We have recently created a free visual guide for seniors who are looking to understand how reverse mortgages work.
With today’s post, I want to look at reverse mortgages from another perspective, or should I say another’s perspective. In other words, I want to examine the role that one plays as a son/daughter in this process. Given that all reverse mortgages (by virtue of the age 62+ requirement) are taken out by older people, and that the burden of taking care of the elderly will increasingly fall on younger generations, I think this is an important issue.
If one of your parents is examining the possibility of taking out a reverse mortgage (or even if the idea is yours), the first step is to sit down with your parents and try to completely understand their financial situation. Ideally, all children and close family members should be involved in the discussion. As part of this conversation, you need to undertake a basic audit of your parents’ finances. What kind of revenue do they have (social security, income, pension, etc.), what are their basic (i.e. cost of living) expenses, and what are their assets and liabilities? After taking account their age and health, you should have a rough idea as to the financial shape they are in.
It is also important to try to understand their expectations. Do they desire to live affluently or simply? Are there are big purchases that they expect to make; will they be doing a lot of traveling? Do they expect to move into an independent or assisted living facility, or would they prefer to remain completely independent for as long as possible. Its your responsibility first to try to understand their expectations, and then after taking account of their financial position, to manage them. If you see a big gap between their expectations and financial reality, then they will obviously require some form of support.
Obviously, the most basic way of supporting them would be for you and your siblings to simply mail them a check every month. If this is unrealistic and/or inadequate, then you will need to think more creatively. The next best alternative would be to formally loan money to your parents. Rather than having them pay you back while they are alive (which would defeat the purpose of loaning to them), it would be understood that the loan would be repaid from their estate, after they pass away. While it is understandable that you would feel guilty about loaning money to your own parents, consider that (assuming you can afford it) it is a solution that benefits everyone, and just like with a reverse mortgage, they shouldn’t have to worry about repaying the loan, since such will be taken care of post-mortem.
You should also consider buying their house outright from them. In this way, both of you can avoid all transaction costs, they can continue to reside in the home for as long as they please, and in the process, they secure plenty of cash to support themselves into retirement. This is an especially good solution if the home is still mortgaged, since they can kill two birds with one stone. It also solves the problem that is posed when one spouse is of qualifying age for the reverse mortgage, and the other isn’t. In such situations, some will go ahead foolishly and obtain a reverse mortgage anyway, only to have one of the parents kicked out of the house when the other one dies, and the loan becomes due.
The final option is to go ahead and help your parent(s) obtain a reverse mortgage. Because of high fees and the accumulation of interest, this is often the least economical option, and I recommend it only as a last resort, to be used when all other options have been exhausted. If your parents are obtaining the reverse mortgage so that they can (continue to) live affluently, perhaps you can recommend an alternative, such as downsizing into a smaller house and/or tweaking their standard of living. This would also be a good time to re-suggest loaning them money yourself, which would serve the same function but would better preserve your inheritance. Speaking of which, this is an important consideration, and one that should be reflected in your parents’ plans.
A final note: when helping your parents to obtain a reverse mortgage, you must make sure that the decision has been made by them and that they fully understand its implications. Even if they are elderly, they must undergo counseling and sign the paperwork themselves. There have been a few recent cases in which adult children fraudulently used their parents’ names to obtain reverse mortgages for themselves, and were later discovered. Lenders and regulators are now on the lookout, and it’s important that the loan is of your parents’ own volition.
As of February 1, reverse mortgages will be significantly more difficult to obtain for residents of cooperatives (i.e. condominiums).
That’s because HUD recently changed the rules governing the process for this class of borrowers, by making the approval process more rigorous. Specifically, condo dwellers applying for reverse mortgages will have to wait a minimum of 8 weeks so that HUD can confirm that the dwelling meets their lending standards. In a recent article on the rule changes, one expert confided that the true wait time is likely to be closer to 18 weeks. In addition, all projects that have already been approved will need to be re-approved by HUD.
Of course, there is always a back door, and in this case, that means seeking what’s known as “spot approval” directly from the lender. Under this system, lenders can certify that individual units meet HUD lending standards, but take responsibility if it is later determined that their assessment was invalid. In order to crack down on lenders that were abusing their power, however, the FHA will replace this with a new version, under which any lender that confers spot approval on a project must also bear responsibility for all future loans against units in that same mortgage. Given the level of potential liability that carries, it’s no wonder that so few lenders are still willing to proceed with such spot approval.
On the one hand, this system is necessary, since condos were among the biggest price losers in the housing bust. From the standpoint of HUD, then, insuring reverse mortgages on these properties against default (i.e. that the home price falls below the value of the mortgage) is incredibly risky. The only way to mitigate against this possibility (and stave off having to ask Congress for a bailout, incidentally) is to approve condo loans on a case-by-case basis. For those seniors that live in private communities that are legal incorporated as cooperatives but whose homes are separated from each other, they can apply for “site condo” designation, which is apparently easy to obtain but complicated to undo.
Given the FHA’s financial troubles, this development was somewhat foreseeable, and probably necessary. And while it represents a small obstacle, it’s certainly not a roadblock for those that live in condominiums and want to obtain reverse mortgages. You’ll just have to be patient.
It has been reported that Congress is considering dealing with the mess of Fannie Mae and Freddie Mac by simply abolishing them. No privatization. No permanent nationalization. Certainly no return to hybridization. Instead, a neat and tidy sweeping into the dust-bin. While other columnists are busying themselves focusing on the complete set of ramifications, here, we’re mainly interested in the potential impact on reverse mortgages.
For whatever reason, Fannie (rather than Freddie, in this case) came to dominate the market for reverse mortgages. At its peak in 2008, it accounted for 90% of the funding of all HECM loans (the FHA-mandated reverse mortgage standard) which it purchased in securitized blocks – the reverse mortgage equivalent of the mortgage-backed securities (MBS) that have gained much notoriety for their role in fomenting the credit crisis. This market share has since shrunk to 10%, however, with most of the slack picked up by its competitor, Ginnie Mae.
Given that the reverse mortgage industry has continued to function (quite smoothly, in fact) in the absence of Fannie Mae, then, it seems that its complete disappearance from the scene shouldn’t matter too much. On the surface, this is probably true, but only because reverse mortgage originations remain small, as a fraction of overall mortgage lending activity. Thus, the industry’s capital needs can easily be met by one of the various mortgage giants (Fannie, Freddie, Ginnie, etc.) and a handful of other institutional investors.
The danger is that the reverse mortgage market is basically a monopsony (only one buyer, the reverse of a monopoly); as long as that buyer remains willing, everything is fine. When that buyer gets full and/or changes its mind, well, other buyers must be found. In this case, it would be difficult to find a buyer with the same capacity as Ginnie Mae.
If the industry continues to grow as fast as many experts expect (and lenders hope), however, lenders will probably have to find other sources of capital. Institutional investors are returning to mortgage-backed securities, but in small numbers and very cautiously. If Ginnie Mae cuts back on its purchases and/or reverse mortgage lending activity outpaces Ginnie’s ability to buy securitized HECM mortgages, lenders could be forced to raise interest rates, lower borrowing limits, and impose any number of other limitations on new loans in order to make them attractive for private investors.
In addition, while Fannie Mae’s overall market share of reverse mortgage lending has shrunk, its share of variable-rate mortgage remains sizeable. Given that most reverse mortgage borrowers prefer the fixed-rate version, this isn’t currently a problem. If Fannie were to disappear, variable-rate reverse mortgage lending would probably trickle to a halt. That could make it difficult for borrowers to select the line-of-credit payment option, and would instead have to opt for monthly payments and/or lump sum payment.
This has been a much-mooted question ever since the National Consumer Law Center issued a report in 2009 that concluded that there was indeed an eerie connection between these two types of mortgages. It implied that the recent boom in reverse mortgages would surely end in bust and losses, just like the explosion in subprime loans. But how accurate is this assessment?
According to Jack Guttentag, the self-proclaimed Mortgage Professor, the comparison is hardly apt: “In fact, the two programs could hardly be more different, and there is no chance of a similar fiasco. Subprime loans imposed repayment obligations on borrowers, many of whom were woefully unprepared to assume them, and which tended to rise over time….But reverse-mortgage borrowers assume no repayment obligation at all…They cannot default on their mortgage because the obligation to make payments under an HECM is the lender’s, not the borrower’s.” He argues further that bank losses associated with reverse mortgages will be non-existent (compared to the extensive sub-prime losses), because the majority are insured by the FHA.
While these are certainly fair points, the counter-argument is that home price declines erode the system behind reverse mortgages just like with sub-prime mortgages. Of course, the FHA stipulates limits to the maximum loan size that reverse mortgages borrowers are eligible for – a major difference. In this sense, it would be as if subprime borrowers were required to make 40% down-payments, so as to minimize the possibility of default. Furthermore, the insurance premiums that the FHA collects are theoretically supposed to offset any losses incurred from declines in property values. In that sense, the possibility of any kid of crisis, akin to the blowup in subprime, seems unlikely, if not altogether impossible. There will be no widespread defaults, no foreclosures, though perhaps some losses which will be ultimately born by the government (taxpayers).
When this round of reverse mortgages begin to mature (i.e. when the borrowers die), however, a crisis of conscience could arise. This crisis will not be financial in nature, but psychological. While the Mortgage Professor correctly points to a survey that established a high degree of borrower satisfaction with reverse mortgages, this could ebb when reverse mortgages come due. In other words, all is well and good when the money is flowing into borrowers’ hands. When it comes to repaying the mortgage and/or turning over the property, though, many borrowers’ (and their heirs) will probably feel some sense of regret. That’s because the very nature of reverse mortgages is such that they are very expensive, both upfront and over the life of the loan.
When borrower realize that in hindsight, the money they were getting wasn’t free, it could provoke the same accusations currently being leveled against subprime lenders: aggressive marketing tactics, inadequate screening of borrowers, a lowering of lending standards, high fees, etc. A crisis? Perhaps not. A growing controversy? Maybe so.
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.