Reverse Mortgages Guide
They’re everywhere these days, as a host of lenders try to convince seniors to turn the equity in their homes into cash, while staying in their residences for the duration. It’s an appealing proposition, but complaints over high fees, the skittishness of the foreclosure-scarred housing market and an exodus from the market by a few of the bigger names in the business have many would-be customers questioning those late-night pitchmen.
Reverse mortgages have certainly earned a mixed reputation over the past few years, so it makes sense to familiarize yourself with the latest information before deciding whether one would be beneficial, detrimental, or simply not worth the effort considering your specific financial situation.
What is a reverse mortgage and how does one work?
A reverse mortgage is that rare product whose name describes it perfectly. In other words, while you pay down a mortgage over time, gaining more and more ownership (equity) in your home in the process, a reverse mortgage flips things by paying you cash for the right to a corresponding ownership stake in your home, which serves as collateral to ensure repayment.
That’s obviously just a general definition, and you’ll need more information in order to truly understand reverse mortgages. First, the basics: you must be at least 62 to qualify for a reverse mortgage; the older you are, and the more equity you have in your home, the more cash you can get. The dominant form of reverse mortgages these days is the Home Equity Conversion Mortgage (HECM), a product administered by the U.S. Department of Housing and Urban Development (HUD). The limit for such a loan increased to the current level of $625,500 in 2009, so it’s clear that borrowers are able to garner a substantial amount of money through the program.
The funds lent via a reverse mortgage can be paid out in one of three ways: through recurring monthly payments, in a lump sum, or as a line of credit that can be accessed at any time. Just like on any loan, interest builds on the loan over the years. However, unlike a traditional mortgage, a reverse mortgage is only repaid when the reverse mortgage holder sells the house, leaves the home for more than a year (for any reason, including medically necessary procedures), or passes away.
Other than age, one of the few requirements to take out a reverse mortgage is that you must have a certain amount of equity in your home; in many cases the lender will require you to agree to payoff your original loan with the reverse mortgage funds. This option can have a big impact on a senior’s budget, instead of having to make a monthly mortgage payment, suddenly they have paid off their old loan and now feel more secure in their homes.
Reverse Mortgage Data and Trends
As you can see based on the graph below, reverse mortgages spiked in the years close to the 2008 financial crisis:
Number of HECM Reverse Mortgages, 1990 - 2012
The decrease over the last few years has been especially surprising as the interest rate for the average reverse mortgage has fallen (see graph 2). It is likely due to the exit of three of the reverse mortgage industry’s titans from the market: Bank of America, Wells Fargo, and Financial Freedom. Each of these companies got out of the reverse mortgage market in the wake of the foreclosure epidemic amid a wave of litigation.
Expected Interest Rates on HECM Reverse Mortgages, 1990 - 2012
Are reverse mortgages a good idea?
A reverse mortgage can be a good idea if:
- You need more income in retirement
- Used as an alternative to a HELOC
- Protecting other retirement investments
For more information about when a reverse mortgage is and is not a good idea, check out this post from our Q&A section.
Problems with reverse mortgages?
The most consistent complaint about reverse mortgages is their cost, which include origination fees (the cost of initiating the loan) of up to $6,000, as well as fees of up to 2% of the home’s first $200,000 in value, plus 1% on any remaining value. When you factor in service fees, insurance premiums and closing costs, a reverse mortgage can be one expensive proposition.
The complexity of reverse mortgages is another common complaint. Being a relatively new product, reverse mortgages are not well understood by the public. The prospect of keeping your home and getting money to help pay the bills might sound perfect to a senior in a desperate financial position, but people often don’t understand just how much they will eventually have to be payback.
Worse though than complexity or price, is foreclosure. For years there was a perception that reverse mortgages would not be taken into foreclosure (and for a time that was even true). But not anymore. Reverse mortgages are regularly taken into foreclosure these days, and it is happening at an increasing rate.
Is there a tax deduction for reverse mortgage interest?
Yes, but it’s very complicated. Unlike mortgage interest, which you can deduct every year, you’re only allowed to deduct interest from a reverse mortgage the year the loan gets repaid. The situation is further complicated by estate taxes and other inheritance rules. More detailed information about reverse mortgages can be found here.
Who does reverse mortgages?
More and more major banking institutions like Bank of America, CitiBank, and Wells Fargo have left the reverse mortgage market. Many of these exits followed the public backlash against reverse mortgage foreclosures, as major banks wanted to avoid the image of running financially ruined seniors out of their homes. As a result if you’re looking for a reverse mortgage, your best bet is to look for a mortgage broker in your area, who can locate lenders for you. Mortgage companies or smaller banks are also an option.
Types of Reverse Mortgages
While there are many different reverse mortgage products on the market, the two government-backed options – the Standard Home Equity Conversion Mortgage and the Saver Home Equity Conversion Mortgage – are undoubtedly the most common. While both products are regarded as “government” reverse mortgages, your actual lender will be a private group like a bank or mortgage company, while the government merely offers mortgage insurance, while setting rules and guidelines that the borrower and lender must meet. The two products share many similarities such as both being available with variable interest rates, and they both allow the borrower to take out their loan as a lump sum payment, as a monthly payment, or as a line of credit that can be used at any time. They do have important differences though:
- Standard HECM – The flagship reverse mortgage product, the Standard HECM is by far the most popular product in the reverse mortgage industry.
- Higher Loan Amounts
- Maximum Upfront Mortgage Insurance Premium (MIP): 2%
- Annual MIP: 1.25%
- Interest Rates: Variable
- Saver HECM – the newcomer to the reverse mortgage market, the Saver HECM was designed by the FHA to help stem the 2009 - 2010 spike in reverse mortgage foreclosures. Recent changes to the Standard HECM program has many experts predicting the Saver HECM will overtake the Standard HECM as the most common reverse mortgage product.
- Lower Loan Amounts
- Maximum Upfront Mortgage Insurance Premium (MIP): 0.1%
- Annual MIP: 1.25%
- Interest Rates: Fixed and Variable
The tradeoff for a borrower comes down to what they need the loan for. Someone in need of a long term, cheaper reverse mortgage will probably look towards the Saver program, while others who need large sums of cash immediately will benefit more from the Standard program -- though they will have to pay steep fees to do so.
Reverse mortgages are a complicated and new financial product. In the past few years they have been both hailed as a savior for seniors and raked over the coals during the foreclosure crisis; the truth probably lies somewhere in between. They should be considered as a viable option for most seniors, albeit one carefully chosen to fit a retirement plan, not hastily jumped into during times of crisis.
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