Reverse Mortgages Can Ease Financial Concerns

By Keith Cummins

Reverse mortgage participation is growing at a remarkable rate. Last year’s total of over 37,000 was more than half of all the federally insured reverse mortgages ever originated in the United States. Over the past few years, the number of homes that have a reverse mortgage has doubled each year and this trend is expected to continue through the year 2010.

Reverse mortgages provide senior homeowners an additional source of funds to help satisfy their retirement concerns. This is done by converting their home equity into tax-free funds and entirely eliminating monthly mortgage payments. Although the product is federally insured, there are no restrictions on how the funds are used. Funds are used for purposes of necessity, leisure, and planning. Let’s examine a sample situation where a reverse mortgage addresses these concerns.

Of course, everyone’s situation is unique. Just like any other product or service, after identifying individual problems and goals, then a solution can be made to satisfy each different situation. This is just one scenario of problems and solutions. In this example we have a homeowner, of primary residence, aged 69. We know she is eligible for the loan because she owns a home, lives there, and is of age. Her problem is she has insufficient income and would like to have long-term care insurance, but can not afford it. Her goal is to remain independent and live comfortably and safely in her own home (“home” means condominiums also).

Her home is appraised at $300,000 and she has a mortgage of $49,500. The monthly principal and interest payment is $548. Given her age, home value, and current interest rates of about 4 3/4%, the net principal funds available from the reverse mortgage are about $152,000; all tax-free. Several products are available. This example uses one of the two federally insured products; the FHA/HUD Monthly Adjustable. It is the most common because it is federally insured and offers the highest amount of funds available to the borrower. The FHA/HUD Annual Adjustable is the other federally insured product. It has a higher initial interest rate but the lifetime interest rate cap for the loan is lower. Together, these two products comprise over 90% of the entire market.

Any current mortgages or other liens against the home are required to be repaid. Most often the funds made available from the reverse mortgage itself are used for this purpose. From the $152,000 available to our example homeowner, her current mortgage of $49,500 is repaid. This leaves $102,500.

Purchase annuity

She receives $65,000 as a lump sum and used to purchase an annuity. She chooses one where the monthly payout is enough to pay the monthly premium needed to purchase long-term care insurance. Although the reverse mortgage has the option to receive a monthly income that she could use to put toward the long-term care insurance, she uses the annuity instead.

The annuity gives about an 11% higher monthly payout than the monthly income would from the reverse mortgage. This method enables her to utilize about $7,500 of the reverse mortgage proceeds elsewhere. Also, if the reverse mortgage is repaid because she moves or sells her home, then the annuity would still be hers no matter where she lives.

She receives $17,500 as a lump sum and uses it to re-design her home. She makes upgrades to the interior and modifications to the exterior to make her home more comfortable and accommodating. A few thousand dollars are left over from her home improvement budget and she goes on the vacation she always wanted.

She then leaves $20,000 as a line of credit that grows. A line of credit from a reverse mortgage is unique because it grows at a rate pegged to the loan balance growth rate. For example, after 10 years growing at 4 3/4 % her line of credit would give her access to over $32,000 (for simplicity, we are assuming the rate stays constant at 4 3/4%; of course, the actual rate adjusts monthly and the actual credit line would be adjusted accordingly). Contrasted with a traditional line of credit that is capped and loses purchasing power, her line of credit can adjust for inflation.

 

Achieved goals

The reverse mortgage has helped our example homeowner resolve her problems and achieve her goals. She has increased her cash flow by eliminating any monthly mortgage payment. She worries less about losing her independence and has a greater sense of security provided by the long-term care insurance, portable annuity, and growing line of credit. She has made home improvements and traveled. Overall, she has significantly eased her concerns.

Although the positives of using a reverse mortgage to satisfy concerns of necessity, leisure, and planning are obvious, let’s examine some of the most often cited negatives. They are costs and misconceptions.

The cost of a reverse mortgage appears expensive when compared to a traditional, forward, mortgage because of the statutory mortgage insurance premium (MIP). The MIP is always 2% of the appraised home value or maximum claim limit; whichever is less. Returning to the above scenario for example, although the appraised home value is $300,000 the maximum claim limit for Baltimore County is $261,609. Therefore, the MIP is $5,232; from $261,609 X .02. This represents about 36% of the total closing costs in this example (about $14,400). 36% is a large portion of the total closing costs, but without the MIP the federally insured product would not exist. One alternative to a reverse mortgage is selling the home. However, selling the home may incur higher transaction costs. If the home in our example were sold at the usual commission rate of 6%, then the cost of selling the home would be at least $18,000; from $300,000 X .06.

Common misconceptions about reverse mortgages are regarding ownership, repayment, and heirs. The most popular one is, “I give my home to the bank.” This is not true. Just like a traditional mortgage, you maintain control and ownership of your home. It is your name on the title, not the bank’s. As the current product became federally insured, a less attractive product was eliminated. It had an equity-sharing component that probably contributed a lot to this misconception. Also, just like a traditional mortgage, the borrower is responsible for maintaining the property taxes, homeowners insurance, and condominium fees (if applicable).

“I could owe more than my home is worth.” This also is not true. Reverse mortgages are non-recourse loans. This means there is a one-for-one relationship between the asset and the loan. In this case, the home is the only asset used to secure the loan. Therefore, repayment can never exceed the value of the home. If the value of the home is less than the loan balance due, then the borrower is released from any further obligation. There is no course of action against them, their other assets, their estate, or their heirs. The lender will have to make up any shortfall from the federal insurance. Conversely, all equity leftover at repayment is the property of the borrower or their estate.

Heirs favor program

“My heirs will be against it”. For the most part heirs are in favor of reverse mortgages. Often, it is the children, or other relatives, who introduce the idea to their parents and encourage them to spend the money on themselves. If there is an inheritance issue, then, through strategic planning, a reverse mortgage enables other ways to transfer the wealth.

A reverse mortgage can be a tremendous endeavor for senior homeowners to pursue. All the variables involved and alternative options should be carefully scrutinized. Although the federally insured reverse mortgage has been available for 15 years, it is now becoming more popular because real estate values are near all-time highs and the cost of living is continuing its long, inexorable climb. This makes a reverse mortgage an attractive source of tax-free funds; especially when it can be borrowed without having a monthly payment.

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