It has been a while since we’ve addressed the topic of reverse mortgages here on the AgingOptions blog, so when we came across this recent Kiplinger article on the subject, we figured it was worth a look. In the story, reporter Alina Tugend explains some of the basics of reverse mortgages and also shares how a growing number of financial planners now seem to be singing the praises of these financial tools. Reverse mortgages are definitely not right for everybody, the Kiplinger article emphasizes, but they may be excellent ways for some retirees to provide a safe and secure retirement for themselves.
“Most people think of reverse mortgages as just standalone loans,” Tugend writes. “But some financial experts are seeing them as an investment strategy that lets people stay in their homes as they age.” Is this a good option for you? Let’s take a look.
The American Dream: A Home That’s Paid For
The article starts with an observation that may explain why so many people who could qualify for a reverse mortgage continue to avoid them: it’s the psychological aversion to debt. “Pulling the equity out of your house through a reverse mortgage seems to fly in the face of the American dream of proudly living in a fully paid-up home,” says Tugend. “That, combined with the sketchy reputation reverse mortgages have sometimes had, is why most people are wary of pursuing these loans.”
But, she states, things have improved dramatically over the past decade where reverse mortgages are concerned. The U.S. Department of Housing and Urban Development, which backs about 95 percent of all reverse mortgages, has adopted stiffer regulations to protect consumers. This has caused some retirement experts (and former skeptics) to change their tune. “Like any financial product, reverse mortgages can be a great tool,” Jennifer Fraser of GreenPath Financial Wellness told Kiplinger. “They work well for some people and are not a great fit for others.”
Home Equity Conversion Mortgages Launched in 1989
The article explains that reverse mortgages have been around for six decades, but it wasn’t until 1989 that the law was changed to allow the Federal Housing Authority to back reverse mortgages through an FHA-approved lender. “The Home Equity Conversion Mortgage was created,” says the article. “HECMs are the only federally insured reverse mortgages.”
But things didn’t progress smoothly. “The following decades, however, proved a bumpy road for these loans,” writes Tugend. “Stories abounded of people taking the loans out without fully understanding – or being told – the specifics.” There were anecdotes about borrowers losing their homes because they couldn’t afford property taxes, homeowners’ insurance, or basic maintenance. Too often, the result was foreclosure.
But the bad old days are mostly gone. “A combination of updated regulations and research means reverse mortgages are now safer for consumers,” Wade Pfau of the American College of Financial Services told Kiplinger’s Tugend.
Reverse Mortgage 101: The Basics
Most baby boomers probably know that a reverse mortgage is a loan in which a qualified homeowner draws from home equity. Eventually, when the home is sold or the borrower dies, you or your estate pays back all the principal you borrowed, plus interest. Borrowers for HECM loans must be age 62 or older, and as of 2022, the loan can’t be based on a home equity greater than $970,800, regardless of the total value of the house. The home must be your principal residence. In 2021, the average age of an HECM borrower was 73 years old.
When the borrower dies, the lender will expect the loan to be repaid in full, normally within a year. Any leftover home equity after the home is sold and the debt satisfied goes to the estate. A reverse mortgage is considered a “nonrecourse loan,” the article explains, which means you or your heirs can’t owe more than the home’s fair-market value, even if the housing market tanks as it did in in 2007-2008. The FHA requires borrowers to have mortgage insurance to protects the lender if the home’s value falls.
Counseling Required, Spouses Protected
According to the Kiplinger article, HUD regulations have added more safeguards for borrowers. “The agency now requires that borrowers receive counseling at HUD-approved sites before closing on an HECM,” writes Tugend, “and limits how much a borrower can draw at closing or in the loan’s first year.” Federal rules require a financial assessment of the borrower’s sources of income from all sources including Social Security. “The amount you can borrow depends on your age (with older homeowners typically receiving more) and your house value, the amount of equity in it and interest rates,” says the article. “Although other debts are considered, there is no debt-to-income ratio requirement.”
There was a time, back before 2014, when a spouse whose name was not on the original loan was at risk of being evicted or required to repay the entire loan if the borrowing spouse died or moved into assisted living. This has since changed. “HUD made it easier for an eligible nonborrowing spouse to stay in the house,” Kiplinger explains, “although the reverse mortgage payments cease. The reverse mortgage is paid off when the nonborrowing spouse dies or moves out of the home.” Partly as a result, the number of reverse mortgage defaults has dropped dramatically, to about 1.5 percent in 2019 versus 5 percent before 2014.
A Large Percentage Have Second Thoughts
The article quotes HUD data to show that just over 49,000 HECMs were taken out in 2021. Surprisingly, a significant number of would-be borrowers – about 40 percent – actually go through counseling but then decide not to proceed. “Expense is a factor,” Kiplinger explains. “Reverse mortgage fees, which are usually rolled into the loan, can be high. For example, fees and the required mortgage insurance are about $25,000 for an $800,000 house, according to Pfau.”
Once the reverse mortgage is secured, borrowers have several payout options. Some choose to receive a lump sum, while other opt for equal monthly payments for life, also called tenure. These payments continue as long as at least one borrower lives and continues to use the home as a main residence. The preferred option in the view of many, including Rajiv Nagaich of AgingOptions, is a line of credit that can be used until the money is gone. “Only the lump sum option qualifies for a fixed interest rate,” says Kiplinger. “Everything else has a variable rate.”
Kiplinger Calls HECM “A Portfolio Neutralizer”
The point of the Kiplinger analysis, we think, comes toward the end of the piece. Quoting Wharton School professor emeritus Jack Guttentag, the article states that it’s time to consider reverse mortgages differently. “The way their full power can be realized is within the structure of a retirement plan,” the professor says. Having an HECM line of credit in place acts “as a built-in neutralizer” for a more stock-heavy portfolio, letting you remain invested in equities longer instead of opting for the cautious investment route most seniors are told they should follow.
Retirement expert Wade Pfau advises seniors not to delay if they plan to stay in their home for the foreseeable future. “It makes sense to incorporate [an HECM] as early as possible rather than leaving it as a last resort,” says Pfau. As the article puts it, a line of credit through a reverse mortgage is like an insurance premium. If you never need the insurance, Pfau adds, “that’s great, and if you do, then you have it.”
One homeowner cited in the Kiplinger article used government and independent third-party websites to do his research, rather than relying on websites offered by lenders. This gave him information that was as objective as possible. The Consumer Financial Protection Bureau offers a good website, as does reversemortgage.org, which is run by the National Reverse Mortgage Lenders Association. AARP also offers reverse mortgage info.
Reverse mortgages certainly aren’t for every older homeowner, and people should never feel pressured into taking one out. But they can work for some homeowners under the right circumstances. Just do your homework and get some objective advice before taking the leap. And, as Rajiv advises, you should work with a financial planner first to get a financial dashboard in place. That way you’ll have the tools to show you how your all your retirement elements – including an HECM if it makes sense – can work together for a secure future.
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(originally reported at www.kiplinger.com)