Reverse Mortgages

Hopefully, the day will never come when you will need to tap your very last line of defense, your home. What does an 80 year old widow do if the last of her savings and investments are disappearing because Social Security is just not enough? More than likely she still has her home, her very last line of defense. The equity in that piece of residential real estate might generate enough income to carry her to the grave. In most cases the best course of action would be to sell the house and invest the proceeds, then move to a nearby apartment, perhaps in a senior community. Unfortunately, 80 year old widows do not tend to view a house filled with a lifetime of memories and treasures as residential real estate. They tend to view their house as a piece of themselves. There is an option, reverse mortgages. However, this relatively new investment tool is dangerous. Reverse mortgages are often sold by slick con artists who take advantage of frightened desperate old folks who sometimes are hampered from making good decisions by cognitive issues. If Grandma or Grandpa is thinking about one of these things, it is your duty as a child or grandchild to make certain they will not be exploited. It is also your duty to tell them if they are incapable of maintaining a home; that it is time to move on. It is quite likely your parents or grandparents will ignore you if you are the bearer of bad news, but it is your duty to tell them the truth.

So what is a reverse mortgage? The correct name for these financial instruments is a Home Equity Conversion Mortgage (HECM). They are offered under FHA guidelines to allow older Americans to withdraw some equity from their homes to fund their living expenses. The National Council on Aging offers a booklet entitled Using Your Home to Stay at Home to explain the basics. This booklet is approved by the U.S. Department of Housing and Urban Development.

Using Your Home to Stay at Home

In order to qualify for a FHA HECM, you must be a homeowner 62 years old or older. You must own your own home or have a very small mortgage balance that can be paid off at closing. The applicant must also receive information on reverse mortgages from a HECM counselor before a loan can be granted. A low cost or free HECM counselor can be found by phoning (800) 569-4287.

The amount of money you can receive from the reverse mortgage is limited to the value of the home or $625,000 (whatever is the smaller number). The amount that you can borrow will also be dependent on the age of the youngest borrower, current interest rates, and the specific terms of the loan. Needless to say, the older the borrower and the lower the interest rates the more you will receive from your home.

According the HUD website, you can select from five payment plans:

Tenure- equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence. This is recommended as the safest option as the owner of the home will need a source of income to pay bills for the rest of her life.

Term- equal monthly payments for a fixed period of months selected. This is a more dangerous option, as payments will end and most likely Grandma will lose her house. On the plus side payments are higher than with the tenure option.

Line of Credit- unscheduled payments or in installments, at times and in an amount of your choosing until the line of credit is exhausted. Think of this option as a Home Equity Line of Credit that never has to be repaid. It is considered more dangerous than either tenure or term. Undisciplined use of this money could quickly exhaust your credit. Then Grandma will need to sell the house and pay off the reverse mortgage at a time in her life that would be extremely inconvenient.

Modified Tenure- combination of line of credit and scheduled monthly payments for as long as you remain in the home. This option offers lower guaranteed monthly payments, but maintains a reserve line of credit for financial emergencies.

Modified Term- combination of line of credit plus monthly payments for a fixed period of months selected by the borrower. In my eyes, this option seems to combine the worst features of the other options. In You Can Do It, The Boomers Guide to a Great Retirement, Jonathan Pond notes, “This combination is only appropriate when the borrower knows that the need for additional monthly income is temporary.”

Remember the companies that offer these products are not in business to help out little old ladies. They are in business to make money. The amount of money you can expect to receive is pretty disappointing. The reverse mortgage only makes sense for the elderly who can remain in their homes, need additional monthly income, and have given up the possibility of leaving the old home place to their heirs. This is an area filled with charlatans and cheats. Be careful when your parents or grandparents are comparing products and offers. Again from Jonathan Pond, “Finally, be particularly wary of anyone who encourages you (or your parents) to take out a reverse mortgage to purchase and investment product, such as an annuity. Those who pull this charade should be pilloried.”

Reverse mortgages have high up-front costs when compared to normal loans. The interest rates on reverse mortgages are higher than on conventional mortgages. It is important to note that since no monthly payments are made on these loans, the balance grows very quickly as compound interest is applied to both the principal received and the interest that has already been assessed to previous payments.

Reverse mortgages are complex financial instruments that are not easily understood by the customers who actually need them. I hope that a combination of Government regulation, responsible journalism, and a growing market fueled by the aging Baby Boomers will, in time, improve the reverse mortgage marketplace.