Tuesday, 02 September 2014 10:14 Last Updated on Tuesday, 02 September 2014 10:20
Your Money Matters, August 24, 2014
There are events in life that can sully pleasant childhood memories, such as finding out your parents bought your Easter candy. And seeing the Fonz pitching reverse mortgages on daytime TV.
The financial crisis changed the entire mortgage landscape, including the reverse mortgage industry, and the Department of Housing and Urban Development tightened up the rules. These new restrictions were necessary to protect consumers, but also to shore up the mortgage insurance fund that took a hit in the crisis aftermath.
Not that I don't trust the Fonz to give you the whole story: There's only so much he can say in 60 seconds, so allow me to update you. And since 95 percent of reverse mortgages are government sponsored Home Equity Conversion Mortgages, when I use the term reverse mortgage, that is what I am addressing.
A reverse mortgage in essence is a loan, available to borrowers age 62 and older, backed by a primary residence, that doesn't need to be paid back monthly. It is most often considered a last resort when all resources are tapped out, or may soon be tapped out; a way to get cash to live on.
Borrowers may take out a lump sum up front, borrow a smaller sum every month, or a combination. The bank keeps track of what is owed and rolls the interest and fees into the balance.
The amount available to borrow is limited by a formula taking into account the borrower's age, the interest rate, the value of the home, any existing mortgages, and the lending limits in the area (currently $625,500 in Monroe and Pike counties).
The most attractive feature of a reverse mortgage is that you can potentially get cash out of your home and not have to pay it back right away. The misconception being that you never have to pay it back. The fact is that once the last borrower stops living in your home for 12 consecutive months, whether because you sell it, you leave it to go to a long-term care facility, you die, or some other circumstance, your loan becomes due and payable.
The good news is that with the Home Equity Conversion Mortgage, you are not required to pay more than the value of the house at that time, regardless of the balance of the loan. Your heirs may even keep your home by paying back 95 percent of the home value to the lender.
But did you catch that part about the last borrower? That means if there are more than one of you living in the home, there is no protection for anyone who is not a borrower on the loan. So if you own the home in your name alone and think it's easier just to take out the reverse mortgage in your name and not jointly with your wife, think again. Should you predecease her, she could be left with no house, no cash, and nowhere to live. So if a reverse mortgage is in your future, be sure to cover all the bases.
Show me the money
The loanable amount with a reverse mortgage depends largely on the age of the youngest borrower, the value of the home, and the current interest rate. The highest cash scenario would come from a combination of the oldest borrower, the highest home value, and the lowest interest rate.
Let's look at a couple, aged in their early 70s, with a home worth $150,000 today. Assuming they own their home outright, they might look at a fixed rate reverse mortgage at 5.06 percent (plus the mortgage interest premium outlined below); under the new rules they are limited to a lump sum of $47,309.
However if they are willing to start with a variable rate of 2.656 percent (capped out at 12.656 percent), they may have as much as $82,770 ultimately available to them. They will likely be limited to taking only 60 percent up front if they want the lump sum; or they may take a credit line or a monthly payout of $522. You can calculate your own scenario at reversemortgage.org.
Just like a traditional mortgage, reverse mortgages come with closing costs, and they can be quite steep. Origination fees may be as high as 2 percent of the first $200,000 of the home's value (not the loan amount), and an additional 1 percent on the remaining value, up to a maximum of $6,000.
Beyond that, there is a mortgage insurance premium payable to the Federal Housing Administration. The MIP depends on how much money you receive up front. If you limit your initial proceeds to 60 percent of the funds available, your MIP is 0.5 percent of the home's value. If you take more than 60 percent, you will pay 2.5 percent of the home's value.
The origination fee and the MIP usually come out of the funds available to be loaned to you. Your home will need an appraisal to determine how much you can borrow, and that typically is paid for in cash. Should the appraiser find your home is in need of major repairs, they must be made before the loan is originated. However if the cost is less than 15 percent of the appraised value, you may be able to pay for them after the loan is completed with funds from the reverse mortgage.
On top of those larger closing costs, the usual document preparation, inspection fees, recording fees and so forth also apply. The mortgage servicer may also charge on a monthly servicing fee.
Your loan, of course, carries interest, which may be fixed or variable, and typically is higher than a traditional mortgage, as we saw earlier. You will also pay an ongoing MIP fee of 1.25 percent of the outstanding loan balance (essentially making your interest rate that much higher).
Can anybody get one?
It used to be that there were no financial qualifications at all for a reverse mortgage. However, due to the large number of defaults, applicants now must go through a financial assessment to be approved.
How can there be so many defaults, if you don't make payments with a reverse mortgage? The issue is a very familiar one in Monroe County — property taxes. If a homeowner with a reverse mortgage does not keep up with real estate taxes, the lender can foreclose. If the value of the home does not satisfy the loan amount that has accrued, in most cases, the lender cannot recover the rest with a reverse mortgage, leaving the government insurance fund on the hook.
Now, the borrower must show the reasonable ability to make real estate tax and insurance payments, as well as general property upkeep, or be required to keep funds in reserve via the reverse mortgage, similar to an escrow account.
An interesting twist
Reverse mortgages can also be used to purchase a home. Let's say our couple sells their home and wants to buy another, also for $150,000. They may make a down payment of $66,738 and take a reverse mortgage for the remaining balance, pocketing the rest of their home sale proceeds. As with any reverse mortgage, they should weigh the costs of the mortgage vs. the need for preserving their equity and options for later in retirement.
Seeking good counsel before making any decisions is always wise.