I’ve seen dozens of solicitations and information sheets that contain a full litany of situations in which reverse mortgages are suitable for potential borrowers. What I have yet to see, however, is a comparable list of situations in which reverse mortgages are definitely not appropriate. Here goes:
- Short-term Time Horizon: Due to high upfront costs (origination fees, insurance premium, etc.), a reverse mortgage is simply not economical over a short time horizon. In order for it to be worthwhile, you should plan on staying in your property for a minimum of 7 years. If your time horizon is shorter, you should consider an alternative source of financing.
- Strong Financial Position: If your financial position is currently strong, there’s no reason to obtain a reverse mortgage, since you will pay annual fees, interest, and insurance premiums for as long as the loan is outstanding. Instead, wait until your cash position deteriorates (ideally, this will never happen), and/or you have a legitimate financial need before contemplating a reverse mortgage.
- Young Age: If you are barely older than 62 (the age at which one becomes eligible for a reverse mortgage), you might want to consider waiting a few years before obtaining a reverse mortgage. I offer this suggestion not only because FHA loan maximums are correlated with age, but also because the longer your loan remains outstanding (the more interest it will accumulate). Therefore, by waiting, you can both obtain a larger loan and save money (on interest) over the life of the loan.
- Desire to Live Affluently: If your primary motivation for obtaining a reverse mortgage is to raise your standard of living, please reconsider. While trading home equity for a nice vacation, new car, and a few fancy meals might seem like a good idea, you will almost certainly regret your decision when the time comes that you have a genuine need for some extra money.
- Property Needs Repairs: If your property is in poor condition, you need to bear in mind that under the terms of the reverse mortgage, it is your responsibility to fix it. Failure to do so could lead to foreclosure. If only minor repairs are necessary, however, you can use the proceeds from an HECM reverse mortgage or better yet, a single-purpose reverse mortgage, to finance the repairs.
- Desire to Will Property to Heirs: If you have any desire to will your home to your heirs, a reverse mortgage is not appropriate, because when the loan comes due, the property will be sold. While your heirs still have the option of repaying the loan with cash at that time, a better choice would be for your heirs to purchase the home from you now or lend you money directly, so that there is no uncertainty when you pass away and/or the hypothetical reverse mortgage comes due.
- Poor Health: If your health is (excessively) poor, a reverse mortgage probably isn’t a good idea. Consider that even if you use the proceeds for legitimate medical expenses and your health worsens, you will be back where you started. Unless you need cash to pay for a one-time (i.e. not chronic) medical outlay, you should consider borrowing money from family members and/or selling your home.
- Lack of Savvy: Finally, if you don’t understand how a reverse mortgage works, do yourself a favor and take the steps to understand it, instead of diving right in. You might discover something that you don’t like that convinces you to reconsider. Then again, you might discover that in fact, it is suitable for you. The point is clear: educate yourself before making such a big decision.
In previous posts, I have explored the decision to obtain a reverse mortgage, and the process that is necessary to produce such a decision. With today’s post, I want to explore a different process- that of actually obtaining a reverse mortgage.
1. Once you’ve decided that a reverse mortgage is right for you, the first step is to confirm that you are indeed eligible to obtain one. You can refer to our handy flow-chart in order to make sure that you meet all of the requirements. If there is any uncertainty, you can skip ahead to step two/three, and ask your prospective lender to confirm your eligibility.
2. The next step is to select the type of reverse mortgage that you wish to obtain. While for many, an HECM reverse mortgage is the obvious choice, it also makes sense to examine single-purpose and proprietary reverse mortgages, as they may offer better terms. I explained the difference in a previous post.
3. Depending on which type you’ve selected, you will then need to identify a handful of suitable lenders and establish contact with them. You can find a list of single-purpose reverse mortgage lenders here. If you’re looking for an HECM lender, I would recommend browsing the National Reverse Mortgage Lenders Association (NRMLA) lender listings. You are advised to avoid responding to solicitations and to avoid working with intermediaries (brokers, estate planners, etc.), who will simply steer you to favored lenders and take a commission for doing so.
4. Obtain quotes from each of the lenders, including the interest rate, origination fees, and insurance costs. Some lenders have started to waive certain fees, and you might be surprised by how much they now differ. In such cases, make sure that there are no strings attached, and try also to understand how, if it all, mortgage terms vary between lenders.
5. On the basis of the quote and face-to-face meetings, you should select a lender and begin the application process. At this point, you will have to decide how you want to accept distribution of the proceeds, whether as a lump-sum, monthly (term/tenure) payment, and/or line of credit.
6. At this point, the lender will begin to process your application and appraise your home. Aside from your age, this appraisal is the biggest variable in determining the size of the reverse mortgage for which you are eligible. Remember: you don’t need to take all of these funds. You can choose the size of your mortgage, as long as it falls within the limits set by the FHA.
7. Before the loan can close, you will need to complete a counseling session with a HUD-approved organization, and present the certificate from the session to your lender.
8. After the lender signs off on the paperwork, the loan is closed. From this point, you have three days to review your decision, and if you’re not satisfied, you have the right to a penalty-free cancellation. If you choose not to exercise this right, the funds will be distributed to you in the manner that you specified, and the reverse mortgage will begin accruing interest.
Eligible homeowners that are determined to withdraw the equity from their homes have two general options: reverse mortgage and home equity loan. In this post, I’d like to briefly explore the advantages and disadvantages of each and try determine which choice is better.
Technically a reverse mortgage is a type of home equity loan, but with one important difference. While a conventional home equity loan must be repaid in periodic (monthly) installments, the interest/principal on a reverse mortgage loan is only due when the loan matures. Therein lies the main advantage (and pitfall) of a reverse mortgage loan, from the perspective of (potential) borrowers. Let’s put this aside for a moment, however, and look at the other differences.
From a cost standpoint, a home equity loan (as well as a cash-out refinancing, for that matter) will almost always be less expensive than a reverse mortgage. The origination fees for the two products are comparable, but reverse mortgages require upfront and annual insurances premiums. In addition, since a reverse mortgage is negatively-amortizing, total interest paid over the life of the reverse mortgage will always be greater than interest paid on a comparably-sized home equity loan.
Failure to repay a home equity loan in accordance with the terms of the loan agreement will almost certainly lead to foreclosure, while a reverse mortgage doesn’t need to be repaid until the borrower passes away or moves out of the home. Although, taxes and homeowners insurance must continue to be paid, and the property must be maintained by the borrower for as long as the loan is outstanding.
In short, for homeowners that currently have no existing mortgage debt and whose cash need is moderate and short-term, a home equity loan is probably the better choice. It will be less expensive to the borrower and will leave the borrower with his home equity intact after the mortgage is repaid. For homeowners with existing mortgage debt and whose cash needs are large/indeterminate, a reverse mortgage is a more realistic option. It basically eliminates the possibility of foreclosure and fixes it so that you don’t need to continue making payments on your primary mortgage. Just be advised that when the reverse mortgage comes due, you might not have much equity left in your home.
Reverse Mortgage Daily recently ran a piece with this title, and it raised some interesting points. The author wonders aloud about whether recent fee reductions will confuse customers to the point of indecision. Not only could this increase bad publicity surrounding reverse mortgages, but it could also lead to decreased volume.
Based on the results of a rudimentary survey, it seems that the readership was evenly split over whether the pricing changes would confuse borrowers. Some readers thought that lower fees would naturally be embraced by borrowers, while other readers considered the notion that older people tend to prefer simplicity: “As one of my older friends used to tell me all of the time: ‘As I get older I find myself hating too many selections on a menu. Why can’t they have fewer choices?’ ”
Personally, I can see the logic in both positions. On the one hand, lower fees are unambiguously a good thing for borrowers, especially if they are adopted universally by all lenders. When you consider the origination fees, service fees, insurance premiums, and interest charges, reverse mortgages are downright expensive. While they remain expensive in spite of the fee cuts, any development which transfers money from the lender to the borrower should be applauded.
On the other hand, I can also understand why pricing changes could be confusing to consumers. Since the pricing changes haven’t yet been adopted by all lenders, some borrowers might be inclined to wonder if perhaps there is a link between price and quality, and obtain a reverse mortgage from a lender that hasn’t lowered its fees. In addition, the fee reductions have been implemented in various ways, which IS confusing. In nominal terms, eliminating origination fees is probably comparable to a 50% discount in the upfront insurance premium, but this may not be clear to borrowers.
Finally, there is the notion that fee reductions can potentially be bad for borrowers, if they increase the size of reverse mortgage loan. As I discussed in a recent post, if a lender shrewdly (with or without the complete understanding of the borrower) rolls the savings back into the reverse mortgage, the interest paid on that additional principal will more than offset the decrease in fees, over the life of the mortgage.
Perhaps borrowers are right to be skeptical, after all.
Anyone who wishes to obtain a reverse mortgage has to undergo an “interview” with a HUD-approved counselor. While there is no substitute for this counseling session, there is still an important step that you can take to ensure that a reverse mortgage is right for you: interview yourself.
In conducting this self-interview, you should first ask yourself: Why do I want a reverse mortgage? Avoid the inclination to answer, because I can, and try to drill deeper into your rationale for obtaining one. Are you especially short on cash, and/or looking for a quick fix for a sudden, personal financial crisis? Towards what end(s) will you use the reverse mortgage proceeds? Perhaps you want to make a big purchase, and you lack the funds to do so? Perhaps, you plan to take the proceeds in monthly increments in order to fund day-to-day living expenses? There are no right or wrong answers to these questions: it’s only important to be honest with yourself when answering them.
Next, ask yourself if you really need a reverse mortgage. If not for the reverse mortgage, what sacrifices, if any, would you have to make? Would you still be able to maintain your current standard of living? Would you even be able to remain in your current home? Perhaps you have a primary mortgage that you can only repay with the help of a reverse mortgage?
How does your reverse mortgage fit into your overall financial plan? Depending on your age, the amount you borrow, and fluctuations in housing prices, you may eventually exhaust all of the equity in your home. Can you afford this possibility? If/when you decide to move into an assisted living facility or nursing home, is it realistic to assume that you can pay for this yourself (taking your reverse mortgage into account)?
Along the same lines, ask yourself if there are any reasonable alternatives to the reverse mortgage. Since reverse mortgage are inherently costly (due to a combination of interest, origination fees, and insurance premiums), you should naturally make sure that there does not exist a cheaper option. For example, can you borrow a comparable sum from friend or family member? Are you eligible for a single-purpose reverse mortgage? Can you “downsize” into a less expensive home?
Finally, consider the impact of your reverse mortgage on your estate. Do you plan to leave money/assets to your children as part of your will? If your home has sentimental value for you, does it also have sentimental value for your children? If you obtain a reverse mortgage, will it still be possible for the home to remain with your heirs after your death? Is this even an important consideration?
In short, you want to take very seriously the decision to obtain a reverse mortgage. Once you make the decision, the process of actually obtaining the reverse mortgage is quite straightforward and will be (psychologically) hard to derail once it gets started. That being the case, the HUD-approved counseling session is basically a formality, undertaken right before closing, designed to make sure that you understand the basic mechanics of a reverse mortgage. Before you get to that point, conduct a self-interview and make sure a reverse mortgage is right for you.
Last week, Arizona became the second state (after California) to pass legislation governing reverse mortgages. The legislation is a hot topic of discussion on the blogosphere, but upon closer examination, it can hardly be considered news.
According to its drafters, the legislation was designed to protect borrowers that aren’t covered by federal regulation: A ” ‘significant segment‘ of the reverse-mortgage market is not subject to federal regulations, said Assistant Attorney General Jennifer Boucek…Rep. Bill Konopnicki, R-Safford, who sponsored the Arizona legislation, said it fills a gap in the law.” To be fair, proprietary reverse mortgages should be regulated, but given that they represent such a minuscule portion of total reverse mortgage lending (the majority of borrowers opt for a federally-insured HECM reverse mortgage), this legislation is tantamount in scope to a law regulating people that have alligators as pets.
If you examine the content of the legislation, it is basically a carbon copy of the regulations which already govern the federal Home Equity Conversion Mortgage (HECM). The first provision of the law “Mandates that adequate financial counseling be provided by a counselor who is an independent third party.” It describes in detail what is meant by “independent third party,” and how the borrower and originator can satisfy this requirement, in a manner consistent with federal guidelines.
The second and third provisions outline the structure of any reverse mortgage, though again, there is almost complete harmony with the federal program. Along the same lines, it bans the cross-selling of other financial products, and lists the disclosure which must be provided to borrowers, such as to promote full transparency. The next provision dictates that a borrower cannot be held liable if the balance of the reverse mortgage exceeds the value of the home. The final provision explains how the bill will be enforced and how violators will be punished.
As you can see, there is nothing groundbreaking or worth getting excited about. Basically, the goal of the law seems to be to regulate proprietary reverse mortgage out of existence in Arizona, since no rational lender would originate one that is identical to the federal HECM reverse mortgage, only without the insurance. Remember that the insurance protects the lender, and the only way for a lender to protect itself absent of insurance would be to charge a very high interest rate and/or to hold the borrower liable if the price of their home declines. The latter is now illegal, and the former would be self-defeating.
So, there you have it: your Tax Dollars at work. If more states follow suit, it looks the only reverse mortgage programs that will be available to borrowers (for better or worse) will be those that are administered by the government.
It’s important to read/listen to reverse mortgage sales pitches carefully and to take everything that is said with a grain of salt. That’s not to say that all reverse mortgage ads are dishonest; however, most that I’ve seen push the limits of credulity. It could just be that the sleaziest companies do the most advertising, but regardless, vigilance is crucial.
First of all, reverse mortgages are not a government benefit, and you should be wary of any solicitation that does so much as hint to the contrary. The majority of reverse mortgages are insured indirectly by the government, but this insurance is priced as though it were being underwritten by a private company, and is not subsidized by the government (at least not intentionally). Reverse mortgages themselves are issued and administered by private lenders, and while subject to government oversight/regulation, they are not meted out directly by the government, like social security payments.
Reverse mortgage are NOT free. You might mistakenly assume that this is the case since ads will undoubtedly promise you that that you won’t have to expend any money in order to obtain one and never have to repay the loan. While this is superficially the case, in reality, all of the upfront costs (which are substantial) as well as the interest, are rolled back into the loan and must be repaid after the borrower passes away or moves out.
In addition, don’t be seduced by the pictures of the “happy borrower,” smiling on the beach or from behind the wheel of a new convertible. While it’s true that the proceeds from the reverse mortgage are not subject to any rules regarding how they can be spent, the program was not designed to fund extravagant purchases. It might seem like a great idea to take that vacation that you have been putting off or buying that sailboat that you have been dreaming of. In reality, if you fund such expenditures using a reverse mortgage, consider not only that you are essentially trading your house for them, but also that if you need to tap the equity in your home for more pressing needs later on, the money will no longer be available.
On a related note, don’t be pressured by “special deals.” Lenders might exhort you to “ACT NOW” to take advantage of low interest rates or a temporary waiver of certain fees. They might warn you that insurance premiums will rise and loan limits will fall. In fact, this sense of urgency is deliberately contrived by the lender to drum up business. It’s true that interest rate are low, but nobody knows if/when they will rise. It’s also true that many lenders have lowered there fees, but again, nobody knows if/when they will rise. Meanwhile, loan limits and insurance premiums are constantly being adjusted by the FHA in accordance with actuarial assumptions about housing prices and life expectancy.
Finally, don’t be fooled by personalized ads. Obtaining a reverse mortgage is extremely easy; as long as you are of a certain age and your home equity is above a certain threshold, qualifying is practically automatic. Chances are that the reverse mortgage lender simply obtained your name because you are over the age of 62, and not because of your specific circumstances. In fact, a low credit score might make you especially vulnerable to reverse mortgage solicitation, because lenders will assume you are more desperate for cash.
In short, remember that reverse mortgage ads aim to persuade as much as inform. Before you make a decision, make sure you have all the facts.
The process of obtaining a reverse mortgage is relatively straightforward from the borrower’s standpoint. The role of adult children, however, is slightly more complicated. If your parent(s) is contemplating a reverse mortgage, here are a few considerations:
The first step – and this applies even if your parent is not even considering a reverse mortgage – is to have a frank discussion with your parents concerning their finances. While this seems self-evident, research shows that the majority of adult children have either never had this conversation, or have undertaken the discussion in insufficient depth. Before they begin the application process, then, sit down with your parents and try to understand their reasons for wanting to obtain the reverse mortgage and whether it will adequately address their financial concerns.
If it’s clear after this discussion that a reverse mortgage is the only real option that will satisfy your parents’ needs, you can suggest a handful of less expensive alternatives. For example, you (and/or your siblings) can extend a private reverse mortgage to your parents, thereby eliminating transaction costs and has the added benefit of keeping any interest that will be charged within the family. Their might also be tax benefits that inure to you as the lender. Of course, it’s important to notarize the loan and structure it in legal terms such that it cannot be challenged by other family members. Another possibility is for you to purchase your parents home outright and simply allow them to continue living there. When your parents pass away, the home can be sold or kept, depending on your preference. Assuming you have the means, both of these alternatives will be more economical for your parents, and as an heir, potentially for you as well.
If neither of these possibilities is realistic and your parents are determined to obtain a reverse mortgage, the best thing you can do is to protect their interests. Actually, the first thing to do is to make sure your own interests are protected. Towards this end, you should urge your parents to obtain an insured reverse mortgage so that you (aka your parents’ estate) are not liable for any shortfall, in the event that the sale of the home is not enough to repay the balance due on the mortgage. Fortunately, the federally insured Home Equity Conversion Mortgage (HECM) is widely available, and a foregone conclusion for most borrowers.
If you are concerned that your parents might be taken advantage of, you can accompany them to sign the paperwork as well as to the counseling session(s). It might help your parents to have another set of ears, and you will be in a better position than the lender to provide unbiased advice in the decision-making process. Otherwise, encourage your parents to shop around, so that they get the best deal. For better or worse, the decision to obtain a reverse mortgage is theirs alone, and even if you disapprove, the best thing you can do once the decision has been made is to be supportive and help them through the process.