“Home Equity Conversion Mortgages (HECM), or reverse mortgages, which are designed, administered and insured by the Federal Housing Administration (FHA), are one of the best engineered financial tools of our generation.”
-Jack Guttentag, Wharton Professor and nationally syndicated mortgage columnist
What is a reverse mortgage? In a nutshell, it is a mortgage where, instead of making payments, home equity is converted into payments TO the homeowner. Payments can occur in lump sums, monthly payments, lines of credit, or a combination of the above.
Reverse Mortgages, also known as HECM’s or Home Equity Conversion Mortgages, have been the topic of much controversy and bad press, in spite of the many they have helped. Unfortunately, as with sub-prime loans, there have been overzealous loan officers willing to push loans that weren’t always fully understood.
Are reverse mortgages risky? Not in the ways you might have been led to believe. In this post, we aim to set the record straight about the myths and realities of HECM’s, and direct you to further resources where you can find reliable information.
Myth: Seniors are losing their homes because of reverse mortgages. Your house will be foreclosed on you if you “use all your equity.”
Fact: The only reason a home with a reverse mortgage on it can be foreclosed on are if the owner fails to pay their property taxes (required by cities and counties) and homeowner’s insurance, which protects the integrity of the asset, or allows it to fall into severe disrepair. The only rare but notable exception to this is when both spouses are NOT on the mortgage; it is essential for both to be on the mortgage if the surviving spouse wishes to stay in the home.
Reverse mortgages have SAVED many seniors from foreclosure, and allow many to stay in their homes for years, even decades beyond what they could previously afford. They can stay there as long as they live, with no more responsibility of making payments – EVER. Regardless of the home’s equity (or lack thereof), the senior is PROTECTED against foreclosure as long as they live in the home, maintain it, and pay their taxes and insurance (basic requirements for all mortgages.)
Myth: The lender can come after heirs for shortages in equity if the home is no longer worth what the homeowner has borrowed against it.
Fact: Reverse mortgages are non-recourse loans, and the lenders cannot seek any remedy other than selling the home to pay for loans against the home equity.
Myth: You lose control of what you can do with the property. Now the lender owns it and controls it.
Fact: The homeowner always retains the ability to live in the home or sell it. (They cannot, however, use it as an investment or rental home.) After the homeowner passes away or moves elsewhere, then the homeowner (or heirs) can decide to either pay for the accrued costs of the mortgage and keep the home, or have the home sold. In the latter case, any equity left in the home after paying the mortgage balance goes to the homeowner or heirs.
Myth: Your home must be free and clear for you to take advantage of a reverse mortgage.
Fact: The only qualifications for a reverse mortgage are ownership of a home with at least 50% equity, living in that home, and being at least 62 years of age. Currently there are no income, credit, or medical requirements.
Myth: The fees and mortgage insurance are unreasonably high, and are simply another example of how seniors are often taken advantage of.
Fact: The fees and PMI are higher than many mortgages, and for legitimate but often misunderstood reasons. In a reverse mortgage, all of the risk and most of the responsibility is on the lender, unlike a standard mortgage, where the homeowner takes the risk of the market going up or down. The lender also takes a risk of not knowing how long the homeowner will live or stay in the home.
For these reasons, lenders charge higher fees than on typical mortgages. For instance, the homeowner pays mortgage insurance in addition to the closing costs and interest typical for any loan. First-time homebuyer FHA loans, 203k rehab loans and VA loans are other examples of higher-risk loans that also require mortgage insurance.
Combine these myths with the following faulty assumptions, and you’ll see why reverse mortgages are so misunderstood and controversial.
Faulty assumption #1: “Seniors should just get HELOC’s (a home equity line of credit) or refinance if they need extra cash.”
While this may make perfect sense in situations where the homeowner has credit and income to qualify for a traditional loan or line of credit, the fact remains that many don’t. And even if they do, what happens down the line if they cannot maintain payments for the mortgage or line of credit? Or what if they wish to stay in their home, long-term, and they cannot do so without the extra cash flow that a reverse mortgage provides?
Yes, those options do have lower fees. They also require payments to be made. Yet even major media such as CNN.Money.com perpetuate nonsensical statements that suggest seniors “can’t afford” reverse mortgages… with no payments required… a mortgage that puts money IN their pocket instead of taking it out. (Hmm… what’s to “afford”?)
While traditional mortgages and lines of credit may make perfect sense in some situations, they can also increase chances for a future foreclosure by requiring new payments. They can even prevent a senior from acquiring a reverse mortgage later, when they need it most, if a traditional mortgage or HELOC leaves them with too little equity for a reverse mortgage.
Faulty assumption #2: “Seniors who cannot afford their homes should sell their homes and rent.”
True, if a homeowner is in the process of transitioning into assisted living, a short-term reverse mortgage (1-3 years) may make no sense at all. Of course, renting anywhere requires an ongoing outlay of cash, which will increase with inflation. And if you’ve checked prices for assisted living lately (most run between $3000 and $5000 a month or more, depending on level of care and location), you’ll recognize that there can be a financial as well as an emotional benefit to staying in a house as long as possible.
Faulty assumption #3: “Reverse mortgages are only for broke or desperate senior citizens who cannot make their mortgage payments.”
Don’t be led astray by of our examples above. While the reverse mortgage can be a great way to get or keep a senior out of a cash-flow crunch, they are also being used by many well-off homeowners as part of sophisticated strategies to spend some assets down while preserving others and lowering taxes. We discuss some of these strategies in our last post http://partners4prosperity.com/too-old-for-life-insurance and also in a recent interview with Tom Dyson of the Palm Beach Wealth Builder’s Club. http://files.csinvesting.com/files/IFL%20Webinars/iflwebinar29.html
We find HECM’s can be a powerful combination with permanent life insurance, especially if there is a concern to leave assets to surviving spouses or heirs. We also believe that the recent trend towards taking lump sums at 62 is a troublesome trend not likely to lead to sustainable wealth. (A reverse mortgage can only do so much to remedy a lack of assets.) Often we advise that clients to wait until their later years to get a reverse mortgage and to opt for payments instead of lump sums, as this will maximize their equity and provide a greater ongoing stream of income. Tax-wise, it also makes sense to use other assets first in many cases.
As Guttentag says in “What’s Right with Reverse Mortgages,”
While there is nothing wrong with using a HECM to meet immediate financial needs, there is something wrong with the very low utilization among seniors who aren’t desperate but who could enrich their lives and don’t. There are about 25 million homeowners 62 or older, and at least 10 million of them could significantly improve their lives by taking out a HECM.
Is a reverse mortgage is right for you?
No major financial decision should be rushed into. We recommend the following steps to make an informed decision:
Get the facts. Don’t make decisions based on hearsay or out-dated information. Some good sources are:
The HUD.gov website “Frequently Asked Questions about Reverse Mortgages”
The Frequently Asked Questions page of the National Reverse Mortgage Lenders Association website
A Wall Street Journal article about the 2013 revisions to the reverse mortgage program: “Reverse Mortgage Redo.”
You can also attend a HUD counseling session about reverse mortgages. (This is required to obtain an HECM, but in no way obligates you to get one.)
Discuss the facts with your family. Seniors who feel a pinch or fear “running out of money” (most do) may feel ashamed to discuss their finances with their children. But only through open communication can families avoid “if only I had known” regrets. Maybe Grandma thinks her kids will want to inherit her house, when in reality they would rather not deal with an asset that must be liquidated. Perhaps Grandpa’s memory is starting to fail, and he needs assistance in paying bills or maintaining the home. (And perhaps it’s time to sell the family house….)
Homeowners should seek advice from a financial advisor operating under the fiduciary responsibility platform This advisor should not simply be a stockbroker, insurance agent, or a “representative” of financial products pushed by a company. (i.e., they should be a bona fide financial advisor who can advise about a range of options, not a salesperson for one particular kind of product.) The advisor should be licensed to give advice for a fee (whether they actually charge or not) and be knowledgeable about reverse mortgage risks and benefits.
A reverse mortgage can be a dynamic part of a prosperous financial strategy. Unfortunately, opportunists do exist who will attempt to sell a senior something they may not need or isn’t in their best interest, using high-pressure sales tactics. If your loan officer is bundling a reverse mortgage with long-term care or an annuity, or suggesting leaving off a spouse to get more money, get qualified financial advice and find a different loan officer.
Could a Reverse Mortgage help you “stretch” your other assets or lower your taxes? We’ve helped many of our clients formulate financial strategies that keep them in control of their cash as well as their “castles”! Contact us to discuss your situation.
We also recommend Kim D. H. Butler’s Live Your Life Insurance book for a discussion about how permanent insurance can be used as a “permission slip” to spend other assets in retirement, including the equity in a home.
Note: Partners4Prosperity does not sell reverse mortgages nor profit from our clients obtaining reverse mortgages. We just wanted to set the record straight on this financial tool. If you have an opinion on this article or experience with reverse mortgages, we encourage you to share it below.