By Michael L. Banner
It certainly appears the only thing consistent about the reverse mortgage these past few years is change. And the latest changes, mandated by the U.S. Department of Housing and Urban Development (HUD), seem to be the most far-reaching improvements to the reverse mortgage product to date. And yes, I did say improvements.
But before we discuss those changes let’s all be clear on what a reverse mortgage truly is, how it works, and exactly who it was designed for.
A Home Equity Conversion Mortgage (HECM), commonly referred to as a “reverse mortgage,” is designed for borrowers 62 years of age and older. It allows this particular segment of our society to borrow against the equity of their primary residence with very minimum income or credit requirements. Both principal and interest payments are deferred until after the last borrower dies and then and only then does the mortgage become due and payable.
A reverse mortgage was not created as a source of funds for investment or any type of financial vehicle that would present a “risk of principal.” It was created to maintain, or in many cases to enhance a senior’s quality of life during the retirement portion of their lives.
Examples of the uses of a reverse mortgage would be, but are not limited to, paying off an existing mortgage or other installment debts, establishing a line of credit to assist with short falls in cash flow or unexpected expenditures, to assist with the cost of in-home care services or the long-term care premiums, or even to purchase a new home and still not be obligated to a monthly principal and interest payment.
What exactly are these most recent changes?
For starters, the two options that had been available in the reverse mortgage industry for the past several years — the traditional reverse mortgage and the HECM Saver — were both totally eliminated. This change took place on September 30, 2013.
As a brief history, the traditional HECM was designed to offer the senior client the highest “cash-out” option, and was offered with both an adjustable and fixed-rate option. With either option, the client could choose to receive 100 percent of their proceeds in a lump sum (in other words, all up front).
This traditional option was generally viewed as a needs-based “product of last resort.” Although this option truly assisted hundreds of thousands of seniors, it was under constant scrutiny from the press, certain members of Congress, and many of the product’s detractors in various fields.
The HECM Saver, introduced in October 2010, was created to attract the more affluent client. It offered less proceeds, but in contrast also eliminated the up-front Mortgage Insurance Premium (MIP), bringing the closing costs of this particular option of the reverse mortgage in line with conventional loans.
The creation of the HECM Saver did open doors previously closed to the reverse mortgage industry, and several prominent Certified Financial Planners in the nation endorsed the product as a viable option to a higher-income bracket of borrowers who in the past would have never considered a reverse mortgage.
These two options are no longer available and have been replaced with a new reverse mortgage product that still offers adjustable and fixed-rate options, but make no mistake about it, this is different!
The “principal limit factor,” the amount of funds a senior can actually access when securing a reverse mortgage, is lower than its predecessor, the traditional reverse mortgage, but in all cases is higher than what could have been accessed by the HECM Saver.
Mortgage insurance premiums have been increased and, most importantly, there is now a limit on how much of the proceeds can be accessed in one lump sum at the point of origination of the mortgage. The maximum amount that can be accessed after September 30, 2013, is 70 percent, and even that will be allowed only for “mandatory and legal obligations” such as paying off an existing mortgage. In fact, a borrower who does not access their entire amount of funds at closing is rewarded with a significantly lower mortgage insurance premium.
Changes that will be implemented by year end will include financial assessment of borrowers and funding requirements for the payments of property charges such as, but not limited to, property taxes and insurance, based on the financial assessment.
Why do these appear to be such drastic changes and why does HUD feel these changes are necessary?
The answer to these questions may come as a surprise to many. First, these changes may appear drastic but in fact are not. This is not the first time the reverse mortgage industry has had principal reductions nor is it the first time we have seen the total elimination of certain products.
Rising from several decades of relative obscurity, the reverse mortgage became an incredibly popular product for seniors as well as a very popular target for its detractors early in the 21st century. Undoubtedly, the highly volatile and turbulent financial environment of the last several years presented this product as an incredible option to many seniors who were referred to as “equity rich but cash poor.”
But the questions that had always been asked about the reverse mortgage were still being asked as this product continued to grow in popularity. Is this product strictly a needs-based product of last resort? Does it truly help the lower-income senior or does it, in many cases, just prolong the inevitable?
Those questions seemed to gain strength when HUD announced that its Mortgage Insurance Premium Fund was now projected to be in the negative billions of dollars due to record-high defaults, and the reverse mortgage was playing a proportional role in that claim.
How could this be? There is no obligation of a monthly principal and interest payment for as long as the clients maintained the subject property as their residence. Why are they defaulting?
The answer to this question was, to the dismay of the entire reverse mortgage community, that it appeared many of the “needs-based borrowers” were receiving the maximum amount of up-front funds possible from their reverse mortgage, but they were not budgeting for ongoing future expenses such as taxes, insurance, and of course the myriad unexpected expenses that may arise during the retirement portion of life.
So, once again, the reverse mortgage industry had to take a step backward. This time it was not a step backward in popularity or a step backward caused by its detractors. This time it was a step backward to look at the strengths and weaknesses of the reverse mortgage product and craft changes to the product that would guarantee its success in the long run.
Is this the beginning of the end of the reverse mortgage, or is it a new beginning?
There is no way to deny that seniors today are facing the “perfect storm.” Record-low rates of returns on savings, annuities, and CDs (vehicles commonly used by seniors in retirement) combined with heavy losses taken in their portfolios in recent years have played havoc and changed the “view” of retirement for millions of seniors in the country. Add to these the ever-rising costs of long-term care insurance premiums as well as rising costs of in-home care services and there is no doubt the use of home equity, “housing wealth,” should be considered as a component in an overall and more comprehensive retirement plan.
This newly designed reverse mortgage, with its lower principal limit, financial assessment of the borrower, and built-in safeguards on the up-front cash distributions, yet still no requirement of any monthly principal and interest payment for as long as the borrower resides in the home, may very well be the product of choice for financial advisers of all types.
In-Depth Look at How a Reverse Mortgage Could Be Used
Here are two illustrations in which a client in the retirement segment of their lives can use the reverse mortgage.*1
Illustration #1 — HECM for Purchase
This illustration is based on the HECM for Purchase (also known as the “purchase reverse mortgage”). It allows a person to purchase the retirement home of their dreams, yet maintain more liquidity than originally planned, while still enjoying the benefit of “no monthly principal and interest payment.”
The Scenario: These clients, both age 65, have just sold their current home for $400,000. To their dismay, the value of that home was roughly 50–60 percent of the value they had planned on several years ago before the real estate bubble burst. In addition, their investment portfolio has decreased significantly due to losses taken in recent years. Add to this, their current investments are yielding much lower returns than anticipated. Millions of seniors are facing this exact situation throughout our country today.
The Problem: How do they purchase the retirement home of their dreams when their current home sold for hundreds of thousands of dollars less than projected, without tapping into their liquidity that has also decreased greatly due to the volatile financial market of the past several years?
The Answer: The HECM for Purchase (H4P)
Sales price of new home: $400,000
Down Payment: $207,381
H4P Net proceeds: $192,619
Total $400,000
Unlike the traditional reverse mortgage where a client receives monthly benefits from the proceeds, the H4P gives all the proceeds up front toward the purchase price of the home.
Results: The client has purchased their dream retirement home, met the goal of no monthly principal and interest payment, but retained $192,619 in liquidity.
Illustration #2 — Traditional HECM Refinance
This illustration is based on the traditional HECM refinance. It allows clients to totally eliminate their current monthly mortgage payment and establish a line of credit to assist them with the unexpected but inevitable financial shortfalls that can occur during retirement.
The Scenario: These clients, also both 65 years of age, presently own a home worth $400,000 with a current mortgage balance of $125,000 and a monthly payment of $750 per month. Current low rates of returns on their CDs, annuities, as well as their investment portfolio has caused them to have to draw down on the principal of their investments in order to meet their monthly financial obligations.
The Problem: How do these clients maintain their current lifestyle without continually drawing down their portfolio and risking it being 100 percent depleted before they die?
The Answer: The Traditional HECM Refinance.
Secure reverse mortgage in the amount of $212,000
Payoff present mortgage $125,000
Establish credit line of $67,618
Results: The clients have eliminated their monthly mortgage payment of $750 and established a $67,618 line of credit to draw upon for unexpected expenses, rather than continue to deplete their savings.
1 Please note that all figures quoted in both illustrations are valid as of the day this article was submitted but are subject to change with no notice. Variable rate of 2.419%, 2.419 APR (Home Equity Line of Credit) 12.419% maximum APR over the life of the loan. Fixed rate also available. Estimated fees, including the up-front FHA mortgage insurance premium, range from $8,000 to $17,000, depending on the value of the home (included in mortgage).
Michael L. Banner is the National Education Director at Security 1 Lending, Clearwater, Fla.
(NAELA News, December 2013/January 2014)