government billions of dollars over the years, so the Trump administration tightened lending rules in 2017. Which brings us to…
Pros and Cons of Reverse Mortgages
They are a steady stream of income that lasts for years. You can convert the equity in your home into a pile of cash without having to move out.
The money is tax free. Rather than income earned, a reverse mortgage is considered a loan so the IRS can’t get its sticky fingers on it. And a reverse mortgage will not affect your Social Security or Medicare payments.
As for the cons, failing to keep up with the monthly fees has cost a lot of people their homes. Of course, if they didn’t pay those bills they’d also face foreclosure with a traditional loan.
The difference is that with traditional loan, the debt decreases every month. Since there are no mortgage payments with a reverse mortgage, the loan balance increases every month.
Between the interest and other costs, the debt may eventually exceed the home’s market value. If you want your children to inherit the house, they could be stuck with a steep bill.
The good news is you or your estate will never have to pay a lender more than the market value of the house. The bad news is Uncle Sam got tired of paying the difference.
Since 2009, reverse-mortgage losses have cost the Federal Housing Administration reserve fund $12 billion. That’s the same fund that insures low-income newcomers to the housing market.
Essentially, reverse mortgages were redistributing wealth from the poor to the predominately middle class. Beginning in October 2017, new rules require prospective borrowers to make much higher upfront payments and significantly lowered the amount that can be borrowed.
“Fairness dictates that future HECM loans do not adversely impact the overall health of FHA’s insurance fund, which supports the financing needs of younger, mostly first-time homeowners with traditional FHA mortgages,’’ HUD Secretary Ben Carson said. “We’re taking needed and prudent steps to put the HECM program on a more sustainable footing.”
The average reverse mortgage borrower drew 64% of their equity under the old rules. That will drop to 58%, according to the Wall Street Journal.
All that makes reverse mortgages less attractive, but the offers will keep coming.
Is a Reverse Mortgage a Good Idea?
For some people, yes. They have asked pertinent questions like:
Do I want to maximize what I can leave to my heirs?
Am I going to live in my home deep into my retirement?
How much extra income will I need to meet my needs?
Can I pay the taxes, insurance and meet all the obligations that come with a reverse mortgage?
Unlike all those people who’ve been foreclosed on, do I really know what I’m getting into?
If the answers to those questions are sketchy, you should consider a safer financial route like a traditional home equity loan or line of credit.
Whatever the decision, seek personalized advice from a financial counselor or debt-management agency.
Tom Selleck might say reverse mortgages are not too good to be true. But Magnum P.I. showed that it always pays to investigate.