Reverse Mortgages, Reconsidered

Once widely disparaged, these loans are getting a second look.

Too many baby boomers are retiring with insufficient savings. Some of these boomers are “house rich” and “cash poor,” and in response to their circumstances, they may decide to arrange reverse mortgages. That move could make funding their retirements a little easier.

Opinions about reverse mortgages are changing. Once saddled with an image problem, they are now seen as potentially useful instruments for producing additional retirement income. They are not without risk, however.

Decades ago, reverse mortgages were marketed to senior citizens who were down on their financial luck. Retirees in jeopardy of outliving their money could turn to lenders for what was widely viewed as a “loan of last resort” – a loan against their home equity. 

Does borrowing against the value of a home seem like a clever idea or not? It might be clever and useful for cash-strapped retirees. The average American household has about 75% of its net worth in real estate.1  

Not everyone is eligible for a reverse mortgage. Most of these loans are insured by the Federal Housing Administration (FHA), which imposes some rules. One, the couple or individual applying for the loan must be age 62 or older. Two, the home involved must have a certain level of equity. Three, the borrower(s) must have the means to pay property taxes and insurance. Four, the borrower(s) must pay a fee to attend a counseling session on reverse mortgages. In addition, you cannot have a reverse mortgage and be delinquent on any federal debt.1,2  

Reverse mortgages are not limited to single-family homes. Some manufactured homes and even condominiums in developments approved by the Department of Housing and Urban Development (HUD) may also qualify for them.2

The loan can be as large as $625,000. The limit varies per county, and three other factors can influence the loan amount – interest rates, the appraised value of the residence, and the age of the borrower(s). A retiree household can access the money in one of three ways – as a lump sum, as a monthly income stream, or as a line of credit, letting the money grow. Borrowers usually cannot acquire more than 60% of the loan value within the first year.1,3

Interest accrues during the life of a reverse mortgage, so the loan grows larger over time. A reverse mortgage is a non-recourse loan, though, meaning that the borrower never owes more than the home’s value. A reverse mortgage only needs to be repaid when the borrower dies, sells the home, or moves out of the home – provided the borrower maintains the home sufficiently and pays insurance premiums and property tax.1,3 

Reverse mortgages come with sizable risks. First off, a senior who arranges a reverse mortgage better be prepared to age in place. If a borrower needs to sell or move during the life of the loan, repayment is in the cards. If borrowers fail to keep up with property tax or insurance payments or let a home fall apart, the reverse mortgage could default and the house could be repossessed.3 

Another problem can occur for couples if one spouse dies or moves out of the home. If the other spouse was too young to be on the loan when it originated, the lender can hand that person a cruel choice – either repay the loan or face foreclosure. HUD put a policy in place in 2015 to let people in this situation stay in their homes so long as taxes and insurance are paid and the home remains their primary residence – but the loan still needs to be paid off.3

Reverse mortgages also come with large closing costs, thanks to their high origination fees and FHA mortgage insurance requirements. Borrowers may spend several thousand dollars more on these costs than they would with a conventional home loan – they pay 0.5% of the loan amount up front; then, 1.25% of the loan amount per year for FHA insurance.1,3 

Retirees who opt for a reverse mortgage should understand these loans thoroughly. A reverse mortgage may be a gateway to greater retirement income, but that income could possibly be generated through other means. Some households lower their expenses and free up more money for retirement by downsizing, for example. Fundamentally, a reverse mortgage is a lien against a home – and retirees and pre-retirees must recognize that fact if they arrange one. 

Securities and Advisory Services offered through Triad Advisors Member FINRA/SIPC.

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.        

Citations.

1 – cnbc.com/2016/11/01/putting-it-in-reverse-advisors-warm-to-reverse-mortgages.html [11/1/16]

2 – portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/hecm/hecmabou [4/5/17]

3 – consumerreports.org/personal-finance/reverse-mortgage-reforms/ [4/4/16]

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