Is a Reverse Mortgage Right for You?

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1 The information contained herein has been obtained from sources that we believe to be reliable, but its accuracy and completeness are not guaranteed. Any examples shown on this website are purely hypothetical and have been included for demonstration only. Is a Reverse Mortgage Right for You? By: Leslie J. Lammers Riverstone Advisors, LLC (914) On Joe Greene s 84 th birthday, he had only $22,000 remaining in his retirement savings. He was happy to still be living in his own home and taking care of himself but he worried about how he would cover his ongoing expenses. His house needed a new roof and a paint job. His wife of many years had passed on five years before. He wanted to stay in his home as long as possible. A friend suggested he might benefit from a reverse mortgage. He was able to arrange one. He contacted two lenders through the mortgage website nrmlaonline.org. This is the National Reverse Mortgage Lenders Association. Click on the Locate A Lender box on the top right. Joe met with a counselor to complete the required counseling. Counselors are found on the HUD site: Put reverse mortgages into the search box on the site. The lender agreed to a mortgage of $200,000. Joe spent $40,000 on home repairs. The remaining $160,000 he left untouched to provide for his future needs. He thought he might live another ten years as both his parents had lived into their 90s. The remaining money would allow him to draw $16,000 a year to supplement his social security and small pension. The original mortgage that Joe and his wife had used to buy their home had been paid off long ago. If it had not, proceeds of the reverse mortgage would be used to pay off in full any existing mortgage and any outstanding home equity line. The reverse mortgage must have the first claim on the house. During the life of the reverse mortgage, Joe continues to own and hold title to his home. He pays his property taxes and makes home repairs. The terms of the reverse mortgage require him to stay current on his property tax payments. There are no interest or principal payments on the reverse mortgage. Interest accrues until the homeowner moves, sells or passes on. Joe would make

2 payments to the federal insurance agency that guarantees that the bank will be repaid. There are upfront closing costs and fees. These might total 3% of the value of the house. These fees may make a reverse mortgage unattractive depending on how much one wants to borrow against a house. Borrowing a small amount relative to the value of the house may make the reverse mortgage unattractive. In this case, a home equity line would be more attractive. Joe had no heirs. At his death, he planned to give his remaining estate to his local senior center and town library. At his death, his home would be sold. The bank would be repaid the principal and accrued interest on the loan. If the sales price of the house was less than that owed the bank, the Federal Housing Administration would pay the bank the shortfall. The insurance premium that Joe had paid went to provide insurance to cover any shortfall. Joe cannot be forced to sell the home to pay off the mortgage, even if the mortgage balance grows to exceed the value of the property. An FHA-insured reverse mortgage need not be repaid until the borrower moves, sells, or dies. When the loan is due and payable, if the loan exceeds the value of the property, the borrower (or the heirs) will owe no more than the value of the property gained from a sale. If the sale of the home produces more than the loan amount, the excess goes to Joe s estate. In another case, Stephanie and John Hanlon were able to use a reverse mortgage to improve their quality of life. They had both been widowed in their 50s. They married each other in their 60s. They wanted to start their marriage in a fresh home without any memories. They bought a home together using a 7% fixed rate 15 year mortgage. All was good until their investment portfolio declined in the 2008 market correction. John had some margin debt on his portfolio. He was forced to sell some bond holdings to pay off the margin debt which came due when his stocks declined. The sale of the bonds reduced their income by 20%. As they entered their 70s, they found their mortgage payment had become too much as a percent of their living expenses. They wanted to enjoy their retirement by traveling and socializing. They knew that their mortgage interest rate of 7% was much higher than the current mortgage rates of around 5%. They talked with their lender about re-

3 financing into a lower rate mortgage. The lender wasn t comfortable committing to a new, longer loan. Instead, Stephanie and John arranged a reverse mortgage. In their case, their indebtedness rose slightly at the start of the reverse mortgage because they chose to finance the upfront costs of the mortgage by adding the costs to the amount borrowed. The reverse mortgage was large enough to cover the fees and costs of the reverse mortgage and also to pay off their existing mortgage. By entering into the reverse mortgage, they eliminated their monthly mortgage payment. Essentially, they kicked the can down the road. Stephanie s daughter was a very successful software entrepreneur who did not need an inheritance. John had had six children with his deceased wife. His children did not expect an inheritance. Elizabeth Allen was 64 when her husband, Alex, died after a long illness. Like many couples, Alex had been the financial decision maker. He had insisted that they pay off their mortgage early. Elizabeth thought that Alex had been tight with money. Elizabeth was not used to making financial decisions. Her property taxes had risen dramatically as her town upgraded their schools. She traveled and remodeled her home the way she had always wanted. It wasn t long before Elizabeth began to have trouble making ends meet. Elizabeth confided her troubles to her friend, Patricia. Patricia had heard about reverse mortgages. Elizabeth met with a reverse mortgage counselor. The counselor explained that with Elizabeth now at the relatively young age of 65, the percent that she could borrow against her home would be relatively low. Since the amount of the loan grows over time as interest is added to the loan, the beginning amount is low relative to the house value when the borrower is young. The value of Elizabeth s home was $250,000. She found that she could borrow $129,000 on a reverse mortgage. Her thought was that she would use a set amount each month to supplement her income. Her parents had lived into their 70s and 80s. At 65, she expected to live another 20 years. Using this expectation, she planned to draw down the $129,000 mortgage line of credit over 20 years. Dividing $129,000 by 20 and then 12, she found that she would only be able to gain $500 a month from the loan.

4 She doubted this would solve her cash flow problems. She then met with a fee only financial planner named Susan. Susan required her to make up a detailed budget of her monthly expenses. Susan then explored with Elizabeth what her options were at this point. As they talked, it became apparent that Elizabeth did not like living alone and thought she might want to move into an assisted living facility when she was older. Susan pointed out that encumbering her home now with a reverse mortgage would make it less likely that Elizabeth could later sell her home to finance a move to assisted living. Susan suggested that Elizabeth think about finding a housemate to share the expenses of her home. Elizabeth s cousin, Ann, had been interested in moving back to their home town. She moved in with Elizabeth. Ann paid rent of $800 a month to Elizabeth. Ann also took over the gardening, minor home repairs and paid half of the electricity and gas bills. When is a Reverse Mortgage Not the Answer? If you are considering a reverse mortgage for yourself or another, start by examining why it might not work. The youngest borrower must be 62 or older. The borrower must be the homeowner, live in the home and own the home outright (or have a low mortgage balance that can be paid off with proceeds from the reverse mortgage loan). The property must be a single family home; a 1-4 unit home with one unit occupied by the borrower; a HUD-approved condominium; or a manufactured home that meets FHA requirements (i.e., a mobile home). In order for a reverse mortgage to be helpful, any existing debt against the property must be low relative to the value of the house. If it isn t, the amount of money that can be accessed may not be enough to justify the exercise. I use 35% as a guideline. If the total of any existing mortgage and any equity line outstanding is more than 35% of the value of the home, I doubt the reverse mortgage will be very compelling. A lender or counselor can give you more specific guidance as to amounts. Families differ. Some families view the house as a family asset. The children expect to inherit the house or the proceeds from a sale after the parents pass on. Other families have more distinct financial lines drawn. The parents assets are the parents assets and the children don t have a sense of ownership.

5 In the former case, the children will resent the use of the reverse mortgage as they may be left with little proceeds from the house at the end. Think about the emotions surrounding this. The best approach in this case is to open up a discussion as to how to support mom and dad. Perhaps the children should buy the house from mom and dad in order to provide the cash for living expenses. Most children can t swing this financially. Perhaps the house should be sold now to provide the cash for the parents living expenses. The younger the borrower, the less likely it is that a reverse mortgage will be the answer. This is because the interest accrues during the life of the mortgage. With a longer life expectancy, more interest will accrue. This reduces the amount that the lender will lend. There is a cushion in the loan to house value in order to allow for the interest. The interest is tax deductible for the borrower in the year it is paid. The shorter the borrower s life expectancy, the larger the loan to home value will be. Generally, the more valuable a home is, the older the owner and the lower the interest rate, the more one can borrow. Under current limitations, the home must be valued at less than $625,500. The mortgage loan can be repaid in full if the borrower chooses to do so later. The homeowner should carefully consider all other alternatives. These are: 1) take on a housemate; 2) cash in or sell a life insurance policy; 3) sell the house and either buy a condo or rent a place to live; 4) get a home equity line if one can make the interest payments or borrow from one s children; 5) go on Medicaid. Comparing a Reverse Mortgage to a Bank Home Equity Loan There are three major differences. First, with a traditional second mortgage, or a home equity line of credit, you must have sufficient income to qualify for the loan. Second, with a home equity line, you are required to make monthly interest payments. Third, with a home equity line, you can be foreclosed or forced to vacate your house because you missed a mortgage payment. With a reverse mortgage, the bank can neither foreclose on you nor demand payment

6 until you sell, move out of the home, pass on, fail to pay property taxes or let the home s upkeep decline dramatically. More about the Mandatory Counseling Reverse mortgages are regulated by the federal government through the Department of Housing and Urban Development (HUD). Almost all reverse mortgages made in the U.S., especially since the credit crunch of 2008, are insured by the Federal Housing Authority (FHA). An FHA insured reverse mortgage is called a Home Equity Conversion Mortgage (HECM). Note that the FHA is not the lender. As with standard mortgages, a bank or other financial institution will be the actual lender. The FHA s role is to insure that the bank will be repaid. A review with a loan counselor is required as part of the qualification process. HECM loan counselors are third-party providers (i.e. they are not affiliated with the lender or with the FHA). HECM loan counseling can be obtained for free or at a low cost. Counselors can be found on HUD s website or by calling HUD at (800) During the reverse mortgage counseling session, the counselor will explain how reverse mortgages work, the financial and tax implications of taking out a reverse mortgage, payment options, and costs associated with a reverse mortgage. Upon completion of the counseling session, the prospective borrower will be issued a certificate of participation that will be required by the lender in order to obtain a reverse mortgage loan. Another Alternative The new HECM Saver loan, which debuted in October 2010, charges only 1% of a home's value up front. This loan has some restrictions, however. The HECM Saver usually carries a higher interest rate and you can't borrow as much as you can with the HECM Standard. The amount you're allowed to borrow depends on your age. Both HECM Saver and HECM Standard loans require borrowers to pay mortgage insurance premiums on an ongoing basis equivalent to 1.25% annually of the outstanding loan balance. For More Expensive Homes, Consider A Non-FHA Reverse Mortgage The Federal limit on an insured reverse mortgage is $625,500. A jumbo reverse mortgage may be available on a more expensive home. This type of loan comes

7 from a private lender, like a bank. Private company reverse mortgages will go as high as $6 million. The interest rate will probably be 2 to 3% higher, and the loanto-value will be lower than with a HECM. There will be no FHA insurance on this loan. More Information WHEN researching reverse mortgages online, consumers should focus on information published in 2009 or later. Information from 2008 and earlier may be outdated due to the many changes in the marketplace since the credit crunch of FHA does NOT recommend using any service that charges a fee for referring a borrower to an FHA lender. FHA provides this information for free, and HECM housing counselors are available for free or at very low cost, to provide information, counseling, and a free referral to a list of FHA-approved lenders. Search online or call (800) toll-free, for the name and location of a HUD-approved housing counseling agency near you. You can read up on reverse mortgages on the AARP website at Put reverse mortgages in the search box on their site. Their document Borrowing Against your Home (located at ires_nocrops.pdf) is particularly informative. The National Reverse Mortgage Lenders association is at nrmlaonline.org. They have a find a lender button on their site. Receipt and Use of proceeds: Borrowers can choose to receive the reverse mortgage funds as a lump sum, monthly income (for up to life), or line of credit, or as a combination of monthly income and line of credit. No mortgage payments are due during the life of the loan. The five payment options are: (1) tenure, by which the borrower receives monthly payments from the lender for as long as the borrower lives and continues to occupy the home as a principal residence; (2) term, by which the borrower receives monthly payments for a fixed period selected by the borrower;

8 (3) line of credit, by which the borrower can make withdrawals up to a maximum amount, at times and in amounts of the borrower's choosing; (4) modified tenure, by which the tenure option is combined with a line of credit; and (5) modified term, by which the term option is combined with a line of credit. Fees for Reverse Mortgages There are substantial upfront fees (i.e., mortgage insurance premiums, loan origination fees and closing costs) with these loans, as well as ongoing fees (mortgage premiums, interest and servicing fees), during the course of the loan. Before you take out the loan, you will have to consider how much you will shell out in fees so that you will have enough to cover your expenses. For example, the standard HECM loan charges a 2% mortgage insurance premium up front on the home value not the amount borrowed as with regular forward mortgages. For example, if you own a $400,000 home, the upfront MIP would be $8,000 whether you borrow $30,000 or $200,000. A reverse mortgage loan counselor can give you a break down of the expected fees.

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