Friday July 25, 2008

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As Population Ages, Reverse Mortgages May Finally Catch On

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Reverse mortgages have been around for a long time without really catching on. Banks considered them more of an insurance product than a mortgage product and they could be a hassle to service; consumers either did not understand them or were afraid of them, and the principal marketing target was a small sector of the American population and one that had historically considered debt to be a very bad thing. Senior advocacy groups were pretty much the only ones out there educating consumers and pushing banks to provide reverse mortgages and, even though their popularity is growing slowly, only around 40,000 were written in 2004.

So the reverse mortgage is slowly increasing in availability and getting a lot of notice in the press. This is probably a good thing. Understood fully and used properly the product can be a positive addition to a retirement planning arsenal and/or a Godsend to cash-strapped seniors.

As the name implies, a reverse mortgage is the mirror image of a regular mortgage. Instead of a borrower paying off a mortgage in order to own his house, the house subsidizes a mortgage which pays the homeowner.

Reverse home mortgages are predicated on the premise that many seniors have a lot of equity in the homes they have occupied for years. Paying off the mortgage was a major 20-year goal for folks who bought homes in the 1950s and 1960s and many have lived in debt free houses for decades. Even in the 1970s refinancing was not a major financial game the way it is today so mortgages once paid stayed that way. Home values, as we hear on the news every single night, have escalated dramatically. Seems like the premise mentioned above may be a little modest; many seniors indeed have a very high net worth.

On paper.

And there is the problem.

Some senior are what an older generation called “house poor,” with so much money tied up in bricks and mortar that they cannot afford much else. The tragic stories are out there; the necessity to decide between food and heat; foregoing needed medication. Yet, for many seniors the homes they have occupied for years may be the least expensive place they can live, especially if it is mortgage free. But the cruel reality is that the cheapest roof in the world is useless if you can’t afford to keep it over your head.

As values have risen, so have property taxes, hazard and maybe flood insurance premiums. Still, an apartment, condo, or assisted living situation may be much more expensive than staying put and could quickly drain any cash that is cleared from the sale of the old homestead. In addition, many of our elderly are confronting increasing medical costs – even the cost of Medicare goes up every year, and large numbers, particularly women, have little in the way of retirement savings. Many live on Social Security, and for a single person that can be a very paltry sum indeed, and/or small pensions which are ever more endangered as large corporations bail out of their obligations.

Even homeowners who have been able to save comfortable amounts toward retirement may find reverse mortgages of interest. They can assist with unexpected expenses, provide a few luxuries, or even be a vehicle to enable additional investments – all while letting the homeowner continue to retire in place.

And one cannot overlook the emotional benefits of being able to stay in a home one loves; remaining independent, and feeling safe and secure. These can even translate into social service and health care savings that might otherwise be passed on to the public.

The FHA/HUD sponsored loan carries pretty simple requirements; the borrower must be at least 62 year of age, the home must be mortgage free (or small enough to be refinanced under the constraints of the reverse mortgage,) and there are some reverse mortgage fees involved, although by all accounts these are not excessive and can usually be rolled into the mortgage. There is no income requirement nor is credit (other than an unresolved bankruptcy) taken into consideration.

In return for a mortgage on the property, the homeowner receives a loan that is tied to the appraised value of the home and capped by the maximum FHA loan amount for the particular geographic area. The total amount that can be borrowed is also affected by the age of the borrower, the older he is the more he can borrow.

Other lenders are now developing products with higher lending limits and other bells and whistles but the FHA guarantee will probably continue to make that product more affordable than private market products.

The borrower can receive funds in a lump sum, fixed to a line of credit to be drawn down as needed, or paid out in monthly payments (like an annuity). In each case interest accrues only on the amount that has actually been collected by the borrower. Aside from required up-front fees, a borrower might view taking a reverse mortgage as a good rainy-day strategy.

But why shouldn’t a senior just use a regular refinance or a home equity loan to draw equity out of the house? In the latter case there are often no fees and banks are generally offering generous rates and terms.

The problem is that banks want to be repaid in a timely manner and many seniors do not have the income to qualify for mortgages or equity lines. Reverse mortgages are ideal for seniors because they require no payment until the house is sold. Further, if home prices should decline to a point where a sale does not provide enough to cover the outstanding balance of principal and accrued interest, FHA reimburses the lender for the difference. This is covered by an insurance fee which FHA charges the borrower. The homeowner or his heirs retain the right to any amount from the sale above the debt.

There are drawbacks to be sure. Disadvantages of reverse mortgages include:

The homeowner might be spending his children’s inheritance. Hopefully most children will be supportive of this if it means a better standard of living for the parent.

The vagaries of age might make such cash availability dangerous. Families should be prepared to monitor draw downs and/or expenditures if this is a risk.

If a reverse mortgage looks like a good idea for you or an aging relative you may still have to do a little research. If a local bank or mortgage company is no help try the FHA Web site, a senior advocacy group such as AARP or a local senior center for information on reverse mortgages. And be sure and consult with an attorney or financial advisor on the terms and personal ramifications of such a loan.