Are Reverse Mortgages Safe for Seniors?
The question is complicated and the answer is even more complicated. In fact, reverse mortgages are complicated; they are likely the most complex financial transaction that you’ll enter into in your entire lifetime. While reverse mortgages can be a benefit for some homeowners, they are rarely beneficial to those individuals who are likely to enter a nursing home in the near future. But, perhaps the most important point about reverse mortgages is that you NEVER want to make a decision about them without getting third-party professional advice, even with new federal protections that went into effect in 2015. Read on to learn why:
Government insured reverse mortgages—formally known as Home Equity Conversion Mortgages (HECMs)—have been around since 1987. Congress created them with the aim of helping cash-strapped homeowners pay for critical everyday living expenses by drawing income from their home, usually their biggest asset. A reverse mortgage is a loan available to seniors over the age of 62 which allows them to convert equity in their home into cash. These loans were created to give seniors access to cash for expenses such as home improvements, unexpected medical costs, and in-home care by utilizing the accumulated equity in their homes. This type of loan is called a reverse mortgage because instead of the borrower making monthly payments to their lender as they would with a traditional mortgage, the lender makes payments to the borrower. Unlike a traditional home equity loan or second mortgage, a reverse mortgage does not have to be repaid until the borrower no longer occupies the home as their primary residence.But after the real estate bust deflated home values and the Great Recession hit, homeowners in shaky financial positions began falling behind on property tax and home insurance payments. Defaults rose by half, from 8 percent in 2010 to 12 percent in 2014. But over the past three years, new government regulations aimed at protecting older borrowers and shoring up the government-backed loan program have gone into effect.
For certain homeowners, with the new regulations in place, it may make sense to consider a reverse mortgage. It’s an unfortunate reality, he says, that many people haven’t saved enough for retirement. At the same time, a fast-growing number of the 76 million baby boomers, now 52 to 70 years old, are moving into the eligible age range for reverse mortgages, making them a prime audience for the loans. Some seniors are finding that they can put off taking Social Security longer by using a reverse mortgage to supplement income early in retirement. Delaying Social Security allows the benefit payment to grow, which would give you a higher lifetime guaranteed income stream that is adjusted for inflation. But even this financial strategy is highly complicated. In order to qualify for a reverse mortgage, you have to retain a significant amount of equity in your home, and demonstrate that you can pay the homeowner’s insurance and property taxes as well as manage basic upkeep. A reverse mortgage is NOT based upon your income or credit rating.
The large number of misleading claims about reverse mortgages is troubling. The U.S. Government Accountability Office recently found dozens of misleading marketing claims about reverse mortgages in materials distributed by several large lenders. They include:
Claim: You’ll have income for your lifetime. Truth: Income from a reverse mortgage stops if you sell your house or move.
Claim: You’ll never lose your home. Truth: You can lose your home if you can’t afford to pay taxes, insurance, or maintain the home.
Claim: You’ll never owe more than the value of your home. Truth: If your loan exceeds the value of your home, you or your heirs will have to make up the difference if the home isn’t sold when the loan is due. The loan payoff is the lesser of the loan balance of 95% of the home’s appraise value. So you may not need to sell the home.
Claim: A reverse mortgage is a government benefit rather than a loan. Some lenders even use government logos to convince you to buy. Truth: While there are some new government protections, a reverse mortgage is definitely a loan……and a costly one.
On August 9, 2013, President Obama signed into law the Reverse Mortgage Stabilization Act of 2013 (Pub. L. 113-29). This law gives the Federal government the authority to establish, rules necessary to improve the fiscal safety and soundness of the HECM program authorized by section 255 of the National Housing Act. Those new Federal protections rolled out starting in 2013 and continuing through last year were instituted not just to weed out selling to borrowers unsuited to the loans but also to reduce its own risk insuring them. As of April 27th, 2015, borrowers are legally obligated to undergo a form of financial assessment before they can get approved for a reverse mortgage. These newer reverse mortgage rules have been put into place to help reduce the amount of evictions or foreclosures by assuring that only qualified borrowers are approved.
But beyond the legally required assessment, we strongly urge that seniors considering reverse mortgages fill out a detailed questionnaire walking them through the loan’s possible consequences before filling out a mortgage application. The worksheet, designed with help from a neurology professor who studies decision-making in older adults, is mandatory in California and should be used by seniors in ALL states. If your assessment finds that you can’t afford to pay taxes or insurance on the loan, you will have the option of having those funds withheld from your lump payment, line of credit or monthly payout options.
If you choose to pursue a reverse mortgage, Here are some questions to consider before applying for a reverse mortgage:
1. Is there another, cheaper way for you to achieve your financial goal?
Before tapping into your home equity, see if you can find a way to lower your expenses. If you need extra money to cover living expenses, see if you qualify for a state or local program to lower your bills. You might also consider downsizing to a more affordable home. According to a calculator provided by the National Reverse Mortgage Lenders Association, the average reverse mortgage borrower can expect to pay $8,908 in fees and other closing costs on a $100,000 reverse mortgage.
In other words, a reverse mortgage is a rather expensive form of borrowing, and there might be cheaper alternatives. For example, a home equity line of credit can generally be obtained without any closing costs and just a small annual fee. According to the HELOC calculator on one lender’s website, a $100,000 HELOC on a $250,000 home can be obtained with a variable interest rate as low as 3.875%, with a low $75 annual fee and no closing costs. Plus, with a HELOC, you have the ability to borrow only the money you need. Keep in mind however, that unlike with a reverse mortgage, you’d be responsible for making loan payments. Alternative financial options for seniors may include, but not be limited to, less costly home equity lines of credit, property tax deferral programs, or governmental aid programs. With peer-to-peer lending or other contractual arrangements, you can use your home equity to secure loans from family members, friends, or would-be heirs.
2. Do you need to tap into your home equity now or should you save it for an emergency?
Home equity loans should be a last-resort option in your financial portfolio options. It is usually best to preserve your equity if you have other resources to meet financial needs. However, if you think you may need to access your equity, speak with a housing counselor and a trusted financial adviser now, rather than later. A financial plan will help you explore better options. For example, rather than take a reverse mortgage as a lump sum, you can access the equity in your home as a monthly payment. Alternatively, you could set up a reverse mortgage as a standby line of credit. That way the money is available if you have big unexpected expenses, such as a health emergency.
3. Are you on a fixed income with no other assets?
If you don’t have much income, a reverse mortgage might not be the best option for you. If you take out a reverse mortgage loan and then have trouble paying your property taxes and homeowner’s insurance, you could face foreclosure. Another option might be to downsize. If you sell your home and use money from the sale to buy a more affordable one, you could be more financially secure in the long run.
4. How long do you and your family plan to live in the home?
In most cases, a reverse mortgage makes more sense if you plan to live in your current home for a long time. Reverse mortgages can be an expensive way to borrow money if you don’t plan to stay in your home for many years. Here’s why: Most reverse mortgages require you to pay insurance premiums. The insurance is there in case your loan balance grows to be more than your home is worth. With insurance, you won’t have to pay the difference. But, if you only stay in your home for a short period of time, chances are you are paying for insurance you don’t need. If you only plan to stay in your home for a short period of time, the loan balance is less likely to grow to more than your home value. Reverse mortgages can also have high upfront costs. If you sell your house within a few years, you won’t have gotten as much benefit from those costs than if you stayed in your home for a longer time.
5. Are you intending to use the reverse mortgage to purchase a financial product?
If so….don’t do it. Due to the high cost and accelerating debt incurred by reverse mortgages, using home equity to finance investments is not suitable in most instances. The cost of the reverse mortgage loan will likely exceed any financial gain from any product purchased. If you feel the compulsion to gamble, go to your nearby casino. But don’t bet your house on any investment.
6. Consider the impact of reverse mortgages on your eligibility for government assistance
Reverse mortgages can affect your chance to get government assistance in the future. For example, income received from investments will count against individuals seeking government assistance. Converting your home equity into investments may create non-exempt asset statuses. Plus, if you go into a nursing home for an extended period of time, the reverse mortgage loan will become due, the home may be sold, and any proceeds from the sale of the home may make you ineligible for government benefits.If you are a Medi-Cal beneficiary, a reverse mortgage may stymie the ability to transfer the home, thus, resulting in Medi-Cal recovery.
7. How much will it cost you in fees to obtain a reverse mortgage?
Fees vary depending on the type of reverse mortgage that you choose. Fees and other charges can be high in some cases, so it is important to shop around for the best deal. First, the mortgage lender can charge an origination fee. With the HECM program, these fees are currently allowed to be up to 2% of the home value for homes worth $200,000 or less. For homes worth between $200,000 and $400,000, the maximum allowed origination fee is $4,000 plus 1% of the home’s value above $200,000. For homes worth more than $400,000, the maximum origination fee is $6,000. If this calculation leads to a fee below $2,500, the lender may charge up to $2,500.
A second source of upfront costs is the initial mortgage insurance premium paid to the government, which is based on the value of the home. This fee has changed over time. Since October 2013, it has been sitting at 0.5% of the home value (up to $625,500) if the borrower takes out less than 60% of the PLF in the first year, and 2.5% if taking out more than 60% of the PLF in the first year. For those staying under the 60% threshold, the initial mortgage insurance premium is $500 per $100,000 of home value, up to $3,128 for the $625,500 limit.
Finally, you have closing costs. These will be similar to closing costs experienced with any type of mortgage. These costs include the FHA-mandated counseling session, home appraisal costs, credit checks, and any costs related to titling. Then additional home repairs may be required as part of setting up the reverse mortgage. A 2011 AARP report estimated that typical closing costs fall into a range of $2,000 to $3,000. This range is also consistent with the numbers found on the calculator created by the National Reverse Mortgage Lenders Association. Then there are state and federal taxes on the income investments financed through home equity — these can add up. It’s important to have a plan for how you will pay for these higher taxes, along with property taxes and homeowner’s insurance. If you fall behind on either one, the lender could foreclose on your reverse mortgage and you could be forced to move.
8. Does your spouse or partner want to keep living in the house if you die?
You’ve got to discuss this question carefully with your partner. If you take out a reverse mortgage without your partner as a co-borrower, then your partner will have to move out or repay the loan if you die. If your partner is a co-borrower, both you and your partner will be able to keep living in the house after one of you dies.
Before you enter into a reverse mortgage, but sure to check out the resources at CANHR, so that you know all of your options.