It sounds almost too good to be true, and for some people it might be.
Reverse mortgages are financial instruments that replace your monthly mortgage payment with a tax-free income advance on the equity of your home. This relatively small corner of the lending sector all but vanished after the housing collapse as many banks stopped offering the option after defaults rose.
But in recent months, they’ve made a comeback. New applications are rising sharply with new players stepping into the void left by big banks and touting their services with high-profile ad blitzes on cable TV and Web sites.
Although the overall level is far below the pre-collapse peak, home finance experts see a bigger bounce in the next few years. A big factor is that the loans have gone through a makeover that works better for homeowners whose equity has been ‘downsized.’ The Federal Housing Authority, which is the source of virtually all the loans, has come up with a "lite" version, a reverse mortgages that allows users to tap equity at lower fees for shorter time periods.
But are the new 'cash-out' home loans really better for you? And was the full flavor stuff so bad for your financial health as many financial advisers once claimed? Financial advisers say you can get just as smashed on the lite's stuff if you don't use it wisely.
Some of the new options that make reverse mortgages more attractive also add a layer of complication. “The myriad of terms, fees and different products make finding the right mortgage an enormous challenge,” Consumers Union said in a recent report.
It helps, of course, to know what you are getting into. Reverse mortgages are loans turned upside down. Your monthly payment is deferred to a future date. When you sell the home it all comes due and it is repaid from remaining equity. It is a transaction that resembles shorting a stock more than it mirrors taking out a traditional home mortgage.
"Financial planners often don’t even understand them because the lessons they have learned (from other financial products) don’t apply,” said Barbara R. Stucki, vice president of home equity Initiatives at the National Council on Aging.
But advisers are now jamming them into their tool boxes. Financial planners who once shunned them as too costly and confusing are starting to see their value – especially as other cash sources dry up for retiring baby boomers.
“A reverse mortgage can be a perfectly good way to use your home equity,” said Stephanie Moulton, an Ohio State University public policy assistant professor and housing finance expert who has worked as a reverse mortgage counselor for American Association of Retired Persons.
“A reverse mortgage can be a perfectly good way to use your home equity,” said Stephanie Moulton, an Ohio State University public policy assistant professor and reverse mortgage expert who has worked a reverse mortgage counselor for American Association of Retired Persons.
“The danger is that boomers might draw down their equity and spend it on the wrong thing, like expensive vacations, and find themselves with none left at age 75 when they need it even more. But if you use reverse mortgages as part of a financial strategy, they can be a sophisticated product that fills a real need.”
How They Work
Reverse mortgages are offered to people who are at least 62 years of age. There are two main types set up under the FHA’s Home Equity Conversion Mortgage, HECM, and referred to by insiders as ‘heck ‘em.’ (The Federal Trade Commission has a reverse mortgage primer on its site.)
The “standard,” or traditional, reverse mortgage, gives you a stream of income for a number of years, usually as long as you live in hour home. They are not cheap. The loan initiation fees are as high or higher than a standard home mortgage, typically $6000 to $8000. As with Social Security, though, there is no “means-testing” or upper income limit. The program can pay thousands of dollars per month on principle of up to $625,000. It is government-guaranteed and not taxable income, and it is not likely to affect Social Security or Medicare benefits. The older you are, the higher the payout.
More people are opting for the new “saver” reverse mortgages. The lite version has shown double digit annual growth among 62-to-64 year olds, according to a Met Life study released earlier this year. They tend to offer much lower monthly payouts. But fees are far lower for the “saver” mortgage and – a feature boomers love – they don’t require a long-term commitment to stay in a home or make other long-term decisions.
With fees of less than one percent of the loan amount, they can be cheaper than conventional home equity refinancing. The monthly payments are tax-free. Borrowers can opt for a lump sum payout or a monthly check with the reverse mortgage lite version. There is also an option to set up a line of credit to draw upon only when needed.
Reverse mortgages in general could have appeal for the growing army of ‘unretired,’ said Andy Schwartz, a wealth manager and owner of Bleakley, Schwartz, Cooney & Finney.
"Things are changing, people are rethinking retirement, and this is one way people might use to get some money while they do that,” he said. “Even people with a lot of wealth are facing short-term income demands they never expected. This is one option for freeing up home equity. And if home values rise, they can still get the increased equity.”
IRA expert and accountant Ed Slott, chief executive of Ed Slott and Company LLC said it’s a better way to raise cash than to raid your IRA. “Those are the hardest funds to replace – they represent a lifetime of savings.” For people who are nearing Social Security milestones it can provide a bridge loan until they reach the qualifying age.
Negatives and Positives
They seem simple, but a reverse mortgage is a fairly complicated financial instrument. Even the title is bit of a misnomer. It suggests that your mortgage is being erased. It is not. The money is still owed to a lender. In fact you accrue interest debt at a compounding rate on the full amount you borrow, which is unlike traditional mortgages that reduce principle each month. “Your equity can disappear a lot faster than you expect,” Stucki said.
On the upside, the FHA guarantees the loans, which minimizes risks to lenders and borrowers alike. And the loans are ‘non-recourse,’ meaning you cannot become personally liable for more than the amount of the loan. And there is no early payment penalty. If you fall behind on taxes or upkeep, you can be declared in default. But the FHA guarantee still protects you from creditors seizing other assets.
While it helps to get counseling, Stucki says there is a wealth of useful information in the form of FAQs and calculators that will tell you exactly what you can get based on your age and home equity.
Some finance experts saw the exit of major banks from the reverse mortgage market in recent years as a death knell for the loans. But Moulton sees a silver lining that might be positive. Instead of dealing with big lenders treating the loans just another financial product to sell, financial advisers may find ways to use HECMs as part of a broader financial strategy. The Journal of Financial Planning published a story about “Reversing the Conventional Wisdom” on reverse mortgages. Registered Rep, a widely read industry publication said in a recent article, "Any advisor worth his or her proverbial salt is familiar with reverse mortgages.”
“As a financial planner, I have not had many requests from my clients about reverse mortgages,” said Schwartz, whose firm has a $1 million asset minimum and the reverse mortgages may not fit "the demographics of my particular client base.” But he can see the appeal of home equity cash even more the affluent who own stocks and bonds. It could be a way “to make up for portfolio return shortfalls so they will not have to reduce their standard of living in retirement.”