Reverse Mortgages: 3 Different Types

In the press (and here on the Reverse Mortgage blog), so-called Home Equity Conversion Mortgages (HECMs)get most of the attention, and for good reason. By most estimates, HECMs account for more than 90% of reverse mortgage lending nationwide, and are generally safer for both borrower and lender. Still, it’s important for prospective borrowers to realize that there are two other types of reverse mortgages which may be available to them.
 
The first type is known as a single-purpose reverse mortgage. They are offered mainly by state and local agencies and by some non-profit organizations. They differ from HECMs in a couple important ways. The first is that they are not federally insured, which means that the mortgage insurance premium – which represents more than half of the closing costs on an HECM mortgage – doesn’t need to be paid. When you also factor in the annual insurance premiums, this could save you more than $10K over the life the of the mortgage. While you would assume that the lack of insurance would make such mortgages more risky, you would be wrong. That’s because reverse mortgage insurance serves to protect the lender against default (even though the premiums are paid by the borrower), so the lack of insurance in this case is a risk born exlclusively by the lender.
 
The other major difference is the way in which single-purpose reverse mortgage proceeds can be used. Most lender agencies will stipulate that the loan can only purpose, namely to repair/renovate the home and/or pay property taxes. For better or worse, no such limitation exists on HECM loans, the proceeds from which can be spent as the borrower pleases. This distinction is also connected to the lack of insurance. Single-purpose reverse mortgages typically involve only a small portion of home equity, which means default is unlikely. With an HECM loan, in contrast, a borrower can obtain up to 60% of the value of his home, which significantly raises the possibility of default, and thus necessitates the HUD insurance policy.
 
If you are interested in a single-purpose mortgage, you can consult our list, which has state-specific information. You can also check the Elderware Locator, a service of the federal Department of Health and Human Services, which can help you find “local agencies, in every U.S. community, that can help older persons and their families access home and community-based services.” You can also ph0ne them for the most up-to-date information. Be advised that some applicable programs don’t explicitly invoke the term reverse mortgage, and you might have better luck if you query “property tax deferral” or “loan programs for home improvement.” For all intents and purposes, however, these programs function as reverse mortgages, and if you’re already considering an HECM, you might as well look into single-purpose reverse mortgages for the sake of comparison.
 
The other type of reverse mortgage is known as a proprietary reverse mortgage. As the name suggests, such loans are underwritten by private lenders. While still subject to government regulation, they are not subject to the same standards as HECM reverse mortgages, and are not eligible for federal insurance. As a result, these mortgages tend to be more expensive and carry higher interest rates, but proprietary lenders may be more accommodating for borrowers with special needs and/or are not eligible for HECMs. As the FTC points out, “HECM loans are widely available, have no income or medical requirements, and can be used for any purpose.”
 
Conventional wisdom suggests that your best bet for a “multi-purpose” reverse mortgage is still the HECM. For a smaller loan used to pay taxes and/or improve your home, however, do yourself a favor and check out single-purpose reverse mortgages.

“Are HECM Reverse Mortgages Too Cheap?”

This was the title of a recent article by Jack Guttentag, the self-styled Mortgage Professor. And when the Mortgage Professor Speaks, people listen; his column has been reverberating around the blogosphere for over a month, and now it’s my turn to weigh in.

The crux of Mr. Guttentag’s argument is that there is nothing to compare reverse mortgages to, so it’s ultimately impossible to determine whether they are too cheap or too expensive. Still, he points out that the closing costs seem reasonable compared to other mortgage products, and that the most expensive component is the FHA mortgage insurance premium which is necessary to keep the program financially viable. Guttentag concludes by arguing that on a short-term basis, reverse mortgages are hardly economical, but on a long-term basis, the upfront costs can be rationalized, and at prevailing rates, the current APR is a modest 5%.

In my opinion, this final conclusion is really the only one that actually stands up. Even without doing the math, it’s obvious that any mortgage (conventional or reverse) is not cost-effective if you intend to repay it within a few years of obtaining it. And generally speaking, the longer you hold it, the more economical it is. This is not in dispute.

The Mortgage Professor’s first two points, however, are a bit more dubious. Beginning with FHA insurance premium, this IS both expensive on an upfront (~$4,000) and annual (~$300) basis. Because reverse mortgages are inherently risky from a lender standpoint, the practice of insuring them makes perfect sense. Just because it’s necessary, however, doesn’t mean it shouldn’t be a consideration when analyzing the costs of a reverse mortgage. If you obtain a reverse mortgage, it needs to be paid, but if you don’t obtain one, then of course you don’t need reverse mortgage insurance. This might sound like a tautology, but it’s still a point worth making.

Finally, since there is no product comparable to an HECM reverse mortgage, it’s true that it’s impossible to say whether it’s cheap relative to other reverse mortgages. Still, we can say with near certainty that it’s probably going to be cheaper than any other alternative that doesn’t involve an institutional lender. Borrow money from friends? Cheaper. Sell your current home and buy a smaller one? That’s cheaper, too. Save money by simplifying your lifestyle? Definitely cheaper. Ask your heirs (especially if they want you to keep the home) if they can lend you money using the same structure as a reverse mortgage? Probably cheaper, too.

If you still want to obtain a negatively amortizing home equity loan with high upfront costs and pay interest on interest (aka a reverse mortgage), know that it will be cheaper than borrowing money with your credit card. Compared to almost anything else, however, it will cost you more.

Reverse Mortgage Certification Test is Challenging!

As part of the ongoing overhaul of the reverse mortgage industry, HUD (via the FHA) has revamped the test that counselors are required to pass before they can work with prospective borrowers. According to the front lines, the test is quite hard!

Some background: HUD reverse mortgage rules clearly stipulate that borrowers are  “required to receive consumer information from an approved HECM counselor prior to obtaining the loan.” Previously, this session was treated as perfunctory (it probably still is by many participants), as counselors breezed through a list of caveats and pitfalls to prospective borrowers. These sessions were (and still are, to some extent) conducted by phone, often involving individuals other than the actual borrower.

There were many reports of abuse and conflicts of interest (counselors were using their positions to refer customers to specific lenders on a commission basis), which the General Accountability Office (GAO) identified in a recent report, completed after participating in 15 interviews on an undercover basis. As a result, the rules were tightened, and the counseling requirements enhanced. Prospective borrowers are now encouraged to complete the session in person and must sign an affidavit stating that they understand the risks, etc.

In addition, the certification test for counselors has become more difficult, to the extent that even veteran counselors are finding it difficult to pass. The result is not necessarily that unqualified counselors will be prevented from counseling, but rather than all counselors should be more knowledgeable in the both the benefits and drawbacks of reverse mortgages, and should be able to pass this on to potential borrowers.

From the standpoint of borrowers, this means that the counseling session should theoretically be more useful. If you are even considering obtaining a reverse mortgage, you may as well as undergo counseling as early as possible in the process, before you have committed (either psychologically or to a lender) to going forward. This way, you can fully weigh what the counselor tells you, and make a better-informed decision afterward. If you wait until right before you sign the documents to complete the counseling session, you risk treating it as perfunctory, since it won’t possibly be able to influence your decision.

From the standpoint of counselors, meanwhile, you had better study hard!

Think Twice about Obtaining a Reverse Mortgage for Affluence

I haven’t seen any statistics on the precise reasons for borrowers obtaining reverse mortgages. Anecdotally, though, it seems a sizable portion are obtaining them for no “real” financial need, and are instead using them merely to maintain existing lifestyles. It would be one thing if that translated into moderate subsistence, but quite another if it meant affluence.

What do I mean by affluence? To be honest, I’m not exactly sure, because the term means different things to different people. For some, it conjures up images of sumptuous luxury, while for others, it brings to mind certain middle-class comforts. For the purposes of our discussion, it’s probably better to think of the concept in relative terms. Let’s define it as a lifestyle that is extravagant relative to one’s financial condition.

Using the proceeds of a reverse mortgage to maintain or even improve one’s affluent lifestyle is an implicit acknowledgement that one’s lifestyle is unsustainable and requires “outside” sources of cash to support. Remember that a reverse mortgage is ultimately just a loan. It avoids this label because it isn’t usually repaid by the borrower, and is couched in clever terminology such as monetization. Despite being different from a loan in form, however, it is the same in principle. It accumulates interest, is secured by collateral (one’s home). and must be re-paid. While the terms of a reverse mortgage are certainly better than a credit card loan, the idea behind both is the same. Think about it this way: would you ever borrow $50K (or more!) using your credit card, simply so that you could continue to make fancy purchases and nice vacations. I suspect the answer is probably not.

That’s not to say that affluence is a vice, or something that should be shunned. On the contrary, I think that those who worked their entire lives and paid into the system are entitled to enjoy a comfortable retirement. Still, there is no free lunch, and borrowed affluence is irresponsible. Those who desire such a lifestyle should accept the trade-offs and compensate for their spending by making cutbacks in other places, namely by downsizing into a smaller house. This solution could free up $100K (or more!) in cash, depending on the difference in price between your old and new home, and best of all, leave you debt-free. Maintaining your current lifestyle AND continuing to live in the same home when you can’t afford to do so naturally is naive. If you like your house, then you should consider spending less on your lifestyle. If you cherish your lifestyle, consider moving into a smaller house.

Defenders of this practice would probably argue that they are simply “monetizing” what is rightfully theirs, and that they shouldn’t have to economize when they are sitting on a pile of potential cash. This mindset blithely assumes that one will be healthy for as long as the reverse mortgage ATM has money in it and will die shortly thereafter. The same applies to he who obtains a reverse mortgage in order to compensate for retirement account (i.e. stock market) losses under the assumption that it will inevitably rebound. This ignores the possibilities that one will spend all of the proceeds from the reverse mortgage and/or that one will live longer than expected and/or that one’s health could suffer. If any (or all) of these occurrences should transpire, it would necessitate sudden and radical changes in your way of life. When you look at it this way, taking out a reverse mortgage to fund affluence looks misguided at best and foolish at worst.

In short, think twice before obtaining a reverse mortgage so that you can continue to live beyond your means. While you may get lucky and “beat the system,” the law of averages means that you probably won’t, and your Day of Reckoning will only be delayed.

What if Your Parents Want a Reverse Mortgage?

With today’s post, I want to look at reverse mortgages from another perspective, or should I say another’s perspective. In other words, I want to examine the role that one plays as a son/daughter in this process. Given that all reverse mortgages (by virtue of the age 62+ requirement) are taken out by older people, and that the burden of taking care of the elderly will increasingly fall on younger generations, I think this is an important issue.

If one of your parents is examining the possibility of taking out a reverse mortgage (or even if the idea is yours), the first step is to sit down with your parents and try to completely understand their financial situation. Ideally, all children and close family members should be involved in the discussion. As part of this conversation, you need to undertake a basic audit of your parents’ finances. What kind of revenue do they have (social security, income, pension, etc.), what are their basic (i.e. cost of living) expenses, and what are their assets and liabilities? After taking account their age and health, you should have a rough idea as to the financial shape they are in.

It is also important to try to understand their expectations. Do they desire to live affluently or simply? Are there are big purchases that they expect to make; will they be doing a lot of traveling? Do they expect to move into an independent or assisted living facility, or would they prefer to remain completely independent for as long as possible. Its your responsibility first to try to understand their expectations, and then after taking account of their financial position, to manage them. If you see a big gap between their expectations and financial reality, then they will obviously require some form of support.

Obviously, the most basic way of supporting them would be for you and your siblings to simply mail them a check every month. If this is unrealistic and/or inadequate, then you will need to think more creatively. The next best alternative would be to formally loan money to your parents. Rather than having them pay you back while they are alive (which would defeat the purpose of loaning to them), it would be understood that the loan would be repaid from their estate, after they pass away. While it is understandable that you would feel guilty about loaning money to your own parents, consider that (assuming you can afford it) it is a solution that benefits everyone, and just like with a reverse mortgage, they shouldn’t have to worry about repaying the loan, since such will be taken care of post-mortem.

You should also consider buying their house outright from them. In this way, both of you can avoid all transaction costs, they can continue to reside in the home for as long as they please, and in the process, they secure plenty of cash to support themselves into retirement. This is an especially good solution if the home is still mortgaged, since they can kill two birds with one stone. It also solves the problem that is posed when one spouse is of qualifying age for the reverse mortgage, and the other isn’t. In such situations, some will go ahead foolishly and obtain a reverse mortgage anyway, only to have one of the parents kicked out of the house when the other one dies, and the loan becomes due.

The final option is to go ahead and help your parent(s) obtain a reverse mortgage. Because of high fees and the accumulation of interest, this is often the least economical option, and I recommend it only as a last resort, to be used when all other options have been exhausted. If your parents are obtaining the reverse mortgage so that they can (continue to) live affluently, perhaps you can recommend an alternative, such as downsizing into a smaller house and/or tweaking their standard of living. This would also be a good time to re-suggest loaning them money yourself, which would serve the same function but would better preserve your inheritance. Speaking of which, this is an important consideration, and one that should be reflected in your parents’ plans.

A final note: when helping your parents to obtain a reverse mortgage, you must make sure that the decision has been made by them and that they fully understand its implications. Even if they are elderly, they must undergo counseling and sign the paperwork themselves. There have been a few recent cases in which adult children fraudulently used their parents’ names to obtain reverse mortgages for themselves, and were later discovered. Lenders and regulators are now on the lookout, and it’s important that the loan is of your parents’ own volition.