Ten years ago, reverse mortgages were primarily used by widowed or single women well into their 70s with little other means of retirement income. Now, big losses to retirement savings as a result of the financial crisis have stoked interest among younger retirees of both sexes.
Reverse mortgages let a homeowner age 62 or older convert a portion of the equity in his home into cash. Unlike a traditional mortgage or home equity loan, repayment isn't required until the borrower either no longer uses the home as his primary residence, sells it, or dies. Instead, he receives a lump sum for the amount of the loan less up-front fees, or monthly payments from the lender.
In the 22 years that Home Equity Conversion Mortgages, or HECMs, have been available, 637,000 have been issued and 500,920 were outstanding at the end of July 2010. That represents roughly 7.2 percent of the 6,933,404 owner-occupied housing units for people age 65 and older recorded by a U.S. Census Bureau survey in 2008. HECMs, which are insured by the Federal Housing Administration (FHA), are now roughly 99 percent of the reverse-mortgage market.
"It's viewed even now as a niche product that people only make use of in desperation," says Anthony Webb, research economist at the Center for Retirement Research at Boston College. "Given the inadequacy of retirement savings, it really is something that everyone ought to be thinking about, even if in the end they choose not to take advantage of it."
Demand Expected to Rise
Demand for reverse mortgages is expected to rise, not only because more retirees need extra income since the recession, but due to efforts by the U.S. Housing & Urban Development Dept. (HUD) to lower up-front costs for borrowers. Lenders have indicated to Peter Bell, president of the National Reverse Mortgage Lenders Assn. (NRMLA), that the largest number of borrowers so far this year has been 62- and 63-year-olds, most of whom want to use some of the money to pay off an existing mortgage as they prepare for a drop in income during retirement.
Americans' retirement assets took a big hit from the financial crisis and income shortfalls are projected to worsen as health-care costs continue to rise faster than general inflation in the years ahead, says Jack VanDerhei, research director of the Employee Benefits Research Institute in Washington. The median holdings for individuals ages 55 to 64 in 401(k)/IRAs at the end of 2008 was $56,000, down 30 percent from $78,000 at the end of 2007, according to the Federal Reserve's Survey of Consumer Finances.
A look at clients' monthly cash-flow needs shows that a reverse mortgage is often an economic necessity, according to Margaret McDowell, the founder and principal of Arbor Wealth Management in Miramar Beach, Fla. "[A] reverse mortgage can offer financial salvation for retirees. Often the additional capital will allow them to stay in their homes and get out from under a mortgage payment or simply improve their monthly cash flow," she wrote in an e-mail message. "However, the ongoing success of that decision relies on the self-discipline of the individuals."
Jim Heitman, an independent, fee-only financial adviser in Alta Loma, Calif., has seen a big jump in client interest in reverse mortgages in recent years. "When I introduce the topic, I need to do a lot less educating as to what that is than I used to," he says.
Slump in 2010
Any increase in issuance would come on the heels of a slump following the collapse in U.S. home values. After climbing steadily since 2000, the number of HECMs issued fell to 79,106 for fiscal year 2010, which ended Sept. 30, from 114,692 in fiscal year 2009, according to the NRMLA. That would make fiscal 2010 volume the lowest since before 2006.
The median value of homes that have already taken HECMs is around $300,000, says NRMLA's Bell. He estimates that about 60 percent of reverse mortgages are used to pay off an existing mortgage using a lump sum, with borrowers taking the balance as a line of credit. The market for HECMs is expected to grow, aided by a temporary boost in the FHA loan limit under the 2009 Economic Recovery Act to $625,500 from a prior ceiling of $363,000. Congress recently extended the higher loan limit through Sept. 30, 2011. (Data on the average size of a reverse mortgage are not readily available, partly because the Mortgage Industry Standards Maintenance Organization has yet to finalize a tracking methodology.)
Older people intent on leaving a legacy to their children may resist tapping into their home's equity. Another major objection is the higher up-front costs vs. home equity lines of credit, the closest alternative for people who want to stay in their homes. The up-front fees can be as much as double those for a HELOC, says Andy McVay, a financial adviser at Avalon Financial Advisors in Orange, Calif. Where HELOCs will generally cost users a couple of percentage points of the total loan value, up-front costs can run as high as 18 percent of the amount of a reverse mortgage. A borrower can get a fixed interest rate only by taking a lump sum, which incurs higher interest costs over the long term. Variable rates are initially lower than fixed rates but have to be watched since they could rise as the economy improves.
Another disadvantage is the premium borrowers have to pay for mortgage insurance required by lenders, which was raised to 1.25 percent from 0.5 percent on Oct. 4, and which increases the loan's interest rate vs. a home equity loan, warns McVay.
Some Advantages over HELOCs
Fear of losing access to Medicaid-funded assisted living facilities has also damped interest in reverse mortgages, since eligibility is based not only on income but total assets, excluding a primary residence. But that's only a problem for reverse-mortgage holders if they take out a lump sum or squirrel away monthly payouts instead of spending them on living expenses.
Reverse mortgages have some clear advantages to retirees over HELOCs. They continue to generate income and don't have to be repaid until the house is sold. Borrowers won't be thrown out of their homes as long as they continue to pay property taxes, and lenders can't cut or eliminate the lines of credit even if the property value falls below the loan amount. It's also much easier for older, low-income retirees to qualify for them than for HELOCs. The amount you can borrow depends on your age, the current interest rate, and the lesser of the appraised value of your home, sales price, or the FHA's mortgage limits. Generally, the more valuable your home, the older you are, and the lower the interest rate, the more you can borrow.
Another benefit of federally insured reverse mortgages: Neither the homeowner nor his heirs has to make up the difference if the home is sold for less than the total amount of the mortgage once accrued interest is added to the principal loan amount. That's one reason the ongoing insurance premium more than doubled starting this week.
Three Changes Under Way
Three major changes are expected to usher in a new era for federally insured reverse mortgages, says Bell at the NRMLA. To bolster demand, HUD launched the HECM Saver on Oct. 4, which slashes up-front costs for borrowers who need smaller loans than those available under standard HECMs. The HECM Saver has a mortgage insurance premium of 0.01 percent rather than 2.0 percent of the loan value, in exchange for reducing the loan size by 10 percent to 18 percent. The FHA expects roughly one-third of all new borrowers to opt for the Saver loan and hopes the increased revenue will lower its total insurance risk.
Second, HUD has stepped up its counseling process. Since most counseling is done by telephone, there's now a series of questions counselors must ask to confirm a client is grasping what he hears, and a Benefits Check tells a client if there are financial alternatives to a HECM for which he may qualify.
Lastly, higher investor demand for securitized pools of HECMs offered by Ginnie Mae, part of HUD, is driving more competitive interest rates and letting lenders waive the up-front mortgage insurance premium for fixed-rate mortgages. That's a substantial savings at 2.0 percent of the first $200,000 of a home's value, plus 1.0 percent of the remaining value, up to a maximum of $6,000. Some lenders are also waiving origination fees, which can run as high as 2.0 percent of a home's appraised value.
Even if costs decline, David Diesslin, a financial adviser in Fort Worth, recommends that reverse mortgages be done as private family transactions when feasible instead of using a third-party lender. If a homeowner's grown son or daughter can afford it, it saves the estate money in the long term. The family would need to get a real estate attorney and connect the loan to the home's title, so it's an official lien, he says. And when the house is eventually sold, any funds over the lien go to the estate.
Michael Kay, president of Financial Focus, an advisory firm in Livingston, N.J., advises clients, especially older ones, to bring someone they trust, whether a family member, close friend, or CPA, to sit in on meetings with lenders and be part of the decision-making process. "[Having] someone who has competency in financial issues and can also ask questions that might not occur to you … adds to the level of comfort," he says.