We have recently created a free visual guide for seniors who are looking to understand how reverse mortgages work.
I recently read a press release (masquerading as a “news article”) in which one reverse mortgage lender aimed to refute 10 carefully selected reverse mortgage myths. While the refutations are certainly accurate, many of them struck me as unfair, and were deliberately worded so as to be easy to refute. Thus, I’d like the opportunity to refute their refutations.
Myth: If I take out a reverse mortgage the lender will own my home.
While this is not legally the case (the title still belongs to the borrower, who retains his rights as the homeowner), it can quickly become so financially. Those that borrow the maximum they are entitled to will quickly discover that they own less than half of the value of the home, and that their equity will continue to fall (both in nominal and relative terms) over the life of the home, such that when the loan matures, the lender will be entitled to the majority of the proceeds. In addition, the lender can force the premature sale of the property if the borrower fails to maintain the property and/or pay property taxes.
Myth: My children will be responsible for the repayment of the loan.
If your children want to keep the property after the borrower (you) dies, they MUST repay the loan. Otherwise, the lender has no basis, legal or otherwise, for contacting the children of the borrower.
Myth: I cannot get a reverse mortgage if I have an existing mortgage.
Borrowers with high LTV primary mortgages (perhaps 75%) will find it very difficult if not impossible to obtain a reverse mortgage, especially as a result of the recent lowering of FHA lending maximums. For those whose primary mortgage are close to being repaid, this myth is indeed a myth, and they can in fact use some of the proceeds from the reverse mortgage to repay the primary mortgage.
Myth: Only low-income seniors get reverse mortgages.
If this myth was reworded to read that “Only low-income seniors SHOULD get reverse mortgages” it would no longer be a myth. While it is true that income is not a factor when applying for a reverse mortgage, those whose financial/income positions are strong would have no reason to consider a reverse mortgage. In the event that one’s income declines or ceases, then one would perhaps have a basis for considering a reverse mortgage.
Myth: If I outlive my life expectancy, the lender will evict me.
It’s true that the lender would have no legal basis for doing so, under the terms of the loan. It’s worth pointing out, however, that loans are structured according to actuarial assumptions, such as life expectancy. Thus, if you outlive your life expectancy, you can expect your (heirs’) equity in the home to be even less than otherwise. The only point I’m trying to make here is that there is no free lunch by living longer, since the loan will accumulate interest until it is repaid.
Myth: Reverse mortgage lenders pressure seniors to buy additional financial products.
While I’d like to believe that the majority of reverse mortgage lenders don’t engage in so-called cross-selling, more than a handful of lenders apparently do, necessitating new legislation to ban the practice.
Myth: There are no objective advisors available to seniors trying to decide if a reverse mortgage suits their needs.
Thanks to recent FHA legislation, this myth can be firmly declared a myth. Borrowers are now required to undergo counseling with an FHA-approved adviser prior to obtainingthe reverse mortgage.
Myth: There are restrictions on how reverse mortgage proceeds may be used.
It is unfortunate, in my opinion, that there aren’t restrictions. While borrowers (and especially lenders, for marketing purposes) are probably happy that they can use the proceeds of a reverse mortgage for “frivolous” expenditures, they will probably regret this leniency in hindsight, when genuine financial necessity arises and/or they have very little equity left in their homes.
Myth: Reverse mortgage lenders take advantage of seniors.
As with the “myth” about cross-selling, I’d like to believe that the majority of reverse mortgage lenders do not try to exploit their customers and are simply fulfilling legitimate demand for the service that they are providing. The reality, however, is that reverse mortgages are inappropriately marketed (and often sold, it seems) to customers that simply do not need them. While such borrowers still have every right to obtain reverse mortgages – this being a free country – it is arguable that lenders exploit their ignorance.
Myth: I’ve heard I won’t qualify for a reverse mortgage because of my limited income.
This is basically a restatement of an earlier myth, and it seems it was added by the lender solely to underscore the eligibility of low-income borrowers. What was I just saying about exploitation?
I think a large portion of my posts begin with some variation of the phrase, “There is a great deal of confusion surrounding aspect xx of reverse mortgages.” While this certainly speaks to a lack of originality in my part, let’s face it, reverse mortgages are complicated. There are a lot of aspects which seem superficially similar to conventional mortgages, but are actually quite different. Reverse mortgage interest is one such aspect.
It’s not the the calculation of reverse mortgage interest which is complicated. Just like any other loan, interest is calculated on the outstanding balance of the loan. Whether you take the proceeds from a reverse mortgage as an upfront payment or in installments, interest charges will be calculated monthly based primarily on the amount of money that has been withdrawn to date. However, since you aren’t expect to make payments (interest or otherwise) to the lender with a reverse mortgage during the life of the loan, the loan balance will actually increase over time, such that you are not only paying interest on the principal, but also on the accrued interest. In this sense, a reverse mortgage can be thought of as a kind of negatively amortizing mortgage.
When it comes to the issue of tax deductibility, things get a little hairy. Unlike a conventional mortgage, the accrued interest associated with a reverse mortgage is not tax-deductible on an annual basis. Thus, while you can write off all (in most cases) of the interest on your conventional mortgage when you file your taxes every April, you can’t include interest on your reverse mortgage.
Instead, reverse mortgage interest can only be deducted when the loan matures. According to the IRS, “Because reverse mortgages are considered loan advances and not income, the amount you receive is not taxable. Any interest (including original issue discount) accrued on a reverse mortgage is not deductible until you actually pay it, which is usually when you pay off the loan in full.” Thus, the IRS feels that since it has been kind enough not to tax you on the proceeds you receive under your reverse mortgage, borrowers then don’t have any grounds for complaint when it comes to not being able to deduct the interest.
If you drill even deeper, however, into the abyss that is the US tax code, you will learn that IRS treats reverse mortgage proceeds as home equity debt, rather than conventional mortgage debt. While this distinction might sound trivial, it actually has serious implications. That’s because the IRS limits the amount of tax-deductible home equity debt to $100,000. Interest on any proceeds that you receive(d) in excess of that threshold, cannot be deducted.
It gets even more complicated when you consider that reverse mortgages are ultimately repaid not by the borrower (assuming he has passed away when the loan “matures”), but by his heirs. This introduces estate tax issues into the equation. Unfortunately, this is beyond my personal expertise, and anyone who ultimately wishes to minimize the tax burden associated with the repayment of a reverse mortgage is encouraged to consult a tax specialist. A financial planner might also be able to make some suggestions about some of the products (insurance and otherwise) which are designed to similar ends.
Speculation is mounting that the Federal Reserve Bank will hike its benchmark federal funds rate (FFR) at some point in 2010. The rate has hovered around 0% for more than a year now, and analysts reckon that the remaining time it can possibly be held at this record low is running out. The question – as far as readers of this blog are concerned – is: How should this potential change be weighed when shopping for a reverse mortgage?
Let me first offer some background. For the purpose of this discussion, reverse mortgages can generally be categorized as either fixed-rate or variable-rate. Fixed-rate reverse mortgages accrue interest at the same (fixed) rate for their entire duration, whereas the rate associated with variable rate mortgages rises and falls in accordance with a stated benchmark rate, such as the FFR, 3-month LIBOR, and other obscure rate indexes that you’ve probably never heard of. In short, when the associated benchmark rate rises, so does the mortgage rate. [This is the exact same principle that governs conventional mortgages, by the way].
In this case, if/when the Fed hikes the Federal Funds Rate, all variable-rate mortgages (reverse and otherwise) linked to the FFR will all rise by a fixed increment. Technically, those mortgages that are linked to other benchmarks won’t rise, but given that most of the oft-quoted short-term rates are highly correlated and tend to move in tandem, it’s likely that a Fed rate hike would affect all variable-rate mortgages.
Trying to predict how fixed-rate mortgages would be affected by a short-term rate hike is difficult to say. That’s because fixed-rates are determined by market forces, and fluctuate irrespectively to short-term variable rates. In the past, short-term rate hikes have typically been accompanied by slight increases in long-term fixed rates, but this relationship is anything but certain.
The takeaway from all this is that while variable-rate reverse mortgages currently accrue interest at lower rates than their fixed-rate counterparts, it’s not clear whether this will be the case for long. Moreover, if the credit crisis has taught us anything, it is that the ability to refinance (from variable-rate into fixed-rate, for example), can no longer be taken for granted. That means it’s important to make the right choice from the outset.
In the current borrowing environment, the right choice s quickly tilting towards fixed-rate. While some borrowers might still be tempted by the low rates offered by variable-rate providers, be advised that they won’t remain low forever. And once they start rising, you might wish you had just gone with a fixed-rate, and saved yourself the headache.
Despite what you may have read and heard, reverse mortgages are not inherently evil. At least, I don’t think so. Rather, there is a tremendous amount of misinformation surrounding them, which has created the perception that somehow they are the province of scammers and opportunists. While this generalization is unfair, there are certainly some practices that push the limits of honesty and run contrary to the “spirit” of the product. I have culled a handful of these, below.
First of all, there is the misconception that reverse mortgages are originated directly by the government, or even worse that they are a “government benefit,” on the same level as social security and medicare. On the contrary, all reverse mortgages are issued privately. While the vast majority are insured and regulated by the government (via FHA), this is quite different from saying that they are administered by the government. For all intents and purposes, then, they are private products with private contracts.
Other misconceptions arise from erroneous comparisons with conventional mortgages. For example, some borrowers fail to grasp that a reverse mortgage is still a mortgage, in that it accrues interest and must be repaid. Other borrowers step too far in the opposite direction, and assume that some of the up-front fees will be used to fund an escrow (like with a conventional mortgage), that will in turn be used to make insurance and property tax payments. On the contrary, it is the responsibility of the borrower to continue making such payments as usual; failure to do so could ultimately lead to foreclosure. Along the same lines, other borrowers have taken out reverse mortgages to make simple repairs on the home, when a (government-subsidized) conventional mortgage might be cheaper, and more appropriate.
One of the most common pitfalls, meanwhile, is to borrow more money than necessary under a reverse mortgage. Not only will that cause a faster erosion of home equity (due to the accrual of interest on a larger balance), but thus could also render one ineligible for certain social-security benefits that otherwise could have been obtained. It’s important to understand that money not withdrawn (such as with a line-of-credit payout option) does not accrue interest. Another pitfall (one might be tempted to use scam, but this isn’t always illegal) is to use the proceeds from a reverse mortgage to “cross-purchase” (the counterpart to “cross-selling) another financial product. Many lenders have earned the ire of consumer advocates and government regulators for cajoling borrowers into buying annuity agreements and other insurance products when closing on a reverse mortgage. That’s because such products are rarely – if ever – appropriate for reverse mortgage borrower, who are advised to rebuff this cross-selling.
Finally, there are the outright scams. Surprisingly, research has shown that most scams are perpetrated not by lenders, but by third parties and family members. Lenders could perhaps be faulted for not being vigilant enough when it comes to policing scams (in fact, they are actually incentivized not to report them), but the primary fault rests not with them. Some con artists, for example, persuade borrowers to obtain reverse mortgages in order to pay for products/services that they are selling. Another elaborate scam involves the reverse-mortgage-for-purchase, in which the victim receives the house, and the scammer takes the proceeds from the mortgage. Finally, there are plenty of cases of adult children blatantly stealing from their senile parents, by taking out reverse mortgages without their knowledge/understanding.
Thankfully, most of these “practices” can easily be prevented, simply through increased information. Reverse mortgages have very niche uses, and should only be obtained only as a last resort. Principal and accrued interest must be repaid after a maturity event (death, moving out, failure to pa taxes and maintain the property, etc.). They should be obtained under one’s own volition – and not under duress – and they should be structured so that the funds received are spent almost immediately, but not frivolously. Any questions?
The most important factor in the size of your reverse mortgage loan (other than your age and your own personal inclination) is the value of your home. As a result, it’s important to understand how the fluctuation of home prices affect reverse mortgage financing, so that you can make an optimal decision.
Basically, HUD – which, through the FHA, administers/insures the majority of reverse mortgages – has calculated a table of “multipliers,” based on your age and prevailing interest rate levels. This multiplier is essentially a ratio of your home equity that HUD has determined you are eligible to borrow at the time you obtain your reverse mortgage. Basically, take the value of your home, multiply it by this ratio, and voila, you have determined the maximum amount (prior to fees and other adjustments) that you can borrow under current market conditions. For example, if you are 65 years old and your lender has quoted you an interest rate of 5.5%, and your home is valued at $300,000, then you can borrow a maximum amount of $175,200 (based on a multiplier of .584) before fees.
Perhaps I’m getting ahead of myself. After all, I keep referring to the value/worth of one’s home, and haven’t yet defined how this is determined. Well, it’s actually quite simple. The value of your home (aka the lender’s collateral) is determined by an appraiser at the time of origination. Remember that with a conventional mortgage, the appraisal serves a tangential function: to merely confirm that the price you paid for the home is supported by market fundamentals. With a reverse mortgage, on the other hand, the appraisal is everything! The lender doesn’t care what you paid for your home, or what you think it’s worth; it only cares about the appraisal. (This distinction between price and worth is especially important when using a reverse mortgage to purchase a home).
If the appraisal is higher than you expected, then Congratulations! As I alluded to in the opening of this post, however, you don’t have to borrow the full amount that you are eligible for. If the appraisal, came in lower than expected, you have a few options. The first is to wait a couple years. During that time, home prices may have appreciated, and you will certainly have aged. Unless interest rates also rise, then, you will almost certainly be eligible for a larger loan when you go to re-apply. Another option, mainly for those that need the cash now, is to go ahead and obtain a reverse mortgage now, and simply re-finance if/when conditions improve. Of course, there are costs associated with this option (just like with a conventional mortgage refinancing) so the first option is probably the most economical of these two, especially if you can afford to wait. The final option is to simply forget about a reverse mortgage for your existing home, and instead, downsize into a smaller home. If you are still dedicated to taking out a reverse mortgage, the decline in home prices would work to your advantage, since the loan would fund a larger portion of the purchase price.
In the end, there is no way to beat the system. If your appraisal is high (presuming that you borrow the full amount you are entitled to), then your equity position will be lower over time then if your appraisal was relatively low. Really, the only way that you can “win” is if your house depreciates over time to such an extent that your mortgage is underwater, and the FHA – thanks to the mandatory insurance policy – picks up the tab for difference. But this is certainly a dubious gain, as it would be better for all parties if your house appreciates so that you still have some remaining equity when the mortgage is repaid.
The only time you really need to pay attention to your appraisal is if you are planning to use the proceeds from the reverse mortgage to repay a large amount of debt associated with a primary mortgage. For those of you to whom this applies, and for whom the fall in home prices has precluded your obtaining a reverse mortgage, my advice is to continue paying your primary mortgage and re-evaluate the situation in a few years. Regardless of how the housing market performs over that time, your own personal financial situation will be more conducive to obtaining a reverse mortgage of adequate size.
For the rest of you, don’t worry too much about trying to time the market. [That's why I didn't include any forecast about the direction of real housing prices in this post. It would have been irrelevant, distracting, and probably inaccurate]. Instead, focus more on whether a reverse mortgage is appropriate, given your personal financial situation. Ask yourself: If home prices stay exactly where they are for the next five years, would it appropriate for you to obtain one now, in five years, or never?
So, you’ve taken the plunge, and decided to borrow using a reverse mortgage. The next decision – and probably the most important one – is how you should receive disbursement of the funds that you are entitled to.
According to the Department of Housing and Urban Development (HUD), which regulates and insures reverse mortgages through the FHA, you have five options: Tenure, Term, Line of Credit, Modified Tenure, and Modified Term. All are generally calculated using actuarial assumptions (i.e. your age and the value of your home) and tweaked by an FHA mandated “multiplier,” based primarily, it seems, on the ever-changing financial situation of FHA – and not the borrower.
One that selects Tenure will receive “equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.” This is certainly the most conservative choice, and some would argue, the reason why reverse mortgages were created. With a tenure payment system, you can essentially turn the equity into your house into an annuity, to be paid out to you for as long as you live. [As a side-note, you would be well-advised to avoid buying annuities in conjunction with a reverse mortgage, since this adds another layer of administrative costs onto the mortgage, and will most likely be lower than the tenure payments. If the annuity provider advertises an annuity with better terms, he has probably made more aggressive actuarial assumptions, paid for with a reduced equity stake in your home].
Term represents a slight tweak on tenure, since it confers monthly payments for a fixed duration, rather than for the rest of the borrower’s life. Naturally, the advantage is a larger monthly payment than under the tenure system, since it can be calculated irrespective of the borrower’s age. The downside is that after the term expires, you could very well be left with little equity in your home. Another downside of both term and tenure payments is that they are not indexed to inflation, which means the money you receive now will be less in real terms than the monthly payment 10 years from now.
With a line of credit, you can access funds as needed. Some borrowers will withdraw all (or a large portion) of funds up-front immediately after obtaining the mortgage, in order to make repairs and/or modify the structure so that it is more conducive to being elderly. Withdrawing funds up-front for “frivolous” spending, is discouraged, even though your broker might dangle this as a benefit when trying to sell you on the mortgage. Using up your line of credit is akin to depleting the equity in your home, which is why the line-of credit is arguably the most dangerous option, when it comes to selecting a disbursement plan.
There are also two variations on the line of credit, known as modified term and modified tenure. As you probably guessed, these options blend the line of credit with term and tenure, respectively. Under both plans, naturally, the monthly payment that you otherwise would have received under a “pure” term or tenure is simply smaller, since some of the funds (with some input from you, of course), must be set aside for the line of credit. For those that want to withdraw a large chunk of money now for repairs/maintenance, will still retaining the security of a monthly payment, a modified term/tenure is probably the best bet.
There is no way to “beat” the system, since the funds available to you are calculated using the same set of assumptions, regardless of which payout system you select. From the lender’s perspective, you are entitled to all of the equity in your home, minus the upfront/administrative costs, accrued interest, and an allowance to mitigate against the possibility that the amount owed will ever exceed the value of the mortgage. This way, when the home is ultimately sold and/or the mortgage is repaid (whether the borrower is still alive or has already passed), there should be some leftover funds, which will be returned to the borrower or his heirs.
In some ways, I feel like my job as reverse mortgage reporter has been transformed into reporter on reverse mortgage reporting. In other words, there haven’t been too many noteworthy developments in the reverse mortgage industry in the last few months. A slight FHA rule change here. A clarification there. But nothing too substantive, or earth-shattering. This is to be expected, since the product is both relatively niche (only borrowers of a certain age are even eligible, for example) and reasonably straightforward. While the number of mortgage products was recently estimated at more than 1,500, the number of reverse mortgage products is basically 3 (not including private arrangements).
As I was saying, there isn’t much primary reporting for me to these days, only secondary reporting. Still, given that public and professional opinion on reverse mortgages seems to evolve daily, with two very different camps emerging. While there is less and less to be said about reverse mortgages themselves, then, but more and more to be said about what other people are saying about them.
Perhaps this year’s most widely-read report on the reverse mortgage industry was that released by the National Consumer Law Center, entitled “Subprime Revisited.” Since it’s release in October, the report has generated a tremendous amount of buzz for its unequivocal opposition to reverse mortgages, and has been seized upon by members from both sides of the divide for conflicting purposes.
Those looking to strengthen their cases against reverse mortgages have been quick to cite its profiles of borrowers that were blatantly scammed. There are stories of subprime brokers transitioning seamlessly into new jobs selling reverse mortgages, in the wake of the collapse of the housing bubble. These brokers are broadly accused of greasing their own commissions at the expense of borrowers, many of whom remain ill-informed, and are simply happy to receive a pile of money while retaining the right to continue living in their homes. Then there are reports of cross-selling, whereby borrowers are cajoled into buying annuities in conjunction with their reverse mortgages, which in one case yielded less than the interest rate on the reverse mortgage.
Those on the other side of the fence (the majority of which have a vested interest in selling reverse mortgages, it should be noted) have labeled the report a “one-sided editorial with a regulatory policy agenda built on generalizations and extrapolations.” They insist that on the contrary, reverse mortgages are easy to understand, and abuse remains the exception, as “brokers are decent, ethical professionals.” They point to high satisfaction rates and the lack of a major crisis as evidence that the reverse mortgage industry is fulfilling its fiduciary responsibilities to its customers.
As a rejoinder, I would argue that while scams and abuse are still relatively rare, they are on the rise, due to an in increase in the number of unaffiliated lenders (some of which are rightfully accused of employing sub-prime tactics to sell reverse mortgages). In addition, given that the FHA (which insures the majority of reverse mortgages) is on the verge of insolvency, it looks like a crisis is not far off. Finally, satisfaction rates remain high because the majority of borrowers only obtained their mortgages a few years ago. Thus, high satisfaction is to be expected, since these borrowers have only tasted the upside (”free” money) so far. When these loans start coming due en masse (due to borrower death, change of residence, bankruptcy), many of these borrowers will start crying foul and insist that in hindsight, they were duped.
Still, I think that it’s fair to say that the truth probably lies somewhere in between. Certainly, all mortgage brokers aren’t sleazy and all potential borrowers aren’t idiots. The incentives being the way they are, however, you can excuse people for being cynical about the motives of reverse mortgage lenders. On the other hand, with the recent enhancement in reverse mortgage counseling requirements, borrowers may have a more difficult time claiming that they were misled. Whether reverse mortgage mortgages are ultimately appropriate for the average eligible borrower is impossible to say; the best we can hope for is increased transparency and a lack of coercion.
Let’s face it; in a free society, the government (in this case, the FHA) can’t arbitrarily outlaw reverse mortgages because of a few bad apple lenders steering unsuspecting borrowers towards reverse mortgages even when not suitable. What the FHA can do, however, is increase the transparency of the process and the flow of information to potential borrowers, so that they can make informed decisions about the appropriateness of the product. Towards this end, the FHA is in the process of overhauling the system of reverse mortgage counseling.
It is already the case that every borrower must first complete a mandatory information session with an FHA-approved counselor. The problem was that many of these counselors were either disingenuous, uninformed, or downright dishonest. [Apparently, the FHA learned this the hard way through some undercover detective work, where counselors posing as potential borrowers discovered gaping holes in the counseling process]. The “problem” is that counseling is available either free of charge or at very low cost, which means that unscrupulous counselors must find another way to get paid. In many cases, counselors have provided referrals to reverse mortgage lenders, in exchange for a commission. While this is dishonest enough, perhaps it is worse that recommending a reverse mortgage lender carries the implicit belief that the reverse mortgage itself should be recommended.
The reformed counseling program, then will begin with a paring down of the list of approved counselors, so that these shills for the reverse mortgage industry can be weeded out. Those that remain on the list will then be required to pass an examination, demonstrating competent understanding of reverse mortgages. Furthermore, the protocol for the counseling session will be enhanced, and there will be a required list of items that must be covered. Opponents of reverse mortgages will be relieved to learn that one of these items is a summary of the alternatives to reverse mortgages. The counseling session will conclude with a brief “quiz” of potential borrowers. If the borrower can demonstrate a thorough understanding, then he will be presented with a certificate, which is necessary to obtain a reverse mortgage.
One of the potential downsides of the new FHA requirements is that they allow counseling sessions to be completed over the phone, where there is a possibility for misunderstanding and even impersonation by third parties which may wish to steer the borrower towards a reverse mortgage. While this could certainly increase convenience, it also could lead to abuse.
As a potential borrower, it is recommended that you complete the counseling session before you begin shopping for a reverse mortgage. The counseling session will not only provide insight into what you can expect from the application process and the types of questions you should ask, but also a list of approved lenders. To find an FHA-approved counselor, click here.
Traditionally, there were two lines of thinking regarding reverse mortgages. The first held that reverse mortgages should only be used by those in desperate financial circumstances, after most other options have been exhausted. The other camp insisted that reverse mortgages are perfectly appropriate for all borrowers, as long as they are of retirement age and have selected a reputable lender.
Now a school of thought has emerged that suggests reverse mortgages are rarely, if ever, appropriate for the majority of potential borrowers. Goes the argument- borrowers who feel compelled to turn to reverse mortgages for cash are necessarily house poor. That is, a disproportionate share of their spending goes towards their respective homes. This condition is actually exacerbated – rather than alleviated – by taking out a reverse mortgage, which gradually erodes the equity in one’s home, based on inherently unattractive terms.
Granted, this characterization is overly simplistic. The idea behind it, however is meaningful and straightforward. Reverse mortgages are structured to the benefit of the lender. They are marketed aggressively towards borrowers under the premise that the cash can be used for fun-filled spending sprees, rather than for emergency needs. The implicit assumption behind reverse mortgages is that it is necessary for you to stay in your home.
While borrowers can be excused for the sentimental desire to want to remain in their homes at all costs, for the vast majority, it’s neither practical nor economical. Borrowers that obtain reverse mortgages often fail to scrutinize the terms of the mortgages because the flow of cash is moving towards them. Whether or not they are receiving reasonable compensation for the equity in their homes is beside the point. Most people are just grateful to have the cash.
Instead, why not consider moving into a smaller house or into a retirement community. While even contemplating such a ghastly decision might be anathema to many borrowers, it is eminently reasonable. In this way, all of the accrued interest that otherwise would have otherwise inured to the lender (in the form of equity) can instead be used by you, at your discretion. In addition, if you still decide that you want/need a reverse mortgage, you can always obtain one on the new property. For those that advise against this on the grounds that you are selling into a weak market, consider how illogical this is, since you are simultaneously buying into a weak market. Sell for less, buy for less; it should work out to be a wash, regardless of home price levels.
In the end, the best advice I can offer is not a definitive ‘yay’ or ‘nay’ regarding reverse mortgages. The decision is ultimately yours, and yours alone. Just remember that alternatives exist, and that there is no such thing as a free lunch.
On November 18, 2009, the FHA published MORTGAGEE LETTER 2009-49, the purpose of which was to clarify “FHA requirements for secured subordinate financing under the Home Equity Conversion Mortgage (HECM) Program.” Specifically, the letter imparted that “there shall be no outstanding or unpaid obligations, either unsecured or secured, incurred by the HECM mortgagor in connection with the HECM transaction…”
This immediately sparked a raging debate in the reverse mortgage industry, where second liens had always been thought of as legal (if not uncommon) when subordinated under reverse mortgages. This debate has played out on the comments section of “Reverse Mortgage Daily,” where readers seem to have concluded that under no circumstances (except if used to make repairs, as stipulated in the FHA letter) can a second lien exist under a reverse mortgage.
Here, I’d like to offer my two cents. Let’s start with the basics: a second lien is basically another mortgage, that has lower priority than the primary mortgagee when it comes to being repaid by the borrower. This is especially relevant in the case of default, whereby the proceeds from the sale of the property would first be used to repay the primary mortgage holder before the second lien mortgage lender would receive anything.
The FHA has made it clear (on previous occasions, in fact) that it is forbidden for a borrower to take out a second lien in connection with a reverse mortgage. In other words, if the proceeds from the HECM reverse mortgage are not enough to pay the closing costs and/or repay any existing mortgage debt, the borrower is forbidden to take out a new (second lien) mortgage.
What’s less than clear is whether existing second liens are allowable. In other words, if the reverse mortgage proceeds were sufficient enough to repay an existing primary mortgage but not quite enough to cover a secondary mortgage, would the borrower still be allowed to obtain the reverse mortgage while continuing to service the existing secondary mortgage?
This uncertainty seems to be focused on a recent story that described precisely this kind of situation. The subject of the piece used the reverse mortgage to completely repay the primary mortgage but only partially repay an existing secondary mortgage. The folks over at Reverse Mortgage Daily have declared that “the subordination in the story by Mr. Kelly would be a violation of the mortgagee letter.”Personally, I’m not inclined to agree. The FHA’s letter forbids subordinated financing in connection with the HECM transaction. It doesn’t go so far as to say that subordinated financing is forbidden outright. Still, the letter is ambiguous, and we hope that the FHA will issue further clarification, so we don’t need to speculate further.
On a side note, subordinated financing (whether new or existing) is rare when the primary mortgage is a reverse mortgage. Since reverse mortgages are negatively amortizing (i.e. the loan value increases over time), there is a risk that the value of the mortgaged home could actually exceed the value of the mortgage. While lenders are protected against this possibility through the mandatory FHA insurance, a lender holding a second lien would have no protection against default, and thus would probably reject such an arrangement. In the case at the center of the RMD controversy, the reverse mortgage enabled the borrower to pay down half of the balance of the second lien. It is probably only because of this that the subordinate lender consented to a new primary mortgage.