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1 Reverse Mortgages Think Before You Leap By Vicki Kasomenakis, MS, CSA, CPA, CFP Reverse mortgages are one of the largest growth areas in the mortgage industry. These mortgages allow older homeowners to convert part of the equity in their homes into cash which can be used for any purpose without having to sell their homes or to make monthly loan payments. Reverse mortgages can be complex and confusing; but when fully understood and used properly, these mortgages can be a positive addition to a retirement plan. Reverse mortgages are becoming a hot trend in both the financial and mortgage world. It seems as if everywhere you turn there are free seminars, literature, and TV commercials touting the incredible benefits that reverse mortgages offer. Indeed, many financial planners are recommending reverse mortgages as a mainstream financialplanning tool for homeowners who are age sixty-two and older. The predominant claim about reverse mortgages is that they may allow seniors to transform part of the equity in their homes into cash. The loan proceeds can be used to supplement a senior s retirement income to pay for daily living expenses and pay off existing debts, or simply as a cash reserve to be used for any purpose without losing home ownership. Reverse mortgages are loans against the home that must be repaid when the borrower sells the home, permanently moves out of the home, or dies. Reverse mortgages are becoming increasingly popular among low-income seniors who want to remain in their homes, are house-rich but cashpoor, or are looking for ways to enhance their financial resources in order to make ends meet. A reverse mortgage can be a powerful tool to help seniors secure living arrangements in their homes and maintain independence. For wealthier retired seniors, a reverse mortgage can be a key financial strategy to maintain preretirement standards of living, purchase longawaited luxury items, or go on a dream vacation. The possible uses of the loan proceeds from a reverse mortgage are unlimited (Reed 2008). Differences between Reverse and Conventional Home Mortgages Think of a reverse mortgage as the mirror image of a conventional mortgage. In a conventional mortgage, a homeowner pays a monthly amortized amount over a specific period of time. With each payment, there is a gradual decrease of the amount of debt owed and a gradual increase in the amount of equity in the home. Reverse mortgages are the opposite. They allow homeowners age sixty-two and older to convert some of their home equity into cash without selling or moving out of the home. Over time, as cash advances are made and interest accumulates, the loan balance grows and the equity declines. This is the reason reverse mortgages are also known as home equity conversion loans. Reverse mortgages do not have predetermined maturity dates like traditional mortgages. Many people confuse home equity conversion loans with home equity loans. They are not the same. In a home equity loan, homeowners are required to have sufficient income to support the loan, and payments must be made to the lender on a monthly basis. For those older adults living on limited fixed incomes, a home equity loan may not be the best option for them, simply because they may not be able to afford the monthly loan payments. Unlike conventional home mortgages, loan approval for a reverse mortgage isn t based on income and credit eligibility. Instead, eligibility is generally based on age, home ownership, and CSA Journal 41 December

2 if the borrower occupies the property as a principal home residence. Fiction versus Fact When it comes to reverse mortgages, it is helpful to separate fact from fiction. The following examples address some of the most frequent misunderstandings surrounding home equity conversion loans: Fiction: The lender gets possession of the house. Fact: The borrower/homeowner retains the title to the property throughout the term of the reverse mortgage and cannot be forced to sell the property for purposes of repaying the loan. This holds true as long as the borrower maintains the home in reasonable condition and pays the property taxes and homeowners insurance. Fiction: Proceeds received from a reverse mortgage will affect Social Security and Medicare benefits. Fact: Proceeds received from a reverse mortgage are a return of equity. As a result, they are considered to be tax-free and do not affect Social Security and Medicare benefits. Fiction: There are restrictions on how the loan proceeds can be used. Fact: Money received from a reverse mortgage can be used for any purpose. There are no restrictions on how the loan proceeds can be used. Many people use the money to pay for the following: In-home care Adult day care Prescription drugs Credit card debt Improvements and repairs for the home Luxury purchases Travel Fiction: The borrower ends up owing more than the home is worth. Fact: If the sale price of the property is less than the sum of the loan plus the interest, the lender is obligated to accept it and cannot go after the borrower s other assets for the deficiency. In other words, when the proceeds from the sale of the home are insufficient to pay off the loan plus the interest, the lender will absorb the loss. The borrower or the borrower s estate will never owe more than the value of the property. Fiction: The borrower must own the home free and clear in order to quality for a reverse mortgage. Fact: The borrower does not need to own the home free and clear in order to apply for a reverse mortgage. As long as there is sufficient equity in the property, the lender will require that any other existing mortgages and liens be paid off before or upon closing of the reverse mortgage agreement. Fiction: There will be no estate for the borrower s heirs, and the heirs may even owe money. Fact: As mentioned previously, the amount owed on a reverse mortgage plus the accumulated interest will never exceed the value of the home. If the home has appreciated in value, chances are that the sales proceeds will be greater than the loan balance plus accrued interest. Should there be any cash left over after the house has been sold, the excess proceeds can be passed on to the borrower s heirs. Fiction: Proceeds received from a reverse mortgage are taxable. Fact: Payments received from a reverse mortgage are considered cash advances against the equity of the home and not income that is earned. As a result, the cash proceeds received are tax-free. Fiction: One must have good credit and sufficient income to qualify for a reverse mortgage. Fact: Unlike a conventional home mortgage, the borrower s income and credit will not affect one s eligibility when applying for a reverse mortgage. However, the lender will request a credit report to ensure that the borrower doesn t 6 CSA Journal 41 December 2008

3 owe any money to the government or have any other existing mortgages or liens on the property. The amount of money available will generally depend on the value of the home, government or lender limits, borrower s age, current and future interest rates, and fees collected by the lender and intermediary parties. Fiction: Reverse mortgages aren t costly. Fact: Reverse mortgages can have very high upfront costs. If the borrower intends to remain in the home for a short period of time, then the value from the reverse mortgage may not justify the costs. This especially holds true for those who are considering downsizing in a couple of years or will need to move into an assisted-living facility or nursing home. Perhaps a home equity loan would be a better choice. On the other hand, if the borrower intends to remain in the home for a long period of time and uses the cash advances to pay for something that would have been a hardship to manage, then the cost of a reverse mortgage may be worth the value. The time frame for holding a reverse mortgage is critical. It is very important to do the calculations in order to determine how much the reverse mortgage will cost against the amount of cash received. Fiction: Proceeds from a reverse mortgage will not affect Medicaid and Supplemental Security Income benefits. Fact: Depending on what state the person lives in, the proceeds from a reverse mortgage could be a barrier to qualify for Medicaid and Supplemental Security Income benefits because loan proceeds may count as an asset or be considered as income. The current consensus is that if the loan proceeds are spent down in the month they are received, they will not be considered as income. As a result, benefits should not be affected. On the other hand, if loan proceeds aren t spent down in the month they are received, the funds may be counted as a resource and can terminate the Medicaid and Supplemental Security Income (Boroson 2006). General Requirements To qualify for a reverse mortgage, most of the existing mortgage of the home must be paid off. Income is generally not considered, and medical exams or medical history aren t required to apply. Homeowners must occupy the home as a primary residence for the majority of the year. Single-family one-unit dwellings are generally eligible properties for all types of reverse mortgage programs. Some programs also accept twoto four-unit owner-occupied dwellings. In addition, condominiums, planned unit developments, and manufactured homes may be considered as eligible properties. However, mobile homes and cooperative units are usually not eligible properties. Most reverse mortgage programs require the potential borrower to meet with a reverse mortgage counselor before the loan application is processed. Age The borrower must be at least sixty-two years of age or older to qualify for a reverse mortgage. If the property is jointly owned, both parties must be at least sixty-two. A younger owner can be removed from the title of the property to allow the older owner to qualify for the reverse mortgage. However, this strategy is not particularly recommended, because the death of the older owner is one of the triggers where repayment of the loan must be made in full. This may put the younger owner in a very compromising position, especially if the younger owner has occupied the home as his or her primary residence. The estate of the deceased may be forced to sell the home in order to pay back the loan. The younger owner, as a result, may not have a place to live. Life expectancy is just one of the factors that is used to determine how much to lend a potential borrower. The older the borrower is, the greater the loan proceeds will be, because the term of the loan will generally be shorter. CSA Journal 41 December

4 Property The potential borrower must own the home, but the property doesn t have to be owned free and clear in order to apply for a reverse mortgage. However, to protect the lender s security interest in the property, the owner must pay off any existing mortgage or liens on the property before or upon closing. In addition, the potential borrower cannot be delinquent on any federal debt (student loans, federal taxes, Veterans Affairs, and Small Business Administration loans). Also, there can be no bankruptcy proceedings. The potential borrower must occupy the property as a primary principal residence. In other words, the potential borrower must live in the home for at least six months of the year and not vacate the property for more than twelve months. During the term of the loan, the borrower may reside elsewhere for a maximum of twelve consecutive months due to illness. If it is likely that the borrower won t return home at the end of that period, the loan is due and payable because the home will no longer be considered owner occupied. Costs Associated with Reverse Mortgages Myriad fees and costs are associated with a reverse mortgage, and the amounts will vary depending on the type of reverse mortgage program. Generally speaking, reverse mortgages are more costly to set up than traditional loans. Typical costs that will be incurred to obtain a reverse mortgage include: Origination fee Closing fees Monthly service fees Mortgage insurance premium (applicable to certain types of reverse mortgages) Interest costs Finance charges Origination Fee The origination fee is a one-time charge that the lender imposes for preparing and processing the loan. Costs do vary among lenders; however, they may be negotiated. Certain reverse mortgage programs have regulation limits on the origination fee. Closing Fees Closing refers to a meeting that is held to sign legal documents to close the deal. In other words, it is the final step taken to complete the transaction. This step requires the services of many professionals in addition to the lender. Some of these common services include: Appraising and inspecting the property Conducting a title search on the home Obtaining insurance Retrieving credit reports Recording the mortgage The fees charged for these services are known as third-party closing costs. Payments are generally made at the time the services have been rendered. Borrowers have the option, however, to ask for reimbursement at the time of closing and request that these charges be added to the loan balance. When this election is made, interest will be charged on these costs. Monthly Service Fees A monthly service fee is what the lender charges to maintain the loan after closing. For example, during the course of the loan, the lender processes loan advances, changes payment options, and sends account statements to the borrower. Mortgage Insurance Premium Reverse mortgages are non-recourse loans. They are structured so that the borrower or the borrower s estate can never owe more than the value of the home when the debt is due to be repaid. 8 CSA Journal 41 December 2008

5 In addition, the lender has no recourse against any other assets that the borrower may own to be used to repay the reverse mortgage loan. With certain types of reverse mortgages, the borrower will have to pay mortgage insurance. This cost is incurred in order to protect the lender from the risk that the loan balance will exceed the property value when the loan becomes due. For example, should property values decline, the proceeds from the sale may be insufficient to pay off the loan and other related expenses. Because there is insurance, the lender will submit a claim to recover the deficiency. The lender recovers only what is actually owed. In addition, the insurance premium ensures that the borrower will receive promised loan disbursements. The mortgage insurance premium is a one-time payment that is due at the time of closing. There is also a monthly component, which is a certain annual percentage that is applied to the outstanding loan balance. Interest Costs Interest is the price the borrower must pay for borrowing money from the lender. Almost all of the costs and fees previously mentioned could be paid from the loan proceeds, which will reduce the borrower s out-of-pocket expenses. However, this will also reduce the amount of cash that will be made available. In addition, since these costs are added to the loan balance, interest will be charged on them. Finance Charges Virtually all reverse mortgages are adjustable-rate mortgages, which means that the interest rate charged on these loans will fluctuate over time. Most reverse mortgage interest rates have a lifetime adjustment cap. This means that the interest rate cannot increase by a certain percentage from the original interest rate over the life of the loan. Disbursement Options The borrower can choose from a variety of payment options when receiving cash from a reverse mortgage loan. The different options allow borrowers to customize the receipt of funds that best suits their financial situation. Those payment options include: Lump sum Tenure Line of credit Modified tenure Modified term CSA Journal 41 December

6 Under a lump-sum payment option, the entire principal amount is received at the time of closing. A tenure payment plan is one where monthly payments are made for life. With a line of credit, unscheduled payments are made at times and in amounts of the borrower s choosing until the line of credit is exhausted. A modified tenure option plan is a combination of line of credit with equal monthly payments being made for life. Lastly, with a modified term option plan, a combination of line of credit is made available with monthly payments made for a fixed period of time. Counseling Most reverse mortgage programs require that the potential borrower meet with a counselor before the loan application can be processed. The counseling sessions are generally free and provide a wealth of information to help potential borrowers make an informed decision as to whether or not a reverse mortgage is right for them. The borrower has the right to cancel the loan for any reason up to three business days after the loan has been closed. Cancellations must be made in writing (Kraemer and Kraemer 2007). Repayment and Termination Unlike conventional mortgages, the borrower doesn t have to make monthly mortgage payments. However, the loan needs to be repaid at some point in time. The entire loan balance must be paid off in full when one of the following occurs: The last surviving borrower dies. The last surviving borrower sells the home. The last surviving borrower ceases to use the home as a primary residence. The borrower violates the acceleration clause provision as indicated in the loan agreement. The lender has the right to demand payment of the entire loan when the borrower breaches a provision of the loan agreement. This is known as an acceleration clause. Some of the common violations that will give the lender the right to collect the entire outstanding debt include: Not reasonably maintaining the home Not having homeowners insurance Failing to pay real-estate taxes Donating the home to a charitable organization Filing for bankruptcy Obtaining a new debt against the home Adding another owner to the title of the property Committing fraud and making a misrepresentation Popular Reverse Mortgage Plans The three most popular reverse mortgage plans available today are: Federally insured loans Proprietary loans Proprietary jumbo loans Federally Insured Reverse Mortgages The most popular federally insured reverse mortgage plan available today is known as the Home Equity Conversion Mortgage (HECM). HECMs were created by the U.S. Department of Housing and Urban Development (HUD) and are insured by the Federal Housing Administration (FHA), which means that the borrower will never owe more than the house is worth. In addition, borrowers are guaranteed by the federal government that they will receive all cash advances promised to them in the event the lender defaults or fails to make payments. In recent years, growth in the HECMs has been very rapid because they are available in every state, including the District of Columbia and Puerto Rico. Eligibility requirements. In order to be eligible for an HECM loan, a borrower must meet the following criteria: 1. All persons named on the property s deed must be age sixty-two or older. 2. The home must be a single-family residence or a one- to four-unit dwelling. Condominiums that are FHA approved are 10 CSA Journal 41 December 2008

7 also eligible for HECMs. In addition, planned unit developments and manufactured housing that meet FHA standards are also eligible. Mobile homes and cooperative units (except in New York City) are not eligible for HECMs. 3. The home must meet FHA minimum property standards. If the standards aren t met, the potential borrower may be required to repair any problems. HECM loan proceeds can be used to pay for repairs. It is important to note that if the estimated repairs are less than 15 percent of the maximum loan amount, the repairs can be completed after closing. On the other hand, if the estimated repairs are greater than 15 percent of the maximum loan amount, repairs must be completed before closing. For those homes needing estimated repairs greater than 30 percent of the maximum loan amount, the home will not qualify for an HECM. 4. At least one owner must use the home as his or her primary residence. The owner must live in the home for at least six months out of the year. The owner may reside elsewhere for a maximum of twelve consecutive months due to illness. Absence from the home beyond this period of time will trigger immediate payment of the entire loan amount because the home will no longer be considered owner-occupied. 5. Since an HECM is a government loan, the potential borrower cannot owe any type of federal debt (federal student loans, federal taxes, etc.). In addition, any debts secured by the home must be settled at or before closing. Most borrowers use the HECM loan proceeds to pay off such debts at closing. 6. The potential borrower must discuss the HECM program with a HUD-approved counselor. The lender will provide a list of approved counselors that are located within the borrower s state. The counselor will go over the financial implications and discuss alternatives (Kraemer and Kraemer 2007). Amount of loan. The lender determines the amount of proceeds that is made available to a borrower by utilizing a HUD formula that takes into consideration the following information: Age of the homeowner Appraised value of the home Current interest rates Generally, the older the borrower, the more cash will be available. If the home has more than one owner, the age of the youngest one is taken into consideration. In addition, the greater the appraised value of the home, the more cash is made available. However, the value is subject to the 203(b) limit, which is the current maximum loan amount for which the FHA will insure a family residence. The amount will vary based on the geographical location of the home and on the median home value. Due to fluctuations in the cost of living, the 203(b) limit changes periodically. If the home s appraised value is greater than the 203(b) geographical limit, the amount of the loan is based on the 203(b) geographical limit rather than the home s appraised value. CSA Journal 41 December

8 The final piece of information needed to determine the amount of available loan proceeds is current interest rates. In general, the lower the interest rates at the time of closing, the greater the loan amount will be. The interest rate is not the actual rate charged to the borrower but is a rate that HUD requires lenders to use in order to calculate the principal limit. For adjustable-rate loans, the interest rate is the sum of the ten-year U.S. Treasury Security plus the lender s margin. Interest rates. Virtually all HECMs are adjustablerate mortgages (ARMs), which means that the interest rate changes at specific intervals over the term of the loan. HUD defines the formulas used to set the adjustable rates. HECM borrowers do, however, have a choice on how often the interest rate changes. They can choose from an annually adjusting rate or a monthly adjusting rate. The annually adjusting rate is based on the current one-year U.S. Treasury Security rate plus the lender s margin, and it is subject to change once a year based on the increases or decreases in oneyear U.S. Treasury rates. The interest rate change is capped at 2 percentage points per year and 5 percentage points over the term of the loan. The monthly adjusting rate is also based on the current one-year U.S. Treasury Security rate plus the lender s margin. The rate is subject to change once a month based on the increases or decreases in one-year U.S. Treasury rates. The interest rate change, however, is limited to 10 percentage points over the term of the loan. Payment options. HECMs have a variety of payment options to choose from, which makes them so attractive. The payment options are: Monthly tenure plan Monthly term plan Line of credit plan Modified tenure plan Modified term plan A monthly tenure plan provides equal monthly payments for life. This option may be best suited for those who need additional cash on a regular basis. Borrowers may discontinue the monthly payments at any time and resume the monthly payments when the need arises. A monthly term plan provides equal monthly payments for a predetermined number of months, which is selected by the borrower. This option may be best suited for those who need additional cash for a specific period of time. The monthly payments under this option are generally higher than the tenure payment plan. A line of credit provides unscheduled payments at times and in amounts of the borrower s choosing until the line of credit is exhausted. Interest is not charged on the undistributed funds, but rather it is calculated only on the funds withdrawn. One of the unique features of the HECM line of credit option is that the undistributed funds grow, increasing the amount of cash that is made available to the borrower. This option is best suited for those who don t need all of the funds but want to have a cash reserve available to use for some special event, to cover unexpected expenditures, or to have in the event of a temporary loss of regular income. The modified tenure plan provides a combination of an equal monthly payment for life with a line of credit. This option is best suited for those who want additional monthly income but also want an available cash reserve to cover unexpected expenditures. A modified term plan provides a combination of a fixed monthly payment plan with a line of credit. This option is best suited for those who want additional monthly income for a specific period of time and want an available cash reserve to cover unexpected expenditures (Talamo 2005). Costs. There are numerous costs and fees associated with the HECM loan. These costs are as follows: Origination fee Closing costs Monthly service fee Mortgage insurance premium As mentioned previously, the origination fee is a one-time charge the lender imposes for prepar- 12 CSA Journal 41 December 2008

9 ing and processing the loan. Costs vary among lenders. However, the HECM origination fee has a regulation limit. This limit is the greater of $2,000 or 2 percent of the home value or the 203(b) limit, whichever is less. Closing costs include fees that must be paid to various professionals for conducting an appraisal and inspection of the home, retrieving credit reports, recording the mortgage, and so forth. These closing costs may be added to the loan balance. However, this will reduce the principal amount of the loan made available. In addition, interest will be charged on these costs. The monthly service fee is what the lender charges to maintain the HECM loan beyond closing. These costs include keeping records, printing up account statements, making loan advances, and the like. HECM monthly service charges have a regulation limit, which is capped at $30 per month for those loans with annually adjustable interest rates and $35 per month for those loans with monthly adjustable interest rates. There is a one-time mortgage insurance premium that must be paid at closing. In addition, there is a monthly charge component. These costs are only incurred on HECM loans, and regulation limits are imposed on these charges. Specifically, there is a one-time premium of 2 percent of the home value or 2 percent of the 203(b) limit, whichever is less. The monthly component is based on an annual rate of 0.5 percent of the outstanding loan balance. Loan due date. The HECM loan doesn t require monthly principal and interest payments. Instead, the loan plus the accrued interest must be repaid in one full payment when one of the following events occurs: Borrower dies Borrower moves from the home Borrower sells the home Borrower breaches the loan agreement The borrower has the option to repay the loan in full or in part at any time. Because HECMs are non-recourse loans, the borrower can never owe more than the value of the home. If the loan balance exceeds the home s appraisal value, the lender must accept the market value of the home as repayment in full. The lender has no recourse against any other assets owned by the borrower for the deficiency. The mortgage insurance premium will protect the lender for the shortfall in loan balance. Proprietary Reverse Mortgages Proprietary reverse mortgages are private loans that are backed by the companies that issue them. They were created to serve the needs of individuals with property values substantially higher than the HECM 203(b) geographical limit. The Federal National Mortgage Association, also known as Fannie Mae, is a private non-bank financial services institution that has been incorporated by Congress. It offers the most recognized proprietary reverse mortgage called the Home Keeper Mortgage. Fannie Mae does not lend out money but instead works with lenders and insurers. In the event that the lender fails to make the cash disbursements to the borrower, Fannie Mae will step in to ensure that the borrower receives the reverse mortgage proceeds. Eligibility requirements. In order to be eligible for a Fannie Mae Home Keeper Mortgage, the potential borrower must meet the following criteria: 1. All individuals named on the deed of the home must be age sixty-two or older. Unlike the HECM, the number of borrowers is limited to three people. 2. The home must be a single-family residence, a condominium, or a planned unit that meets Fannie Mae s requirements. In addition, manufactured housing and townhouses may qualify if they meet Fannie Mae s requirements. Two- to four-unit dwellings, mobile homes, and cooperative units are generally not eligible. Properties needing repairs in excess of 15 percent of the property value may not be eligible. CSA Journal 41 December

10 appraised value of the home, and the adjusted property value to determine the principal limit that will be made available to the borrower. As with an HECM, the older the borrower, the more cash will be made available. In addition, the greater the appraised value of the home, the higher the loan limits. Fannie Mae also requires the consideration of an adjusted property value, which is the lesser of the appraised value of the home or Fannie Mae s national lending limit. A homeowner with a high-value home located in a geographical area with a low HECM 203(b) limit may be able to borrow more money under a Home Keeper loan. 3. All borrowers must use the home as their primary residence. This means that they must live in the property as a home and not vacate the premises for more than twelve consecutive months. 4. Any debts secured by the home must be settled prior to closing. As with an HECM, most borrowers may use the loan proceeds to pay off any debts that are secured by the property. 5. Each potential borrower must attend a counseling session before the loan application is processed. The counseling session must be approved by Fannie Mae. The job of the counselor is to cover the financial implications of the loan and to discuss possible alternatives (Kraemer and Kraemer 2007). Amount of loan. The Fannie Mae Home Keeper Mortgage offers a higher national limit than the HECM 203(b) geographical limit. Currently the national maximum loan limit for a singlefamily reverse mortgage is $417,000. This figure changes every year and is based on the national average of home prices. Borrowers are not guaranteed that they will receive the maximum loan limit amount. Lenders will utilize three factors such as the borrower s age, the Interest rates. Similar to the HECM, the Fannie Mae Home Keeper loans are adjustable-rate mortgages, which means that the interest rate charged on the principal amount will change at specific intervals over the term of the loan. The interest rate is based on the one-month negotiable certificates of deposit offered in the secondary market, plus a margin as imposed by Fannie Mae. These loans have a lifetime adjustment cap of 12 percent. This means that the interest rate cannot exceed more than 12 percentage points above the original interest rate over the term of the loan. Payment options. Unfortunately, with a Fannie Mae Home Keeper Mortgage, the payment options are somewhat limited as compared to an HECM. These payment options include the following: Monthly tenure plan Line of credit plan Modified tenure plan A monthly tenure plan provides equal monthly payments for life. As it is with an HECM, this option may be appropriate for those who need a stream of income on a regular basis. 14 CSA Journal 41 December 2008

11 The line of credit option, just like for an HECM, provides unscheduled payments at times and in amounts of the borrower s choosing until the entire principal is exhausted. Unlike an HECM, the line of credit does not have a growth feature. The established loan amount will remain the same over the life of the loan. This option may serve well for those individuals who want available cash whenever they need it. Keep in mind that if the line of credit is fully paid off, it will automatically be terminated. It s recommended that a minimum balance be kept outstanding if the borrower intends to use the line of credit again in the near future. A modified tenure plan provides a combination of an equal monthly payout for life with an existing line of credit. Borrowers make their selection of payment options at the time of closing. Payment plans can always be changed. Costs. As with any other type of reverse mortgage plan, there are numerous fees and costs that will be incurred. These expenditures include the following: Origination fee Closing costs Monthly service fee The origination fee is a one-time charge that the lender imposes for preparing and processing the loan. As it is for an HECM, the Fannie Mae Home Keeper origination fee is capped. That is, the fees that can be charged by a lender are $2,000 or 2 percent of the adjusted property value or purchase price of the home, whichever is greater. The closing costs may be added to the loan balance. However, interest will be charged on these costs. The monthly service fee covers the cost to maintain the loan, such as maintaining records, formulating account statements, and processing cash disbursements. The fees range anywhere from $15 to no more than $35 per month. The Fannie Mae Home Keeper Mortgage does not charge a mortgage insurance premium. This is the primary reason the overall fees and costs associated with this type of mortgage are generally lower than for the HECM. Loan due date. As it is for an HECM, the Fannie Mae Home Keeper loan doesn t require monthly principal and interest payments. Borrowers can continue to live in their homes without making any loan payments. The loan, however, must be paid off in full when the borrower: Dies Moves permanently from the home Sells the home Breaches the loan agreement There is no penalty when the loan is paid off entirely or partly. Because of the non-recourse feature of these mortgages, the borrower will never owe more than the value of the property. In the event that the loan balance exceeds the home s appraised value, the lender must accept the market value of the home as payment in full. The lender has no right to place any liens on other property that the borrower may own. Purchasing a new home. The most unique offering of a Home Keeper Mortgage is that it allows borrowers to purchase a new home from the equity of their old home without making any monthly payments. Like other types of reverse mortgages, Home Keeper loans require no income verification. Because of this feature, this may be the only opportunity for many retirees to acquire a new home that better suits their needs. Since the equity of the old home is used to purchase a new home, the borrower will not get any cash disbursements. As a result, borrowers must have other sources of income in order to cover their living expenses during their life expectancy. Proprietary Jumbo Loans Proprietary jumbo loans are also private loans backed by the companies that issue them. They were created to serve the needs of individuals whose property values exceed the HECM 203(b) geographical limit and Fannie Mae s national limit. CSA Journal 41 December

12 Proprietary jumbo loans typically have no lending limits and are especially attractive to homeowners who want to remain in their higher-valued home and take advantage of the appreciated equity. Financial Freedom is the largest reverse mortgage specialist that offers one of the most popular proprietary jumbo reverse mortgage loans called the Cash Account Advantage Plan. Eligibility requirements. In order to be eligible for the Cash Account Advantage Plan, the potential borrower must satisfy the following requirements: 1. All individuals named on the deed of the property must be at least sixty-two years of age or older. 2. Unlike the HECM and the Fannie Mae Home Keeper Mortgage, Financial Freedom accepts a wide array of properties. Qualifying ones include: Single-family dwellings One- to four-unit rental dwellings (the potential borrower must live in one of the units) Condominiums (no limits in a development) Cooperative apartments located in New York State Manufactured homes Planned unit developments 3. As with most types of reverse mortgage programs, all borrowers must use the home as a primary residence. They must live in the property as a home and not intend to leave the property for more than twelve consecutive months. 4. Similar to an HECM and Fannie Mae Home Keeper Mortgage, any debts secured by the home must be paid prior to closing. However, loan proceeds can be used to pay off such existing debts. 5. Each potential borrower must meet with a Financial Freedom approved counselor before the loan application takes place. One of the drawbacks with the Financial Freedom Cash Advantage Plan is that it is not offered in all parts of the United States. These types of mortgages are available in most areas that have high home values (Kraemer and Kraemer 2007). Amount of loan. The total available loan amount is determined by the age of each borrower, interest rates, and the appraised value of the home. What distinguishes the Cash Account Advantage Plan from other types of reverse mortgage plans is that it has virtually no loan limits. As a result, it generally allows borrowers to convert a much higher percentage of their appreciated property into cash. Interest rates. As with other types of reverse mortgages, the Cash Account Advantage Plan is an adjustable-rate mortgage (ARM). The interest rate is based on the six-month London Interbank Offered Rate (LIBOR) index plus a margin imposed by Financial Freedom. The LIBOR index is the rate of interest at which banks offer to lend money to each other in the wholesale money markets in London. LIBOR is the equivalent of the federal funds rate and is used as a benchmark for other short-term interest rates all over the world. The Cash Account Advantage Plan has an adjustable cap of 6 percent, which means that the interest rate can never increase more than 6 percentage points above the original interest rate over the term of the loan. Payment options. The Cash Account Advantage Plan only has one payment option, which is a line of credit. Undistributed funds will grow at a compounding rate of 5 percent per year. Even though there may be only one payment plan, there are three options the borrower can choose from to receive the funds under the line of credit plan: Credit line Combo Cash out The credit line option provides the most flexibility but is the most costly of the three choices. Continued on page CSA Journal 41 December 2008

13 Pros and Cons of Reverse Mortgages For most Americans, their largest assets are their homes. It s impossible to ignore the power of this viable asset to help seniors fund their retirement by potentially tapping into its equity via a reverse mortgage. But is this a wise idea? It can make sense for some people, but for others it may not be the best avenue to take. There are many benefits and drawbacks to using a reverse mortgage, and it s important for candidates to weigh them very carefully before such a strategy is implemented. Some of the pros in utilizing a reverse mortgage include the following: Reverse mortgages allow older homeowners to draw cash from the equity in their home without having to sell or relinquish ownership. If the borrower continues to live in the home, the loan doesn t have to be repaid. However, the entire loan must be paid in full when the borrower dies, sells the property, no longer lives in the home, or breaches the loan agreement. Reverse mortgages do not require potential borrowers to have income in order to qualify. Individuals can get a reverse mortgage regardless of their current credit situation. Most reverse mortgage programs have flexible cash-payment options. The amount owed, including interest, can never exceed the value of the home. If the value of the home is greater than the cost of the reverse mortgage, the borrower or the borrower s estate will be entitled to the difference. Payments received from a reverse mortgage do not affect Social Security or Medicare benefits. Payments received from a reverse mortgage loan are tax-free. A reverse mortgage is ideal for those seniors who are on a limited fixed income and need to supplement their income. The extra cash flow can help maintain or boost the senior s standard of living. There are no restrictions on how the loan proceeds can be used. Many seniors can save their homes from foreclosure by utilizing the equity in their home to pay off delinquent property taxes or to pay off existing mortgages. Heirs can repay the reverse mortgage debt so that the home can remain in the family. Seniors can remain in their home for the rest of their lives. The reverse mortgage debt doesn t have to be repaid until the borrower permanently moves out of the home or dies. Generally, the older the homeowner, the more the homeowner can borrow against the equity of the home. Reverse mortgage interest rates have lifetime adjustment caps. Some of the cons in utilizing a reverse mortgage include the following: Borrowers have to pay numerous fees to obtain a reverse mortgage, which can be much higher than a conventional mortgage. Fees will vary on the type of reverse mortgage program selected and the lender. Reverse mortgage lenders limit their loans below the property s appraised value in order to reduce their risk. This helps ensure that there will be enough equity remaining to pay off the loan. There are age restrictions to obtaining a reverse mortgage. Applicants must be at least sixty-two years old to qualify. Borrowers are responsible for maintaining the home in good condition, paying their property taxes in a timely manner, and paying homeowners insurance. Potential borrowers must attend counseling sessions before applying for a reverse mortgage. Even though the proceeds received from a reverse mortgage are tax-free, it could negatively affect the borrower s eligibility for need-based public benefits, such as Supplemental Security Income and Medicaid. There may be a family feud if the borrower s heirs expect to inherit the home but later discover that the bank has a substantial claim against the home. Interest incurred on a reverse mortgage loan is compounded and isn t tax deductible until the loan is paid off in full or partially. For those borrowers who choose a monthly payment option, the payments do not increase from year to year. The effects of inflation can erode the purchasing power of these payments. When cash is taken out against the equity of the home, interest may be charged on a monthly basis. The accumulated interest can significantly reduce the remaining equity. The interest rate charged on a reverse mortgage is not fixed but is variable. As a result, interest charges will fluctuate (Boroson 2006). CSA Journal 41 December

14 This option works like a revolving line of credit. The origination fee charged to set up this plan is the lesser of 2 percent of the total loan amount or $2,500. The minimum amount of each cash withdrawal is $500. Unused funds will grow at 5 percent per year. No penalties are imposed for full or partial prepayments. Under the combo option, borrowers must withdraw at least 75 percent of the loan amount at the time of closing, with a minimum of $200,000. As with the credit line option, the minimum amount of each cash withdrawal is $500. The undistributed funds will grow at 5 percent per year. There is no origination fee under this option and there are no penalties for partial or full prepayments. With the cash-out option, borrowers must withdraw 100 percent of the loan amount at the time of closing, with a minimum of $275,000. There are no origination fees and closing costs associated with this option. In addition, there is no penalty for full prepayments, but there are penalties for partial prepayments that are made during the first five years of the loan. The unique feature available with all three options is called equity choice. Equity choice is a value-added feature that allows borrowers to protect a minimum of 10 percent up to a maximum of 50 percent of their home equity. This feature assures that a certain percentage of equity will remain for the borrower or heirs when the loan becomes due. When the borrower elects this feature, it means that the amount of the loan or the line of credit may be less than the amount for which the borrower otherwise qualifies. Costs. Similar to other types of reverse mortgages, there are numerous costs and fees associated with setting up and maintaining a Cash Account Advantage Plan. These costs include: Origination fee Closing costs Monthly service fee Some costs can be eliminated depending on which particular payment option the borrower chooses under the line of credit. The origination fee for the Cash Account Advantage Plan is a one-time charge that covers the lender s cost of preparing the application and processing the loans. The fee is capped just as it is for the HECM and Fannie Mae Home Keeper loans. The cap is the greater of $2,500 or 2 percent of the maximum loan amount. This differs from HECM and Home Keeper loans, where it is the percentage of the home s value. As mentioned previously, the origination fee will be waived if the borrower chooses the combo payment option or the cash-out payment option under the line of credit. Closing costs that apply to other types of reverse mortgage programs will also apply to the Cash Account Advantage Plan. However, borrowers who choose the cash-out payment option under the credit line will have the closing costs waived. The monthly service fee is similar to the monthly service fee of other types of reverse mortgage plans. The monthly charge is automatically financed and added to the loan balance. As it is for the Fannie Mae Home Keeper Mortgage, there is no mortgage insurance premium for the Cash Account Advantage Plan because Financial Freedom is the one that manages the risk. Other Considerations Before jumping into a reverse mortgage, there may be other possibilities that are more suitable for paying expenses and maintaining independence. For those individuals who do not wish to spend down their equity in their home, there are other viable options to consider: Home equity line of credit Single-purpose loan Sale of home Sale-leaseback plan Property tax relief program Annuity purchase 18 CSA Journal 41 December 2008

15 Home Equity Line of Credit A home equity line of credit works like an ordinary line of credit, where the borrower can draw upon it at any time up to the maximum amount approved. Unlike a reverse mortgage, the potential borrower must have sufficient income and meet certain credit standards in order to qualify for this type of loan. Cash withdrawn from the equity line of credit can be used for any purpose. The costs associated with a home equity line of credit are typically lower than a reverse mortgage; however, the interest rates are generally higher because there are usually no adjustment caps. Single-Purpose Loan Single-purpose loans are offered by state and local governments and nonprofit organizations. The proceeds received from the loan must be used for a specific purpose, such as paying for repairs and property taxes. The loan doesn t have to be repaid as long as the borrower lives in the home. Under some single-purpose loan programs, the debt may be forgiven if the borrower continues to live in the home for a certain amount of years. These loans have very low costs. They generally have no origination fees or mortgage insurance. In addition, the interest rates on these types of loans are low. Single-purpose loans are usually limited to homeowners with incomes far below the median income for a given geographical area. These loans aren t available everywhere. It s recommended that individuals contact their city or county housing department, local Area Agency on Aging, or the nearest community development agency to find out about these types of loans. A single-purpose loan may be an excellent alternative, especially if cash is only needed for home repair (e.g., to replace a leaky roof, fix faulty electrical wiring, or replace old flooring). Sale of Home Selling the home may be an alternative solution for many retirees instead of obtaining a reverse mortgage, especially for those seniors who do not intend to stay in their homes. The excess proceeds received after selling the home may be invested in order to generate a stream of income that could help supplement their current income, be used to purchase a smaller home, or pay for rent for the upcoming years. Before a decision is made to sell the home, the following should be considered: Estimated net proceeds received from selling the home Property taxes and the availability of taxrelief programs for the new location Estimated costs to maintain the new home or rent a new home Availability of health-care and senior services at the new location Proximity of new location to friends and family Availability of transportation, shopping, and cultural and recreational activities at the new location Sale-Leaseback Plan The sale-leaseback plan is another alternative for seniors who don t want to move from their homes. This is where a family member or friend buys the home from the senior. The senior becomes a renter, and the new owner guarantees the senior a lifetime tenancy. The senior may choose to hold a mortgage upon selling the home. This is where the senior will receive monthly payments (principal and interest) from the new owner. However, there is a danger in holding a mortgage. If rent increases are excessive, the senior may be paying out more for rent than is received in monthly mortgage payments. In addition, there could be financial implications if the senior holds a mortgage note. That is, this new source of monthly income CSA Journal 41 December

16 received may affect their eligibility for Supplemental Security Income and Medicaid. If the new buyer finances the house through a commercial lender, the senior will receive full payment on the house. The senior can subsequently invest the proceeds received or purchase an annuity. Property Tax Relief Program Property tax relief programs help those who are living on fixed incomes and having a hard time paying escalating property taxes. Fortunately, many state and local governments offer some type of tax-relief program that can help those seniors who are struggling to pay their real-estate taxes. Some programs are made available to all seniors regardless of their level of income. Other programs require seniors to have low income in order to qualify. The three major property tax relief programs are: Homestead exemption Property tax deferral Property tax abatement The homestead exemption reduces the assessed value of the property by a certain amount. Once the assessed property value is reduced, it is subject to taxation. A property tax deferral allows seniors to postpone paying their property taxes until they die or sell their property. The state pays the realestate taxes for the homeowner and charges interest on the unpaid taxes. The state will place a lien on the property for the amount of the unpaid taxes and accumulated interest. This is done in order to secure the payment when the owner dies or sells the property. With a property tax abatement, a state or local municipality may either reduce or waive property taxes for those seniors who qualify. and it provides the annuity owner minimum payments over a period of time. Individuals can purchase an annuity by paying for the entire contract all at once or over time. Some annuities start to make payments as soon as the investment is made and others make payments sometime in the future. When payments commence, the annuity owner can choose how often to receive the payment monthly, quarterly, or annually. There are three basic types of annuities: fixed, variable, or a combination of these. A fixed annuity guarantees a minimum fixed rate of return. As a result, the annuitant will be receiving fixed payments. The danger with receiving fixed payments is that the annuity owner may be exposed to significant loss of purchasing power due to inflation. Variable annuities do not promise a rate of return. The premium payments made are invested into a separate account, where the annuitant may allocate dollars into one or more sub-accounts. The premium dollars allocated into the sub-accounts are used to purchase various types of securities (stocks, bonds, etc.). With a variable annuity, the owner anticipates that the overall rate of return will outperform the rate of inflation. Combination annuities allow the annuitant to apply the premium payments between the insurer s fixed and separate accounts (Kraemer and Kraemer 2007). A reverse mortgage can be a valuable financial tool that individuals can implement when the circumstances are right. It s highly recommended that anyone considering a reverse mortgage first consult with an experienced financial professional. A good advisor will determine if a reverse mortgage is the most appropriate vehicle to be used and will also discuss other viable options. Annuity Purchase Annuity purchases can provide an additional source of income for retirees. An annuity is a contract that is sold by an insurance company, References Boroson, Warren The Reverse Mortgage Advantage: The Tax-Free, House-Rich Way to Retire Wealthy! New York: McGraw-Hill, CSA Journal 41 December 2008

17 Kraemer, Tammy, and Tyler Kraemer The Complete Guide to Reverse Mortgages: Turn Your Home Equity into Instant Income. Avon, MA: Adams Business, Reed, David Mortgages 101: Quick Answers to Over 250 Critical Questions about Your Home Loan. 2nd ed. New York: AMACOM, Talamo, John J The Mortgage Answer Book. 1st ed. Naperville, IL: Sphinx Publishing, Additional Resources U.S. Department of Housing and Urban Development (HUD). Top Ten Things to Know If You re Interested in a Reverse Mortgage. rmtopten.cfm (accessed on November 11, 2008). Contact Information Administration on Aging 200 Independence Avenue, SW Washington, DC This site has information on government programs and provides many links to other sites relating to reverse mortgages. American Association of Retired Persons 601 East St. NW Washington, DC This site provides articles and resources to help you evaluate a reverse mortgage. American Institute of Certified Public Accountants 1211 Avenue of the Americas New York, NY This site will help you find a Certified Public Accountant with special training in personal finance. Fannie Mae 3900 Wisconsin Ave. NW Washington, DC The site has a vast amount of information about reverse mortgages. It also lists reverse mortgage lenders. Financial Freedom Senior Funding Corp. 1 Banting Irvine, CA Financial Freedom is one of the leaders in reverse mortgages. Financial Planning Association 4100 E. Mississippi Ave., Suite 400 Denver, CO This site will help you locate a financial planner near you. Seattle Mortgage Company th Ave. NE, Suite 700 Bellevue, WA Seattle Mortgage Company is one of the leaders in reverse mortgages. U.S. Department of Housing and Urban Development (HUD) 451 7th St. SW Washington, DC Wells Fargo Home Mortgage P.O. Box Des Moines, IA Wells Fargo Home Mortgage is one of the leaders in reverse mortgages. Vicki Kasomenakis is an assistant professor in the Department of Business at Queensborough Community College of the City University of New York. She may be contacted at Federal Trade Commission 600 Pennsylvania Ave. NW Washington, DC This site alerts consumers about scams that may involve reverse mortgages. CSA Journal 41 December

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