Current Topics - Reverse Mortgage

Reverse Mortgages, YOU’VE COME A LONG WAY BABY (August 2019)

Past spokesmen/pitchmen for Reverse Mortgages were Jerry Orbach, Robert Wagner, Fred Thompson, Henry Winkler and Tom Selleck.  Well, reverse mortgages AINT WHAT THEY USED TO BE.

PAST

Reverse mortgages of the past encouraged borrowers to use the money for a last-ditch effort to manage a money crisis, use the funds for investing in the market, rather than using the loan as a long-term financial planning tool.  It was pitched as being risk free.  What the borrowers failed to understand is that they were still responsible for real estate taxes, homeowner’s insurance, and general upkeep of the premises.  As a result, defaults occurred. 

PRESENT

The new, improved, and regulated reverse mortgage is different in that changes have been made and safeguards put into place. A reverse mortgage also known as a Home Equity Conversion Mortgage (HECM) is a Federal Housing Administration insured loan available to homeowners who are 62 years or older that enables them to convert part of the equity in their home to cash, a line of credit or both.  It is a non-recourse loan that is insured by the (FHA). The FHA does not fund loans, these loans are issued by FHA approved lenders. The FHA acts like an insurance agency for banks that makes loans that conform to its standards. FHA Mortgage Insurance safely allows a lender to make a loan to a borrower without fear of incurring a loss due to a declining property value or a payout exceeding the value of the home. FHA also insures borrowers against bank or lender default. In the event of a bank default the FHA would continue to make payments to the HECM borrower. There is stability with this government backed loan, unlike a standard home equity line of credit (HELOC).  The money available on the line of credit to the homeowners on a HECM can never be closed out or shut down as we saw happen during the Financial Crisis of 2008 with HELOCs when home values fell. 

Another safeguard put into place is that ALL borrowers MUST obtain reverse mortgage counseling with a HUD certified housing counselor. The counselor will ascertain that the borrower(s) fully understand the parameters of the loan, such as costs, features and their responsibility, discuss possible financial alternatives, and make sure there are no cognitive issues. This is an out of pocket cost and is currently $125.00.  (2019)

These loan proceeds may be used for a variety of reasons such as but not limited  to cover basic monthly living expenses, fund life insurance and long term care insurance premiums, home improvements, financial planning and  health care costs  (though there is no restriction on how proceeds can be used). The amounts that can be borrowed are determined by a formula.  The amount that is available generally depends on four factors in determining the Principal Loan Limit:

1. The age of the youngest borrower

2. Expected interest rate

3 The lesser of the current Appraised value of the home and government-imposed lending limits or HUD 203b lending limit (Max Claim Amount -MCA), which is currently $726,525

4. Whether the amount borrowed is going to include monies set aside for property taxes and insurance for the “younger” life of the homeowner (referred to as a Life Expectancy Set Aside or LESA). 

There are “closing costs” for the loan, e.g., origination fees, mortgage insurance premium and title insurance

HOW PROCEEDS OF THE REVERSE MORTGAGE ARE RECEIVED

  • Lump sum – a lump sum of cash at closing. (only available for fixed-rate loans)
  • Tenure – equal monthly payments as long as the homeowner lives in the home.
  • Modified Tenure- borrower receives a lower fixed monthly payment and a line of credit for as long as they live in the home.
  • Term – equal monthly payments for a fixed period of time.
  • Modified Term- Borrower receives a fixed monthly payment for a fixed period or term and a line of credit for as long as they remain in the home.
  • Line of Credit – draw any amount at any time until the line of credit is exhausted.
  • Any combination of those listed above

QUALIFIYING SALE EVENT

The loan generally does not have to be repaid until the last borrower no longer occupies the home as their primary residence. A maturity event is an event that can result in the loan being recalled. Examples would be the borrower sells the home or conveys title to someone else, the last remaining borrower passes away, borrower resides outside of the residence for more than 12 months due to illness, fails to pay property taxes, homeowners insurance, condo fees, borrower fails to maintain home and allows it to fall into disrepair.

All remaining equity is inherited by the estate. The estate is not personally liable if the home sells for less than the balance of the reverse mortgage, since this is non-recourse loan. It is the MIP (Mortgage Insurance Premium that allows for this non-recourse feature. If the sale IS LESS, the lender (not the borrower) must take a loss and request reimbursement from the FHA. No other assets are affected by a reverse mortgage; no one can come after other assets like retirement funds, investments, second homes. With a forward mortgage or home equity loan, the lender can attach a lien to the estate. If the equity in the home is higher than the balance of the loan, the remaining equity belongs to the estate. If more is owed than the value of the house and the heirs wish to purchase it, they have the right to purchase it for 5% below the appraised value.

STRATEGIES FOR USING A REVERSE MORTGAGE

The Sell, Buy, & Buy Approach:

The HECM for Purchase allows each spouse to purchase a home using some or all of their share of the proceeds and move on. An example would be: A couple over 62 years old has a house with $500,000 equity. They sell it, split the proceeds and each purchase a house or condo (FHA approved condos only) and put down 40-60%  (based on their age and price of home) of the purchase price and will enjoy all the benefits of not having to make a mortgage payment for as long as they live in the home.

The Leave/Stay Approach:

The departing spouse receives a buyout from the spouse keeping the home with the proceeds of the reverse mortgage. Now one spouse remains in the home and the other can use the proceeds as either a down payment with a forward mortgage or purchase a home with a reverse mortgage.

As long as there is enough equity in the house, both options allow for each spouse to move on and be homeowners.

Reverse mortgages are commonly used for 3 reasons: need, lifestyle and financial planning.

  • Tax Bracketing: CPA’s can help manage a client’s adjusted gross income (AGI) by drawing a portion of their cash flow needs tax free with their HECM line of credit.
  • Capital Gains: Draw from housing wealth late in the year instead of selling off long term investments thus avoiding the capital gains.
  • Medicare Premium Surcharges: By keeping the AGI lower they may save the following year on their Medicare Surcharges
  • Delay Social Security benefits. At roughly age 66 a person can receive 100% of their monthly benefit. If a person waits until age 70, they will receive 132% of the monthly benefit.
  • Whatever a borrower uses in their line of credit interest and Mortgage Insurance Premium (MIP) are added on to what you owe, however, whatever is not used remains in the line of credit and it grows.
  • Many people take out a reverse mortgage and use the funds to purchase a home/condo by the beach or in another state or a ski house, etc. A place that allows the borrowers to vacation with their children and grandchildren.
  • The HECM line of credit is not in place to fund the investment but rather to protect the investment. This will help to protect the investment by drawing on the line of credit during bear markets and drawing from the investments during bull markets. 

This information is for educational purposes only, and is not a recommendation to utilize a reverse mortgage. LPL Financial representatives do not provide reverse mortgage services. All information is believed to be from reliable sources; however no representation is made as to its completeness or accuracy.