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.
Last month, I reported that a handful of reverse mortgage lenders had eliminating their servicing fees, in a move that would potentially save borrowers thousands of Dollars. Since then, many other lenders have already followed suit, with some going one step further and eliminating origination fees as well.
At this point, most of the major players in reverse mortgage lending have moved to match the fee cuts in one form or another, including Genworth Financial, Wells Fargo, OneWest Bank’s Financial Freedom, MetLife, and Bank of America. The former four will eliminate the origination fee and service fee set aside (SFSA), while Bank of America will contribute 50% of the reverse mortgage insurance premium. (In practice, these cuts are almost equivalent). All of the lenders have also announced reductions in in the interest rates that they will charge borrowers.
The fee reductions (which could “save” borrowers $10,000+) have unfolded in the context of increased competition and decreasing volume: “From Oct. 1, 2009, to March 31, 2010, home-equity-conversion mortgage volume fell 22% from the same period a year earlier,” perhaps in response to falling home values. Given that reverse mortgages have basically become a commodity financial product, fought over by no less than 1,000 lenders nationwide, shrinking profit margins (in the form of fee cuts) were probably inevitable. In fact, the most recent data shows a slight uptick in volume, which perhaps shows that the cuts are working.
On the one hand, these cuts will probably be appreciated by the borrower. On the other hand, they are not exactly costly from the lender’s standpoint. When you consider that since all reverse mortgages are insured by the FHA (which, then, absorbs all of the risk), the lenders can basically sit back and collect rent (aka interest) risk-free for as long as the loan remains outstanding. The origination and servicing fees were certainly a nice bonus, but not exactly necessary to turn a profit. In fact, the latest trend is for reverse mortgages to be packaged and sold to investors (much like conventional mortgages); in this case, the lender’s responsibility is basically limited to collecting a handful of signatures from the borrower, before passing the reverse mortgage along its way and taking a cut in the process.
Moreover, the so-called savings that borrowers are supposed to realize from the fee reductions are typically rolled into the mortgage to increase the loan amount. Thanks to the structure of reverse mortgages and the law of compound interest, the lender can potentially earn more over the life of the loan by charging you less upfront. For example,$10,000 in savings rolled into the reverse mortgage will grow to $20,000 when the loan needs to be repaid (assuming 5% interest and 15 years), which means that the lender probably comes out ahead.
In short, the only way that you can come out ahead is simply to pocket the savings rather than using them to increase the loan size. For everyone else, these fee reductions might seem like a good deal, but the end result is basically a wash. From where I’m sitting, reverse mortgages are still expensive.
Perhaps more than any other consumer financial product, there is a tremendous amount of misinformation surrounding reverse mortgages. Listed below are ten of the most common misconceptions, printed side-by-side with the truth.
1. Under the terms of a reverse mortgage, the lender owns the property.
This is probably the most common – and most harmful – misconception, and it prevents many would-be borrowers from even seeking information about reverse mortgages. In fact, a reverse mortgage is a loan – just like a conventional mortgage -and the borrower keeps the title to the property. Ultimately, the property may be sold in order to repay the mortgage, but at no point while the reverse mortgage is outstanding does the lender own the property.
2. A reverse mortgage must be repaid in monthly installments, just like a conventional mortgage.
Unlike a conventional mortgage, a reverse mortgage is repaid only when the loan is due, typically when the borrower moves out or passes away. The downside of this structure is that interest will continue to accumulate (aka increase) for as long as the loan remains outstanding.
3. In order to qualify for a reverse mortgage, you need to meet certain credit and income requirements.
The only requirements for obtaining a reverse mortgage are as follows: the borrower must be at least 62 years of age, and the property must be the primary residence. The lender doesn’t care about your credit history or financial position.
4. Upon obtaining the reverse mortgage, all of the funds are meted out to the borrower.
This is only a partial misconception, since all funds will technically become available to the borrower when the reverse mortgage is executed. However, the borrower can choose how he wants to receive them, whether as a lump-sum payment, monthly payments, or line of credit to be drawn from as the borrower pleases.
5. A reverse mortgage will render one ineligible to receive certain government benefits.
I explained the impact of obtaining a reverse mortgage on government benefits in an earlier post. Basically, neither social security nor medicare payments will be affected, but one’s eligibility for certain need-based programs could potentially be impacted if the reverse mortgage proceeds are used for anything beyond monthly expenses.
6. When the home is ultimately sold (if the borrower dies/moves out), any leftover funds (after the reverse mortgage has been repaid) inure to the lender.
When the home is sold, any difference between the sale price and the unpaid balance of the reverse mortgage is distributed to the borrower, or to his heirs/estate. If the home has appreciated in the interim, this should mean that there will be a healthy surplus after such a sale.
7. If the home depreciates and the reverse mortgage is “underwater,” the borrower is liable for the difference.
Reverse mortgages are non-recourse loans, so-called because the lender is legally prevented from seeking any deficiency judgment against the borrower regardless of what happens to the value of the property.
8. Reverse mortgage loans are handled by the government.
Reverse mortgage loans are not a government benefit, and are not arranged by the government. The government’s role (via HUD and its subsidiary, the FHA) in reverse mortgages is to insure them against default.
9. It is the responsibility of the lender to pay homeowners insurance and property taxes.
In fact, the borrower’s only financial responsibilities are to continue paying homeowners insurance and property taxes, as well as to maintain the property in accordance with the law. Failure to do so could trigger a breach in the terms of the loan, and even lender foreclosure.
10. There are rules stipulating how reverse mortgage funds can be used.
Proceeds from a reverse mortgage can be used freely by the borrower for any purpose. While spending “frivolously” is certainly not advisable, it is technically still the borrower’s right to do so.
Thankfully, there seems to be very little confusion now that a reverse mortgage – while insured indirectly by the government – is itself NOT a government benefit. Many borrowers, however, don’t understand how obtaining a reverse mortgage will affect their actual government benefits.
Since reverse mortgage borrowers are necessarily of retirement age, this is potentially a serious issue. After all, the goal of a reverse mortgage is to supplement one’s entitlement income and retirement savings. Thus, it would be counter-productive, if not disastrous, if the funds obtained from a reverse mortgage suddenly rendered one ineligible for other benefits.
Fortunately, there seems to be very little impact of obtaining a reverse mortgage on one’s primary entitlement benefits. With social security, the amount that you receive is generally proportional to the amount that you paid into the fund while you were working, so any additional income you receive after you’ve retired won’t affect your entitlement. The same is generally true for Medicare; once you qualify, it doesn’t really matter what your financial position is, from the standpoint of the government.
On the other hand, obtaining a reverse mortgage can definitely impact your eligibility for need-based programs, such as Medicaid, Food Stamps, etc. When computing these benefits, the government will take all of your income into account, including funds received from a reverse mortgage. However, if these funds are relatively modest, and if you typically spend your disbursement in the same month that you receive it, you may able to claim them as cost-of-living funds (as opposed to disposable income). In this case, your should still be eligible to receive your government funds.
For all of these benefits, you should consider that the government will probably have to make some tough decisions in the next couple decades in order to make sure that they remain functioning. That probably means that they will become more aggressive in determining who actually needs these funds, irrespective of who is entitled to them. Fortunately, this kind of scrutiny is still many years away, and for now, you can rest assured that obtaining a reverse mortgage probably won’t affect your access to government benefits.
Of course, it’s probably wise to speak with the various administrators of your benefit programs (as well as an attorney) before obtaining a reverse mortgage, just to be on the safe side.